Is Rio Tinto Undervalued at These Prices?

With shares of Rio Tinto (NYSE:RIO) trading around $43, is RIO an OUTPERFORM, WAIT AND SEE, or STAY AWAY? Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

T = Trends for a Stock’s Movement

Rio Tinto is engaged in finding, mining, and processing mineral resources. Its products include iron ore, aluminum, copper, diamonds, coal, uranium, gold, and industrial minerals. Rio Tinto has been trying to divest itself of non-core and unprofitable assets since CEO Sam Walsh took over the company. The firm previously stated it was not interested in selling its Mozambique coal operations, but changed its mind after failing to find a buyer for its diamond businesses. Expect Rio Tinto to grow as it grabs hold of its business again, and continues to provide raw materials around the world.

Rio Tinto has achieved a record output of iron ore for the first half of the year. The mining company exceeded expectations for iron ore output, and says it’s on track to expand into a remote region of Australia that could yield a significant addition of iron ore tons per year. However, Rio Tinto makes the majority of its profits from mining iron ore, and the volatile price of the metal could hurt the company’s bottom line, even if they manage to mine a lot of it.

T = Technicals on the Stock Chart are Weak

Rio Tinto stock has struggled a bit in recent years. The stock is now trading at multi-year lows. Analyzing the price trend and its strength can be done using key simple moving averages.

What are the key moving averages? They are the 50-day (pink), 100-day (blue), and 200-day (yellow) simple moving averages. As seen in the daily price chart below, Rio Tinto is trading below its declining key averages, which signal neutral to bullish price action in the near-term.

RIO

(Source: Thinkorswim)

Taking a look at the implied volatility (red) and implied volatility skew levels of Rio Tinto options may help determine if investors are bullish, neutral, or bearish.

Implied Volatility (IV)

30-Day IV Percentile

90-Day IV Percentile

Rio Tinto Options

36.01%

43%

41%

What does this mean? This means that investors or traders are buying a significant amount of call and put options contracts, compared to the last 30 and 90 trading days.

Put IV Skew

Call IV Skew

August Options

Steep

Average

September Options

Steep

Average

As of today, there is average demand from call buyers or sellers, and high demand by put buyers or low demand by put sellers, all neutral to bearish over the next two months. To summarize, investors are buying a significant amount of call and put option contracts, and are leaning neutral to bearish over the next two months.

On the next page, let’s take a look at the earnings and revenue growth rates, and what that means for Rio Tinto’s stock.

E = Earnings Are Mixed Year-Over-Year

Rising stock prices are often strongly correlated with rising earnings and revenue growth rates. The last four quarterly earnings announcement reactions can also help gauge investor sentiment on Rio Tinto’s stock. What do the last four quarterly earnings and revenue growth (Y-O-Y) figures for Rio Tinto look like, and more importantly, how did the markets like these numbers?

2012

2011

2010

2009

Earnings Growth (Y-O-Y)

-417.94%

-121.95%

145.73%

182.46%

Revenue Growth (Y-O-Y)

-19.58%

2.51%

33.28%

-7.35%

Earnings Reaction

N/A

N/A

N/A

N/A

Rio Tinto has seen mixed earnings and revenue figures over the last four years.

P = Weak Relative Performance Versus Peers and Sector

How has Rio Tinto stock done relative to its peers, BHP Billiton (NYSE:BHP), Freeport-McMoRan (NYSE:FCX), Vale (NYSE:VALE), and the overall sector?

Rio Tinto

BHP Billiton

Freeport-McMoRan

Vale

Sector

Year-to-Date Return

-24.96%

-21.02%

-17.46%

-34.69%

-19.33%

In a weak sector, Rio Tinto has been a poor relative performer, year-to-date.

Conclusion

Rio Tinto is a global mining firm that provides raw products for many uses around the world. The company has achieved a record output of iron ore for the first half of the year, but it may not be enough, as raw material prices have experienced significant volatility. The stock has struggled over the last few years, and is now trading near lows not seen since 2009. Over the last four years, earnings and revenue figures have been mixed for the company. Relative to its weak peers and sector, Rio Tinto has been a poor year-to-date performer. STAY AWAY from Rio Tinto for now.

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