Could shareholders in Australia's biggest iron ore miner, Rio Tinto Limited (ASX: RIO), be staring down the barrel of more write-offs and share price underperformance?
Although it's still early days, Rio's share price has fallen 13% in 2014, mimicking the starts it had in 2013, 2012 and 2011. By comparison, the S&P/ASX 200 (ASX: XJO) (INDEX: XJO) is up 2% so far this year.
Many financial commentators (myself included) are attributing the most recent falls to the significant drops in the price of iron ore – a commodity which accounted for over 90% of Rio's FY13 earnings. But what was its excuse for the past five years?
Perhaps it was the impairments of more than $US20 billion in the last three years alone, the disastrous acquisition of Aluminium business Alcan or Mozambique coal miner Riversdale Mining? Here are five reasons why I think investors should avoid buying Rio shares, for now.
1. The spot price of iron ore has fallen 30% from over $US135 per tonne at the start of 2014 to $US94 per tonne this week. Very few miners have control over the price of their products and, despite its size and some investors' claims otherwise, Rio cannot dictate the price it receives for its most lucrative product. For example, Chinese customers could just as easily buy iron ore from BHP Billiton Limited (ASX: BHP) or Vale SA Inc (NYSE: VALE) if they were unhappy with Rio's demands.
2. Dependence on iron ore. Rio is Australia's largest iron ore miner and the world's number two after Vale. Even though Rio will not go bust with the current iron ore price, it's certainly not helping its top line. As noted earlier Rio derives a huge proportion of its earnings from iron ore.
3. Analysts are forecasting lower iron ore prices. Over time, it is expected that China's softening demand and excessive oversupply will result in an even lower spot price. Some are predicting a price as low as $US80 per tonne in coming years.
4. Former management have given shareholders and investors no reason to trust the company. Outside of iron ore, Rio's Aluminium and Energy businesses continue to drag on earnings. Within these businesses are Coal and Uranium, two commodities which are feeling the squeeze of ongoing low spot prices.
5. Better alternatives. Despite trading on a PE ratio of 8.5, there are cheaper resources stocks available on the market. This is the main reason I'm not buying Rio Tinto shares.
