The share price of mining giant, Rio Tinto Limited (ASX: RIO), has underperformed the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) by more than 5% in 2015.
It has also underperformed the market over the past 1, 5 and 10 years.
Its underperformance comes despite China demanding an unprecedented amount of iron ore, copper, aluminium and other raw materials to fuel its infrastructure-led economic boom.
As a commodities producer, Rio Tinto does not have control over the price at which it sells its products. That means, it's dependent on free markets – fuelled by strong demand – to generate growing returns for shareholders.
Unfortunately now, after many years of impressive growth, China is transitioning to a consumer-led economy, which will likely be characterised by slowing demand growth for metals like iron ore – Rio's most lucrative commodity.
A Chinese slowdown is worse for Rio now than it has been historically. Since 2008, a time when commodity prices were riding exceptionally high, the proportion of Rio's sales to China has grown from 18.8% of group total to over 38%.
Adding another layer of risk to Rio's future profits is the oversupply of key commodities iron ore, coal and copper. China is the world's largest producer and consumer of coal. It is also, by far, the largest consumer of iron ore. Metallurgical or coking coal is used with iron ore to make steel.
In 2014 China exported 94 million tonnes of steel, up 50% year over year.
Is Rio Tinto cheap?
Rio Tinto shares appear to trade relatively cheap at today's prices, with a price-earnings ratio of 11 and dividend yield of 4.9%. However with the obvious headwinds facing key commodity markets, it has to be asked whether they're cheap in absolute terms. Personally, I doubt they are.
I think investors who are justifying future profit growth forecasts using Rio's historical performances over the past 5 or 10 years as a guide, could get a rude awaking in future years. This is because the commodity prices of yester-year were almost certainly inflated by China's unprecedented economic boom and are unlikely to continue into the foreseeable future.
Buyer beware.
