Why I think Rio Tinto Limited shares look good value

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It feels like Christmas all over again for Rio Tinto Limited’s (ASX: RIO) shareholders as the iron ore giant returned close to US$10 billion to shareholders when it reported a surge in full year earnings yesterday evening after the market closed.

This sets the stock up for a positive start this morning with Rio Tinto’s London-listed shares jumping around 1% on the news in overnight trade as the miner said it will pay a final dividend of US$1.80 per share to lift its 2017 total dividend to US$2.90 a share – the most it has ever paid in its history and 71% above what it paid the year before.

The miner is also committing an extra US$1 billion to its share buyback program with the extra money earmarked for its UK stock. This is on top of the circa US$4.5 billion that it had completed or announced in 2017.

Rio Tinto is playing Santa Clause as it hands back 83% of its underlying earnings to shareholders as net operating cash surged 64% to US$13.9 billion thanks to stronger-than-expected commodity prices and its aggressive cost savings initiatives.

What will also please shareholders is the sharp increase in earnings before interest, tax, amortisation and depreciation (EBITDA) margin from 38% to 44% – the highest in a decade; and a bigger than expected reduction in net debt to US$3.8 billion from US$9.6 billion.

The future also looks bright with management forecasting a further US$5 billion reduction in costs from 2017 to the end of 2021.

What’s more, operating conditions are expected to remain favourable for the miner as global economic growth is expected to accelerate this year, which should support commodity prices.

Rio Tinto’s coffers will also swell from its divestment program with the miner looking to sell off its non-core coal, aluminium and copper assets.

This puts Rio Tinto in a good position to lift 2017’s record dividend this time next year with the stock currently yielding close to 7% based on Wednesday’s closing share price of $78.31 (if you include franking credits).

That’s a pretty tempting yield for a company with good earnings growth prospects and I think the stock still looks good value despite its 20% rise over the past 12-months versus the 4.5% gain by the S&P/ASX 200 (Index:^AXJO) (ASX:XJO).

All eyes will now be on BHP Billiton Limited’s (ASX: BHP) half year result on February 20, as I suspect the world’s biggest miner will deliver more surprises than Rio Tinto in terms of capital returns.

But it isn’t only the resources sector that is likely to outperform the market this year. The experts at the Motley Fool are particularly bullish on the prospects of a niche sector that they expect will take-off in 2018.

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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited and Rio Tinto Ltd. 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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