The mining sector has proved to be a tough place to do business in recent years. That's because the prices of a wide range of commodities have fallen significantly, which has left companies nursing falling bottom lines and their investors feeling downbeat about their investment losses. For example, iron ore reached a ten-year low earlier this year, while Rio Tinto Limited's (ASX: RIO) share price now trades at its lowest level since early 2009.
Looking ahead, things could realistically get worse before they get better. The Chinese economy is on a downward growth trend and the imbalance between supply and demand for many commodities is likely to be sustained in the coming months. Therefore, it would be of little surprise for the price of iron ore, for example, to come under further pressure even though it has shown signs of stabilising in recent weeks.
As such, Rio Tinto's financial standing is a key reason why it is a sound long-term buy. In its most recent half-year results, it reported that free cash flow stood at US$4.4bn and this affords it the scope to undertake sustaining capital expenditure of US$1.2bn and also pay a relatively generous dividend of US$2.2bn. This indicates that the company has sufficient headroom to not only reward its shareholders and maintain the current level of operations but to also potentially invest for its long-term future.
Meanwhile, with Rio Tinto having a debt to equity ratio of around 50%, it is unlikely to be hit hard by interest rate rises, which is another plus regarding its financial outlook. Furthermore, it means that Rio Tinto is more likely than many of its mining sector peers to survive the current difficulties and also cope with further deterioration in 2016 and beyond.
In addition, Rio Tinto appears to have the right strategy with which to emerge from the current commodity crisis in a relatively strong position. Although its decision to raise production has contributed to a fall in the price of iron ore since it means supply has increased, it means that Rio Tinto has the potential to increase its market share over the medium term. This could equate to rising profitability further down the line, and also put additional pressure on smaller rivals which may have higher costs than Rio Tinto.
The size and scale of Rio Tinto are other key reasons to buy a slice of it for the long-term. Its cost control is exceptionally strong, with the company increasing its target for sustainable operating cash cost improvements to US$1bn for the full year from the previous target of US$750m. And, with US$4.8bn in sustainable cash cost improvements having been delivered between 2012 and 2014, Rio Tinto has retained its position as a relatively low-cost producer.
As a result, under the 'new normal' operating conditions within the mining sector the company seems set to retain its competitive advantage and thereby improve its long-term outlook relative to its higher-cost rivals. For this reason, as well as its sound strategy and strong financial outlook, Rio Tinto remains a relatively appealing, albeit volatile, long-term buy.
