Since 2011 investors have been bearish on big resources stocks.
A slowing Chinese economy, potential oversupply and lower commodity prices were the catalysts for their underwhelming share price performance.
Investors have watched as Australian producers such as Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX: BHP) allowed their debts to swell chasing minimal returns from small but expensive projects. It – unsurprisingly – resulted in new management at both companies.
To their credit, in the past six months, management have begun to undo the damage of their predecessors and investors are responding. Respectively Rio's and BHP's share prices have climbed 17% and 10% in that time.
For Rio it all started around this time a year ago, when CEO Sam Walsh embarked on a cost-cutting agenda to change investors' perspective of the company – Australia's biggest iron ore miner. His success is currently being reflected in the share price gains.
Not only has Rio's senior management stripped $2.3 billion of costs from its operations in the last 12 months, production is up 9% across bauxite, thermal coal and iron ore and capex is down 26%. Enabling the company to lower debt (currently at $18.1 billion) and increase the dividend payout by 15% to an equal yield of its counterpart BHP.
So we're witnessing a new look Rio enter stock pickers' portfolios. One which is focused on capital efficiency and its shareholders – two things overlooked by its previous management. So should you add Rio to your portfolio?
Well, there's two things you'd need to be confident of.
You'd have to be bullish on China's consumption of iron ore – which somewhat relies upon government led infrastructure projects such as railways and high intensity urbanisation – and, secondly, management's competence. Mr Walsh has already received my vote.
These two things are important because Rio generates over 90% of underlying earnings from its iron ore division, making it a near pure-play steel related miner.
Foolish takeaway
With debt falling and Pilbara iron ore production set to reach 360 million tonnes in 2017, the possibility for high returns from Rio shares in the medium term is growing – It's no wonder investors are taking a second look at this potentially big dividend payer.
As long as China – the world's biggest consumer of iron ore and Rio's best customer – continues to grow, the price of iron ore is unlikely to free fall despite big miners ramping up production. However in the long-term, Rio shareholders must acknowledge that iron ore will fall in value, like any competitive price-taking market. Diversification will be key for the iron ore miner moving past its 360mtpa target.