A bumper fourth-quarter operations report from Rio Tinto Limited (ASX: RIO) has prompted analysts at UBS to raise its 12-month price target on the mining heavyweight.
Greater than expected copper production of 632,000 tonnes and iron ore production of 266 million tonnes in 2013 has enabled UBS to raise its target – which is more than 20% higher than Rio's price this morning. The company expects the mining giant to post $11 billion of earnings in its upcoming annual report for 2013, which will put the stock on a price-earnings ratio of 10.7. In addition, it has significantly lifted its forecast earnings-per-share growth for 2014 and 2015 by 18% and 14% respectively.
Higher forecast growth rates have given some analysts reason to believe there is still a strong upside in the stock, but not all are convinced. UBS's 12-month price target is at odds with analysis from Morgan Stanley, who have a price target of $66. However, they have acknowledged there could be "some upside" to its projections – according to The Australian Financial Review.
Rio's reliance on iron ore has torn analysts in two. There's those who believe China's cooling economy coupled with massive oversupply will put huge downwards pressure on the price of iron ore, thus reducing margins. Then there are the bulls who have profited nicely from the uncertainty in the sector over the past six months.
Whether the price of iron ore slumps or not, there will always be demand for the steel-making ingredient and as the lowest cost producer, Rio will always make money – Rio claims to be able to ship iron ore for less than $US50 per tonne. The question is: How much money will they make?
If UBS's forecasts hold up, then it means the stock is trading at a price-earnings to growth (PEG) ratio of 0.47 (1 represents fair value, whereas anything below 1 could mean the stock is undervalued). Taking a bullish view on commodities has rewarded investors lately. Those who bought either Rio, Fortescue Metals Group Limited (ASX: FMG) or BHP Billiton Limited (ASX: BHP) in the second half of 2013 have experienced tidy capital gains of 26%, 73% and 19% respectively.
Foolish takeaway
When Rio dropped to just over $50 per share in June 2013, I was bearish on it despite the likelihood of short-term gains. I knew production was ramping up and costs were coming down. However as a long-term investor, I try to focus my attention on buying businesses which have sustainable growth models and a track record of success.
In my opinion, Rio could well have a strong rally in the short term but iron ore prices will slowly fall as Chinese growth slows and more supply comes online. For investors willing to risk their money on short-term gains in 2014, Fortescue or Rio could easily deliver market-beating returns if things go according to plan. However, if investors want a more diversified long-term resources stock, it's hard to go past BHP.
