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Date : 18/12/2020

Rio Tinto Limited

ASX :

RIO

Market Cap : $42.45 Billion

Dividend Per Share : $2.16

Dividend Yield : 4.95 %

Hold

52 Week Range : $72.77 - $117.12

Share Price : $116.44

Strong and stable firm that is flying high due to the surge in commodity prices. We recommend members to "Hold".

Company Analysis

Rio Tinto Limited (ASX: RIO) is a global powerhouse that is second in global size, behind only BHP. The firm is dual listed on the ASX and London’s LSE. Rio operates across commodities such as Aluminium, Copper & Diamonds, Energy & Minerals, and Iron Ore.

Following a very challenging start to 2020 with widespread movement restrictions putting a halt to operations, Rio has emerged with a very resilient half year performance during FY2020. Few key highlights from their latest financial reports area as follows:

  • $9.6 billion of underlying EBITDA
  • 47% underlying EBITDA margin
  • $2.8 billion of free cash flow
  • $2.7 billion of capital has been invested


Source: Tradingview.com

The stock has had a tremendous 2020 as commodity markets have rebounded with an earlier than expected increase in economic activity. The biggest driver of the economic activity has once again been China. The performance of RIO during the year is as follows:


Source: Tradingview.com

Since our initial coverage, the stock has returned $16.5 for every share or a 14% return. It has been a remarkable performance for the stock on the back of a widespread rally for commodities such as iron ore and copper.

Commodity Exposure & Outlook

Rio has the highest exposure to iron ore of all these commodities with 53% of its revenues coming from the in-demand commodity. China is Rio’s largest customer, and they account for 51% of its revenues. Other major markets for the firm are USA (14% of total revenues) and other parts of Asia. The iron ore assets have also been the best performing of all of the firm’s assets. The return on assets measure shows that iron ore assets have commanded a 114% return in the previous year.

Iron Ore

Iron Ore prices have been soaring recently. The commodity is used to make pig iron, which is used in the production of steel. Over 95% of all the mined iron ore is used in the production of steel. Iron ore prices stayed resilient during the pandemic and have now surged off late. There have been 2 key incidents to trigger this. China is the larger consumer of iron ore. They import 70% of all the iron ore produced in the world. The other big importers are Japan and South Korea. March onwards, China’s economic activity began to recover, and iron ore did not see too much of a drop off in demand. Coming to the supply, Australia and Brazil are the biggest exporters of the commodity. With Brazil still affected by the pandemic, it has led to temporary suspension of mining operations – causing a shortage of supply. The decrease in supply, an increase in demand, and a weaker US dollar has led to higher iron ore prices, and hence, Australian firms with exposure to iron ore have had the benefit of increased margins.

The outlook in the short-term for iron-ore is very bullish going into the next year. It is important to note here that this demand is not just coming from China, but it is being fuelled by other players in Asia that are ahead of the curve when it comes to recovering from the pandemic. However, in the medium to long-term, we expect the demand and price for the commodity to smoothen out.

Copper

Copper prices are very sensitive to the global economy. The metal is extremely important to the manufacturing and infrastructure industries that usually determine economic activity. As global economies were put on a standstill, the price of the commodity took a pounding during March and April. However, since then the price has been climbing. Again, China is the largest importer accounting for about 30%-35% of global imports. The quick recovery of China has ensured that the demand for the commodity does not fall as other economies were put to a halt. On the supply side, Chile and Peru are the largest exporters of the commodity and they were under strict lockdowns – impacting productions and leading to a shortage in supply. A weak US dollar during the period has also added to the copper price increasing. News of a vaccine and return to normal are all fuels to the demand for the commodity during 2021. Another very important consideration to be made here is that a shift to renewable sources of energy will increase the demand for copper in the future.

The outlook for copper is not as robust as that of iron ore. We expect the commodity price to correct itself going into the new year. In the medium term, the price should hold up around US$3 a pound for the metal.

Aluminium

The demand for aluminium is mainly driven by 3 sectors – automobile, aerospace, and construction. The current price levels for aluminium are close to the high levels of late 2018 when global automobile production was at a high. The industrial production in China accounts for over 50% of the output and thus, the price has been rising since March as China’s economic activity restarted. The International Aluminium Institute also noted that the global production has risen by 3.5% as of October 2020. Our estimates suggest that the price should hold in the short-term as demand is likely to sustain and possibly increase as economic activity in the emerging economies of Asia are poised to increase.

Outlook

The long-term demand for iron ore is the only commodity that is raising eyebrows. Copper, Energy and Aluminium are forecasted to sustain in the medium term as economic activity is slowly returning globally. With the year almost wrapped up, we are expecting the same resilient and consistent performance from Rio for the FY2020 full year results.

The chart above shows the return on equity, assets, and invested capital of Rio Tinto for the past 5 financial years.

Production capacity is high for the firm as all their assets are once again operating at levels seen prior to the pandemic. Aluminium production during the Q3 of FY2020 was 1% higher than the previous corresponding period. Copper mining activities, however, have not fully recovered. The 3rd quarter reports showed a 18% drop from the Q3 of FY2019. This was largely due to extended shutdowns experienced in Kennecott.

The Pilbara operation is home to iron ore production for Rio. Given Australia’s relatively quick recovery from the pandemic, Rio has recorded the 3rd quarter with iron ore production at 86.4 million tonnes. This is just 1% lower than the previous corresponding period and it looks like iron ore operations have returned back to pre-pandemic levels. Shipments of the mined iron ore are still yet to recover completely due to the challenges in the supply chain. The quarterly performance showed a 5% drop off from pcp.

The production guidance and operating cost guidance remains unchanged from Q2 FY2020. The iron ore cost guidance remains at $14 – $15 per tonne. The copper operations C1 cost guidance for FY2020 is in the range of 120 -135 cents/lb. We expect Rio to hit these production guidance numbers from the below chart, however, we are not expecting any surprises that will trigger stock price sensitivity.


Source: Rio Tinto

Recommendation

Rio Tinto is an exceptionally strong and stable company. The strength and size of its assets and production levels are high and we are not expecting any surprises in its FY2020 full year performance. The stock price has surged on the back of the high soaring iron ore price which may not turn out to be sustainable in the medium to long-term. We recommend members to “Hold” their positions and inherit the benefit of dividends and stable performance.

 

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