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3 reasons not to buy Rio Tinto

Rio Tinto (ASX: RIO) has been unloved by shareholders since its $150 highs back in 2008. Post GFC, the company has been in damage control mode, selling more than US$5 billion worth of assets, but they still need to offload more. A reduced demand, coupled with higher global supply of many of their products and increasing debt, have all made Rio less attractive to investors.

Demand

As demand for Rio’s products like iron ore and coal falls, the price drops. Over the past year demand for both commodities has reduced significantly and we have seen pure play iron ore and coal companies fall in a heap. Fortescue (ASX: FMG), a pure play iron ore company that sells 97% of its product to China, has fallen approximately 38% in value. Likewise, Whitehaven (ASX: WHC), a pure play coal company, has fallen from above $4 a share to around $2.20.

Today, Rio announced that it will be looking for whole or partial suitors for its Mozambique coal unit, worth an estimated US $700 million. This has produced nothing but poor returns for the company since it purchased Mozambique-focused Riversdale Mining for $3.7 billion in 2011. After significant cost blowouts, the company was forced to write down the project to $3 billion.

Supply

Earlier this year, Goldman Sachs (NYSE: GS) said that total iron ore exports, by far Rio’s most lucrative commodity, will surge from 1.15 billion tonnes this year to over 1.5 billion tonnes by 2015. This includes Australian capacity which is set to rise from 560 million tonnes to 780 million tonnes.

Increases in supply from the world’s biggest miners like Rio, BHP (ASX: BHP), Fortescue and Vale (NYSE: VALE) will account for only two-thirds of the increases until 2017, meaning more big mines will come online in the near future. It’s a double-edged sword for Rio with both demand decreasing and supply increasing.

Asset sales and debt

Although Rio does not have the staggering levels of debt that Fortescue holds, it is still in need of capital to help its balance sheets. CEO Sam Walsh came into power only months ago and has already begun selling non-core assets worth hundreds of millions of dollars, to reinvigorate the balance sheets and prepare for lower prices. Its report for the year ended 31 December 2012 showed a loss of $3 billion dollars after impairments of $14 billion, despite record iron ore production and shipments.

After scraping plans to sell its diamonds business because of a failure to find suitors, the company now has to put its coal assets on the chopping block, but after such a tough year in the commodity, who’d want to buy it? This week we’ve seen Xstrata announce jobs cuts at its Ravensworth coal mine in NSW, blaming a slowdown in demand for coal hinting that it may be tough to find buyers.

Foolish takeaway

The next annual report will provide a keen insight into the company’s current condition and revenues. Investors hoping for a cheap bargain now have the option to purchase bank shares, which pay higher yields and carry less risk since dropping in price over the past two months. Investors will be wise to keep their distance from Rio, until we know how the recent asset sales have affected long term growth prospects, the debt and its balance sheets.

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Motley Fool contributor Owen Raszkiewicz does not have a financial interest in any of the mentioned companies.

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