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Rio’s Balance Sheet Could See It through the Cyclical Downturn

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Jan. 25 2016, Updated 8:06 a.m. ET

Focus on February 11

All eyes are now on Rio Tinto’s (RIO) 2015 results due on February 11, 2016, when the company’s management will report the unit cost reductions for various commodities. It will also provide an update regarding Rio’s capex (capital expenditure) going forward. Due to lower profitability, the market is expecting a cut in capex. We could also see a slew of other cost-cutting initiatives, including cutting the head office costs. The unit costs for iron ore will be another important thing to watch out for. As the price outlook for iron ore remains muted, lower costs could help offset some of the falls in prices.

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Iron ore play

Although Rio is still known as a diversified player, most of its earnings are from iron ore. Recently, its diversification attempts failed when the $40 billion acquisition of Alcan didn’t generate expected returns.

Most of Rio’s share price weakness, ~23% in 2015, was attributable to iron ore price weakness, as the ore’s price fell ~36%. While lower iron ore prices could continue to weigh on Rio’s profitability, Rio has the lowest cost as a producer of iron ore globally and should be able to maintain its competitive edge.

Rio’s balance sheet is more robust, with lower financial leverage compared to other miners such as Anglo American (AAUKY), Glencore (GLNCY), and Freeport-McMoRan (FCX). This could see it through the cyclical downturn.

Peers

BHP Billiton’s (BHP) share price is receiving an additional hammering because of its exposure to oil (USO), as well as the dam failure at Samarco in Brazil.

Investors are probably concerned about a dividend cut given the current spot prices of commodities such as oil, copper, and iron ore. In addition, Samarco liabilities will keep on weighing on BHP and Vale SA (VALE) in the near to medium term. In this context, Rio could be well positioned.

Investors who want to avoid the hassles of picking individual stocks can consider the SPDR S&P Metals and Mining ETF (XME) to get exposure to the metals and mining sector. Currently, Freeport-McMoRan forms 3.6% of XME’s portfolio.

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