Shares in mining giant Rio Tinto Limited (ASX: RIO) are down around 8.5% so far in 2014 as a result of falling iron ore spot prices. With fellow miners BHP Billiton Limited (ASX: BHP) and Fortescue Metals Group Limited (ASX: FMG) also lower than their opening prices at the beginning of the year, some investors are taking a long-term view and snapping up discounted stocks. So should you do the same? Or should you avoid Rio and the other miners?
To answer that question, investors need to understand Rio's past and identify where its management are steering it in the future.
In recent years, Rio shareholders have dealt with huge write-offs as a result of weak commodity prices across key products such as aluminium, coal and uranium. At 31 December 2013, Rio had US$18.1 billion in debt and announced billions of dollars of impairments for new and existing operations.
In the next few years, Rio's management have committed to ramping up production of iron ore, divesting non-core businesses, paying down debt, reducing capex spend and shutting unsustainable projects. So far, CEO Sam Walsh has done everything right by investors in conserving capital and attempting to turn the ship around.
However a falling iron ore price has put a cloud over near-term earnings forecasts and has not helped Mr Walsh's turnaround strategy. It's easy to see why so many investors have sold down Rio shares in recent times despite his ambitious plans. In FY13 the steelmaking ingredient accounted for over 90% of Rio's earnings.
To buy, or not?
Until we can get a clear picture of the effect of the falling iron ore price on earnings, I'm adopting a wait-and-see approach with Rio shares. Whilst I think it would make a great buy and hold mining stock, there's no reason to commit to a purchase now, especially when there are over 2,000 other companies listed on ASX.
