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Should you buy Rio Tinto?

In the past decade, Australia’s economy has been fuelled by exports from some of our biggest miners, enabling them to become some of the world’s biggest companies. However, in the years recently gone by, many mining stocks have been pushed lower and lower by investor expectations. So have they now reached their lowest point or is it still to come?

Rio Tinto (ASX: RIO) is one of those Australian miners that has taken huge falls. Prior to the GFC, Rio traded beyond a staggering $150 per share but now is struggling to keep its head above $50. So why has the mining giant fallen, and is now the time to buy a great stock?

The past is not the present

Leading up to 2010, Rio was producing such high revenues and profits that investors couldn’t resist the temptation. The company declared a massive profit of over $15 billion at its peak. The fuel behind their massive growth was China’s insatiable need for iron ore, providing precious steel for their booming economy. At the time over 73% of revenues came from the commodity.

It was little surprise Rio was breaking company records, at the time its profit was 2.5 times that of the Commonwealth Bank’s (ASX: CBA) and iron ore was sporting a price tag of up to $280 per tonne.

Where are we now?

In such a short period of time, so much has changed to make this company less appealing then its former self. A long way from its May 2010 price tag, spot iron ore currently sells for between $110 and $120. There are many factors that have brought about this important change, one of which is the increased supply of iron ore from around the world.

In March this year, Goldman Sachs (NYSE: GS) predicted that 560 million tonnes a year of iron ore production will come on stream worldwide between 2013 and 2017. Although Rio was behind some of the increased supply levels it, combined with BHP (ASX: BHP), Vale (Nasdaq: VALE) and Fortescue (ASX: FMG), accounted for two-thirds of the predicted increase in supply.

Unfortunately, demand for Rio’s product has also diminished significantly. China, which accounts for approximately 33% of its revenue, is now slowing its manufacturing sector in a bid to focus their economy on services for the rising number of middle class. This is not a good sign for the company because services don’t demand steel making products in the volumes that manufacturing does.

Together with the concerns over supply and demand is rising operational costs which, to say the least, has taken its toll on the mining giant. So much so, that earlier this week the company announced the sale of its Eagle project in a bid to sure up cash flow and reduce debt levels. Last year, the company also faced a number of floods and natural weather events which caused delays, reduced production and a significant amount of lost revenue. However, if investors are thinking that it may be a one-off, and therefore represents a bargain, keep reading.

Outlook

Since its peak profit in 2010, Rio has faced all the issues with steely determination. Investing in poorly thought-out projects in Mozambique and the US and thinking that global demand would exist at the levels it once did, was far from reality. That is why it sits just above $50.

In its most recent yearly update, the company declared a loss of $3 billion. An $18 billion turnaround since 2010. The sale of its most recent projects has been the result of a determined CEO who wishes to build on the strengths and “pursue greater value for shareholders”. He is going to do this by focusing on the core businesses which is what Rio does best.

Foolish takeaway

If investors haven’t yet taken the plunge they will be wise to watch from the sidelines until the next annual report later this year. We do not yet know the full effect of the drop in Chinese demand, the oversupply of iron ore, increased operational costs and the drop in commodity prices will have on Rio. There’s no reason why you should have to take on the extra risk, particularly when other blue chips offer twice the dividend and more stability.

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Motley Fool contributor Owen Raszkiewicz owns shares in BHP.

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