Turkey of the week: overpriced miner
By
Paul Hill Nov 20, 2009
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One recent route to a fast buck has been buying up base metals, such as copper, and then selling them on to the Chinese at a profit. China is the world's biggest consumer of commodities by a mile.
Twelve months ago, as exports collapsed, Beijing had a choice: either accept mass unemployment, or artificially boost the domestic economy. The government chose the latter course of action and proceeded with a whopping $586bn stimulus package and oodles of cheap credit.
The good news is that the plan worked – GDP reverted to trend, hitting 8.9% in the third quarter. But on the downside, traders have had a field day exploiting Beijing's 'forced buyer' predicament. Speculators also piled in just as producers were mothballing loss-making mines and Western nations began their vehicle scrappage schemes (such as 'cash for clunkers'). The upshot? Commodities are now very overpriced.
And China has cottoned on. Last week, Beijing sent jitters through the London Metals Exchange by hinting that it may dump up to 350,000 tons of copper (equivalent to 3.5% of global output). On top of that, the injection of cheap money is being withdrawn, as much of the new infrastructure it paid for is not being used.
Rio Tinto (
LSE: RIO
), rated a BUY by Bank of America
I spoke to the CEO of a Chinese firm based in Guangdong on Wednesday who said many new highways were already sprouting weeds due to a lack of traffic. If China takes the steam out of its construction efforts (perhaps shifting its priorities to domestic consumption, education and healthcare), there's going to be another bloodbath for the metals markets.
That will whack major miners such as Rio Tinto, the world's second-largest producer of iron-ore. Worse, the firm is betting big on China's continued ravenous appetite for commodities.
Rio Tinto CEO, Tom Albanese, said in September that, "strong Chinese demand was the main reason it had stepped up capital expenditure". When asked what other regions he was confident about, he replied "China, China and China". This is going to end in tears. Infrastructure will be a winner long term, but in the next couple of years China will focus on building to need, rather than building for the sake of it.
This wouldn't matter if Rio Tinto's share price factored in another hiccup in demand. But that's not the case. The City is expecting metal prices (aluminium, iron ore and copper) to remain strong in the near term. So the stock trades on a hefty 2009 earnings multiple of almost 18, which seems far too steep.
I rate the firm on a through cycle multiple of six times earnings before interest, tax, depreciation and amortisation. After adjusting for $22.3bn of debt, the share price should be around £21.
Recommendation: SELL at £33.10
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments
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