Shares in mining giant Rio Tinto (LSE: RIO) have risen by almost 15% over the last year, during a period when the FTSE 100 has flatlined. To add to the temptation, the Anglo-Australian firm has also been paying out record dividends — $10 per share in 2021.
My portfolio currently has some cash from a recent takeover bid. Should I invest some of this money into Rio Tinto shares, or have I left it too late?
Here’s the story
Rio Tinto has been benefiting from a massive boom in the price of its main product, iron ore. Between June 2020 and June 2021, the market price of iron ore rose from under $100/tonne to a record high of over $200/tonne.
This led to a windfall for Rio Tinto. The group’s profits doubled from $10bn in 2020 to $21bn in 2021. Rio’s share price peaked at over 6,000p.
However, this massive boost was never likely to be sustainable, as it pushed steel costs up too high. Iron ore prices are already back down under $90/tonne. The construction boom in China — Rio’s biggest market — seems to be slowing too.
Broker forecasts suggest Rio’s annual profits could fall back to around $10bn by 2024 — roughly in line with 2020 levels. However, Rio’s management has made it clear that dividend payments will remain sustainable and be supported by profits.
In my view, the dividend payout is almost certain to fall sharply. City analysts expect Rio to pay a dividend of 476p per share for 2022, falling to 360p per share in 2024. Those numbers could change, but they suggest the dividend yield on Rio shares could fall from 9% to 6% over the next couple of years.
Rio Tinto shares: my decision
At first glance, I admit that Rio Tinto shares look very cheap. This cash-rich FTSE 100 stock is currently trading on just six times 2022 forecast earnings.
However, I suspect this is a classic cyclical trap. It’s common to see commodity producers look cheap when profits are at a cyclical high. That’s because the market is already looking ahead, to a time when profits might return to more normal levels.
As far as I can see the Chinese economy is slowing as continued Covid restrictions affect growth. China’s property boom also appears to have finally come to an end. There’s also the risk of a recession in Europe.
My guess is that demand for Rio Tinto’s iron ore could weaken over the next year. Of course, I could be completely wrong.
Rio Tinto is continuing to invest in copper and other raw materials required for electric vehicles and renewable energy. This could drive new growth. The US economy may also prove stronger than expected, supporting demand.
I can’t be sure what will happen next. But, as a long-term investor, I want to buy cyclical stocks like Rio when they’re definitely cheap.
I don’t think that’s true today, so I won’t be investing.
Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2022