The Motley Fool

Should you buy Rio Tinto?

In the past month, Rio Tinto (ASX: RIO) management has been actively cutting costs, raising capital and selling non-core assets. Is it time to start looking at the long term potential of this stock?

Rio’s new strategy is to cut costs through the removal of non-core projects. Last week, the company announced the sale of its Eagle Project in Michigan to Lundin (TSX: LUN) for an estimated US$235 million. The news was well received by the market and Saturday’s decision to raise $3 billion in corporate bonds was also rewarded with a greener share price in Monday morning trade.

Now, the company is actively considering bids for its Canadian iron-ore operations. Chinese metals giant MinMetals is “watching” the asset and said, “we have invested in the neighbourhood before and we are familiar with the area”. Rio’s 59% stake in Iron Ore Co. of Canada is valued around $4 billion.

In any normal business, these signs of active management and healthier cash flow would be good going into the immediate future. However, companies don’t raise funds unless they need it. Rio’s most recent yearly forecast came in at $3 billion in losses, as a result of increased costs, lower commodity prices and big expansion plans.

Rio and competitor BHP (ASX: BHP) were once sporting price tags much higher than where they are now, but it is still not the right time to buy. In recent months the S&P/ASX 200 (ASX: XJO) (Index: ^AXJO) was driving beyond sustainable levels and I said the miners would perhaps be value for money.

It was a defensive tactic that could have been used when the local benchmark fell because money would have been well sheltered from the inevitable drop compared to their counterparts in the S&P/ASX20 (ASX: XTL) that were expensive. This held true for the likes of ANZ (ASX: ANZ), Commonwealth Bank (ASX: CBA) and Telstra (ASX: TLS) who all fell well over 10% in a matter of weeks, whereas the miners did not.

Next steps

If the run up, and down, in prices has taught investors anything, it’s that you need to buy at good prices. Rio and BHP have both dropped significantly from their highs around the GFC but with the price of iron ore and other minerals expected to drop significantly in coming years, investors may get  a cheaper of point of entry and use their money on wiser opportunities leading up to this potential long term upside.

However, keep an eye on management and balance sheets in the next couple of years, because both companies still have many hurdles to leap over in that time. The way they react to falling prices will be a testament to their business model and long term growth.

Foolish takeaway

Looking at Rio’s potential upside, it has one of biggest gold and copper mines in the world in its back pocket and, although it is getting stalled by the Mongolian government with funding, it’s more than likely a good thing. In a short period of time, once the company has become more efficient  and has a better cash flow, it will be able to maximise the potential of the project and its US$20 billion iron ore mine in Guinea.

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Motley Fool contributor Owen Raszkiewicz has no financial interest in any of the mentioned companies.

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