Is the Rio Tinto Limited share price headed higher?

Commodity prices including iron ore could be set to fall

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Iron Ore Mining Operations

Rio Tinto Limited (ASX: RIO) has seen its share price rise more than 9% since June 21, when it traded around $58 and is now changing hands at above $65.

The giant miner, which generates most of its revenues and earnings from iron ore is heavily dependent on commodity prices as you might expect. While iron ore is by far its most valuable commodity, Rio also counts aluminium, bauxite, coal and copper as income earners. Ultra-low production costs mean the miner also features high earnings margins with iron ore earnings before interest, tax, depreciation and amortisation (EBITDA) at 63% and Bauxite at 50% EBITDA margin. Copper and aluminium had EBITDA margins of 46% and 26% in the 2016 financial year.

Overnight, iron ore prices jumped for the second consecutive day, reaching US$64.05 a tonne according to Metal Bulletin. Unfortunately, no one knows where iron ore prices are heading, although several analysts are forecasting prices of around US$50 a tonne by the end of 2017.

Increasing supply from Brazil and Gina Rinehart’s Roy Hill mine could put downward pressure on the spot iron ore price.

Rio has also committed to cutting its debt levels and is selling off its Coal & Allied business, which is expected to sell for around US$2.45 billion, plus US$240 million via royalty payments over five years. Yancoal Australia Ltd (ASX: YAL) is expected to be the successful bidder, having obtained NSW government approvals for the transaction.

The company had $9.6 billion of debt in mid-May and further cost-cutting, increasing productivity and efficiency should see that fall further.

Foolish takeaway

If China continues to demand raw materials as it has in the past, commodity prices should hold up, and Rio will benefit and so should the company’s shareholders. Higher dividends may also flow through over time. But as a resources company, Rio depends on where commodity prices go, and I don’t have a magic crystal ball to tell me if that is higher or lower.

As such, I’ll be avoiding Rio, like most other resources companies – with better opportunities elsewhere like the company below.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga 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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