We recently downgraded our recommendation on Rio Tinto plc (RIO) from Neutral to Underperform. The bearish view on Rio Tinto is based on the slowdown in demand for iron ore products across the world. Rio, being a very cyclical stock, is largely influenced by worldwide economic activity, which is primarily responsible for the fluctuation in demand.
The company faces execution risk due to resource nationalism, governmental delays on mining permit issues and tax policies. Natural disasters like tropical cyclones, severe monsoon and constant flooding are concerns as well. The impact of higher energy costs and raw material price fluctuations cannot remain understated.
Moreoever, Rio faces tough competition from Brazil-based Vale S.A. (VALE) and Australia-based BHP Billiton Ltd (BHP) as production of iron ore in Vale is cost effective and the transportation costs are lower for BHP to Australia's geographical proximity.
Declining iron ore grades across the world is also responsible for enhanced production costs at Rio. Also, the competitive metals and minerals market, volatility in currency prices and mining cost inflation add to the woe.
Recently, Rio reported weak financial results in half-year 2012 with net earnings down 22% year over year, hurt by lower prices.
However, hope remains, as we witness portfolio of growth projects and continued acquisition as Rio's key growth strategy in times ahead. Investments in iron ore mines and resource acquisitions complement Rio's organic growth pipeline. Rio Tinto's operational efficiency and superior growth prospects are encouraging for the upcoming financial years as well.
Moreover, the company's continued investment in industry-leading, cost-saving technology is expected to increase automation and improve productivity going forward. Also, the company'sdebt reductions tools are anticipated to withstand the downturn in the global economy.
Rio Tinto has a Zacks #5 Rank, reflecting a short-term (1-3 months) Strong Sell rating.