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Are Rio Tinto Limited shares too cheap to ignore?

Shares in Rio Tinto Limited (ASX: RIO), Australia’s largest producer of iron ore, have experienced their fair share of volatility in 2014.

After jumping to nearly $71 in February, the miner’s share price bounced down to a low of $57.26 in October. Now they sit marginally above $60.

But if you thought that was a wild ride. Think again.

Australia’s third largest iron ore miner, Fortescue Metals Group Limited (ASX: FMG) is down 41% since the beginning of 2014, whilst Altas Iron Ore Limited (ASX: AGO) and Gindalbie Metals Ltd (ASX: GBG) are down 74% and 73%, respectively.

The catalyst is a rapidly falling iron ore spot price.

Down from around $US135 per tonne in December 2013, the steel making ingredient now fetches slightly below $US80 per tonne.

Rio is one of the lucky miners because it has transformed its iron ore production from one of digging and crushing to one of logistics. Having an advanced supply chain gives Rio a breakeven cost of around $US43 per tonne. Whereas those three miners above have estimated breakeven costs anywhere between $72 per tonne and $98 per tonne.

So you can see why right now is the wrong time to buy shares in high-cost iron ore miners.

Rio, oft quoted as a diversified miner, derives over 90% of its earnings from its iron ore division. Its other divisions include, Aluminium, which is recovering slowly from massive price declines. Copper, its second most profitable division in 2014, Energy, which includes struggling commodities such as coal and uranium, and Diamonds and Minerals, a small but profitable business.

Buy, Hold, or Sell?

It’s anyone’s guess as to where the iron ore price is going. I suspect it’s going one way (lower) and believe we will witness a price which is significantly lower than the marginal cost of production for nearly all producers.

Whilst the world’s three largest producers, Brazilian giant Vale, Rio and BHP Billiton Limited (ASX: BHP) have the intention to keep pumping more ore into the market (at a time when Chinese demand is falling), I’d like to see Rio paying down debt or pushing into other areas to boost the miner’s outlook.

In the meantime, there’s likely to be much more pain felt for shareholders of medium to high-cost iron ore producers. Proceed with caution.

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Motley Fool Contributor Owen Raszkiewicz is long Dec 2017 $48 Warrants in Rio Tinto Limited. 

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