For capital-intensive companies with different capital structures, it’s appropriate to use EV-to-EBITDA (enterprise value to earnings before interest, taxes, depreciation, and amortization), as it neutralizes the impact of debt structure on valuation.
- Rio Tinto (RIO) currently has an EV-to-forward-EBITDA of 8.2x, which is higher than its last five-year average of 6.0x. BHP Billiton (BHP)(BBL) and Vale SA (VALE) have EV-to-EBITDA ratios of 7.5 and 7.3x, respectively.
- In the last five years, RIO has traded in a wide range of 3.6x to 8.5x.
- Since the start of 2015, RIO’s EBITDA estimates have been revised downward 31%. The downgrade is mainly due to lower commodity price assumptions. The downgrade to earnings has been the major reason why RIO’s valuation multiple has increased from 6.3x at the beginning of the year to the current 8.2x.
- RIO’s returns to shareholders in the form of share buyback are one of the reasons it’s trading at a higher multiple than BHP currently. The two stocks were trading at the same multiple at the beginning of the year. RIO’s further productivity initiatives could help its valuation going forward. However, any unexpected downgrade to commodity prices due to a prolonged weakness in China or any other catalyst would be negative for RIO as for other miners, including BHP, Vale, and Cliffs Natural Resources (CLF).
- In the meantime, an impressive dividend yield close to 6.6% is keeping income-seeking investors interested in RIO at this stage of the market downturn.
Ability to withstand the downturn
While there are near-to-medium term pressures for weaker iron ore and aluminum, Rio is doing a good job of controling costs and increasing productivity. Its iron ore and aluminum assets are of very high quality and offer an advantage compared to its peers in terms of reducing costs to weather this downturn. Further capex reduction could be one of the additional tools for Rio’s management to weather this market volatility.
The SPDR S&P Metals and Mining ETF (XME) invests in the metals and mining sector, so it provides diversified exposure to these companies. CLF forms 3.9% of XME’s holdings.