Could this company be the next Rio Tinto Limited?

Are there big discounts on offer for mining companies?

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Rio Tinto Limited (ASX: RIO) is a giant in the global iron ore scene. Last year it shipped 259 million tons of iron ore to customers all around the world at a cash cost of around US$43 per tonne. At an iron ore price above US$100, Rio is pocketing a margin of near 60% and delivering huge profits for shareholders.

Since 2004, Rio has seen revenue grow from $14.5 billion to over $57 billion in 2013, while profits before abnormals have grown from $2.7 billion to a little over $14 billion. Additionally, in line with the company’s ‘progressive’ dividend policy, dividends have dropped in only two of the past 10 years and at the current price it is yielding around 3.3% fully franked.

But are there any up-and-coming rivals?

There certainly are! However investors must first choose to go for a company already producing and shipping iron ore, or for a more speculative small-cap company searching for an economically viable deposit.

I personally stay away from those companies yet to produce, as lower iron ore prices in the coming years will make securing funding for new mines more difficult.

For those companies already producing, there are two broad categories that investors can buy; those with long or short-life mines. Of course within those will be companies that can produce ore at higher and lower prices as well. Ideally, you want companies with long life, low-cost mines that can deliver bumper profits for years and years, like that of Rio and my pick below.

Alternatively, there are companies like Mount Gibson Iron Ore (ASX: MGX) that have incredibly low cost mines, however the mine life is short so there is a risk that any future mine purchases will not be as low-cost and dilute shareholder returns.

The next Rio Tinto?

In my eyes, the best up-and-coming alternative to Rio Tinto is Fortescue Metals Group Limited (ASX: FMG). Fortescue has relatively high costs compared to Rio, at an estimated US$72 per tonne of iron ore, but is widely considered the third or fourth lowest cost listed global producer. In the past I had been concerned about the group’s high debt load, however it is rapidly being paid down early in order to reduce interest payments and boost profitability even if the iron ore price falls over time.

Fortescue just last week announced the completion of the expansion project to lift production to 155 million tons per annum (mtpa), and while the company has previously flagged an increase to 355 mtpa in the future, this is considered unlikely in the near term.

Fortescue also boasts a dividend yield over 3% which is predicted to rise, particularly when gearing is reduced below the near-term target of 40%.

Foolish takeaway

Fortescue’s share price, like many of its rivals, has struggled so far in 2014 as the iron ore price plunged. It appears to have stabilised and Fortescue is now 20% cheaper than at the beginning of the year. The company is set to release first-quarter 2014 results in mid-April which could prove a catalyst for the share price climbing higher.

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Motley Fool contributor Andrew Mudie owns shares in FMG.

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