What Traders of Commodity Stocks Need to Know About Tio Tinto’s Writedown
The breaking report from Rio Tinto and their unexpected $14 billion write down tells two stories and both are important to traders of commodity stocks -- and I will endeavor to tell you both.
First, there is of course the bad - no, stellarly awful - decisions made by the outgoing CEO, Tom Albanese for the Anglo-Australian mining giant. The first that is coming to light today is the horrible overpayment made for Alcan in 2007; a $38 billion acquisition that has been left unrewarded by lower and lower aluminum prices and awful return on capital. Now, I can see getting stuck in a very bad aluminum trade - often I have wondered over the past 5 years myself about tin and aluminum prices, the one metal that refused to give even the merest spike in prices to trade off of. "Can it really go lower?", I continued to ask myself, once getting stuck in a buy of Alcoa in the hopes that I had found a bottom, only to see that - yes, indeed - aluminum *could* in fact go lower still. In thinking that Aluminum would 'have it's day', Albanese wasn't alone -- one could almost forgive that.
But the Mozambique screw-up is totally unfathomable: How can you spend $4 billion for a company (Riverside mining) with assets for coal deep in the interior of a backwards, third-world nation run by thugs and not have already secured the rights from that nation's government to transport the mined coal you're hoping to produce? This is what has apparently happened to Rio in Mozambique as they've been unable to secure approvals to send barges up and down the Zambezi river from the coal mines to the coast. No barges? C'mon, what's the problem -- too much barge traffic on the Zambezi? Nah, someone didn't do their homework on who to pay and how much. Right now, Riverside is a dead asset and so is Albanese.
Now the two things we can learn: First, in commodity stocks, it's always about volume growth - whether we're talking oil, coal, copper -- we need the growth and that leads us to some very unsavory places with some very interesting sovereign problems to be overcome. Knowing where your investments are seeking this volume growth is critical for choosing the right company in a sector, whether it's oil, coal or copper. This is why, for example, Noble energy (NBL) is outpacing Anadarko (APC), why EOG Resources (EOG) is a better performer than Southwestern (SWN), why VALE (VALE) can be bad for so long. Understanding the chase for volume growth is key to finding the right company in a sector. Know where they're investing, so you can know where you should invest.
Here's the second takeaway: Commodity prices will trump even volume growth and where commodity companies are looking to build it. Going back to Rio Tinto, they had an absolutely tremendous run before this disaster writedown, moving to over $60 a share on the back of an equally tremendous run in iron ore prices in the last quarter of 2012. Even with the incredible embarrassment at RIO, shares are still trading north of $54. With the Chinese comeback and other Asian stimulus plans now being put in place, you want a miner like Rio Tinto, still number two to BHP Billiton but a heckuva LOT cheaper. The market tells me that if I can get shares just a little closer to $50, even with the firing of their CEO, I'm going to want to own it. You should too.