Morgan Stanley analyst Brendan Fitzpatrick isn’t keen on Rio Tinto’s stock.
He says the world’s biggest iron ore miner is trading at nine times 2014 estimated earnings for a reason.
This “reflects the risk of faster and or more pronounced mean reversion in iron ore prices mainly driven by demand risk in China” says Fitzpatrick. China will account for 90 per cent of iron ore demand growth until 2016, according to Morgan Stanley.
Rio’s shares have dropped 14 per cent this year, according to Bloomberg data. Fitzpatrick says the company’s spending is not being cut fast enough.
“We do not expect free cash flow to cover dividends until 2015,” he says. Moreover, the Morgan Stanley analyst says, Rio’s financial leverage remains slightly elevated at 1.7 times net debt to EBITDA, including provisions on Fitzpatrick’s 2014 estimates.
This limits Rio’s ability to launch a buyback program or lift dividends, he says.
“Rio Tinto has stated it wants to generate cash by selling assets,” says Fitzpatrick. “Finding buyers that can and want to pay fair value for assets is not easy in this market in our view.”
At 1542 AEST Rio’s shares were up 15 cents, or 0.3 per cent, to $56.70. Since its low this year on June 25 of $50.24, the stock has gained 13 per cent.