Is Rio Tinto Limited really a bargain?

Credit: Alrosa

The Rio Tinto Limited (ASX: RIO) share price is down 14% in 2016, so far, and a whopping 35% from this time last year. For comparison, rival BHP Billiton Limited (ASX: BHP) is down 17% and 51% over the same timeframes.

The huge share price falls are a result of the ongoing falls in key commodity prices.

Ordinarily, I wouldn’t use charts to prove an investment thesis (be that buy or sell), but I feel that’s all that is needed to show Rio Tinto shares are not a clear cut buy.

The following chart shows the monthly Commodity Metals Price Index over 30 years.

Data sourced from

Data sourced from

The Commodity Metals Price Index includes the copper, aluminium, iron ore, tin, nickel, zinc, lead and uranium prices.

In the chart, it’s easy to see the rally in commodity prices starting in the early 2000’s. Then, the collapse of commodity prices during the GFC is obvious.

Now, for a company producing commodities, you’d think Rio would’ve prospered over the past 15 years or so — but it hasn’t.

Indeed, despite the wide margins a commodities boom usually affords blue-chip miners, Rio’s return on capital (a measure of profitability) has averaged just 11.8% since 2001 and in its 2015 financial year stood at just 7.3%.

Sure, Rio is a ‘volume’ business, but if I were asked to outlay billions of dollars upfront, I’d like some pretty good returns over many years. A ROC of 11.8% is good but it’s not great. BHP’s long-run average ROC is 18.66%, Cochlear Ltd’s (ASX: COH) is 24.75%. Notably, commodity prices have suffered further falls since Rio’s 2015 fiscal year.

To view the risk-reward trade off through the lens of a shareholder, consider this: Rio Tinto’s shareholders have achieved a total shareholder return (dividends plus capital gains) of negative 1.5% over the past 10 years, annualised, according to Morningstar.

I think this next chart is important simply because it puts Rio’s sources of profit in perspective.

Data sourced from S&P Capital IQ

Data sourced from S&P Capital IQ

Foolish takeaway

As the lowest-cost producer, Rio Tinto is unlikely to go bust anytime soon. But as China continues to slow its infrastructure investment, commodity prices could continue to fall lower for longer.

And if Rio – one of the world’s best miners – cannot achieve outstanding returns during the ‘boom’ times, I wonder what it’ll achieve in a much tougher commodity price environment? Frankly, there are better places for your money, in my opinion.

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Motley Fool writer/analyst Owen Raszkiewicz owns shares of Cochlear.

Owen welcomes your feedback on Google plus (see below), LinkedIn or you can follow him on Twitter @ASXinvest.

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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