Is Rio still a bargain?

In the past year, Rio Tinto has been out of favor with investors — but why?

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In the past year, Rio Tinto (ASX: RIO) has been one of the few unloved top 20 companies on the local stock exchange — but why?

Investor expectations

Investors’ expectations can be the difference between a portfolio covered in red or with a lovely shade of green. Investors worried about oversupply and underdemand of commodities have forced them to look elsewhere. It’s not a surprising conclusion given that Australia’s miners have canned more than $140 billion worth of investment in the sector.

Commodity prices

Iron ore is Australia’s most lucrative export but seemingly last in shareholder portfolios. On Monday, one of China’s top five steel makers reminded investors that miners have to face a price which will be considerably lower than in previous years. Zhang Xiaogang, Chairman of Ansteel, has said he predicts a price of between US $110-US $120 a tonne in the second half of 2013. His prediction is just below Fortescue’s (ASX: FMG) bullish guidance of between US $120-US $130 a tonne.

Operational costs

We have already seen mining services companies all but disappear in recent months, citing lower mining investments and tougher contract conditions. The domestic market has been costly for Rio and with lower commodity prices, it’ll be interesting to see whether it can recover from its $3 billion loss last year.

Better alternatives?

It has to be asked, why carry the extra risk of ‘pure’ iron ore companies, or those rely so heavily upon it. Currently, Rio receives approximately 47% of its revenue from iron ore, whereas BHP (ASX: BHP) receives only 31%. It’s a bit more piece of mind for investors who are already worried. When there appears to be so much risk involved, looking at diversified business models is always a good start.

Foolish takeaway

In recent months, Australia’s ‘blue chips’ soared to record highs and an inevitable fall always loomed. Now that that some of those stocks, like Telstra (ASX: TLS), are back down at healthy prices and paying higher dividends it’s got to be asked why an investor would want the extra risk. It may be unwise to take the risk right now, particularly before we know the real impact that the falling iron ore prices will have on the mining giant.

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Motley Fool contributor Owen Raszkiewicz owns shares in Rio Tinto and BHP.

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