Rio Tinto wins out again

This high level of product and geographical diversity has been the backbone of Rio's accomplishments. In fact, so successful has Rio's strategy been that BHP Billiton is now trying to emulate it, quite successfully in fact.

Supporters

We, too, have been long-term supporters. Since issue 10/Jul 98 (Long Term Buy – $18.99) the share price has risen 89%, although little changed since issue 102/May 02 (Long Term Buy – $36.10).

It's a performance that highlights the advantages of picking a good stock and sticking with it.

Rio has had its ups and downs, though. In fact, just after its most recent quarterly production report the share price fell by as much as 6%. In our view, these are the opportunities to top up your holdings in quality stocks. This is one such occasion.

Rio's quality was evident in its result for 2001. Despite its chairman Sir Robert Wilson describing it as the 'most severe decline in demand for many metals for at least 20 years' Rio increased its operating earnings per share by 10% to $2.34 (excluding a $1.1bn copper asset writedown).

This writedown is not insignificant but it is an abnormal and doesn't affect the huge cash flow of US$3.4bn. This is the lifeblood of every company and, in Rio's case, cash flow has financed acquisitions totalling almost $4bn in iron ore, coal, diamonds and salt.

The skill, of course, is not in buying other companies but buying them at good prices and making them work. Here, Rio excels. The company has managed to make acquisitions that generate cash despite depressed commodity prices, and then get them working more efficiently.

Reducing the amount of time taken to load trains and negotiating joint ventures to share rail and power costs are two small but noteworthy examples.

To the matter of price. We're the first to admit that a PER of 15 is high for a resource stock. But this company has averaged a 17% return on equity for the last five years and has grown operating margins to almost 30%. We think this trend is set to continue.

Outstanding

Given those outstanding figures, why has the share price been weak? The answer lies in short-term economic speculation. The market seems preoccupied with guessing when the global recovery will actually happen rather than why Rio offers value now.

Sensibly, Sir Robert admitted he had no idea what the economy will bring in 2002. We have no idea either. But we can say that shareholders are enjoying a 3.2% dividend and won't miss out when the economy does eventually turn.

Rio's fundamental risk is low and its size, backed by hefty cash flows, does matter.

In a consolidating industry the company has shown its quality and we see absolutely no reason to change our view just because of a recent price wobbles. LONG TERM BUY.