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Date : 11/09/2020

Rio Tinto Limited

ASX :

RIO

Market Cap : $37.07 Billion

Dividend Per Share : $2.16

Dividend Yield : 5.67 %

Buy

52 Week Range : $72.770 - $107.790

Share Price : $99.86

The company’s resilient performance in the face of disruptions provides confidence in its execution capabilities which are expected to sustain its long-term value creation for its shareholders.

Company Analysis

Rio Tinto Limited (RIO) is engaged in minerals and metals exploration, development, production, and processing. The company’s Portfolio of assets is concentrated into four product groups: Aluminium, Copper & Diamonds, Energy &Minerals and Iron Ore. RIO’s wholly and partly owned bauxite mines are located in Australia, Brazil and Guinea. RIO’s wholly-owned and joint-venture alumina refineries are located in Australia, Brazil and Canada. RIO’s aluminium smelters are mainly concentrated in Canada. RIO also has plants in France, Australia, New Zealand, Iceland, the United Kingdom and Oman. The company is dual listed at the London Stock Exchange as Rio Tinto Plc and at the Australian Securities Exchange as Rio Tinto Limited.


Source: Tradingview.com

Investment Thesis

For the first half-year ended June 2020, consolidated revenues came in at US$ 19.4 billion, which was 7% lower than that in the first half of 2019 primarily due to lower prices and volumes of copper and also lower aluminium prices.

Underlying EBITDA came in lower at 6% compared to the year-ago period at US$9.6 billion, with a margin of 49.4%.

Net earnings came in at US$3.3 billion which was 20% lower than in the first half of 2019.

The company has declared an interim dividend of US$2.5 billion, equivalent to US$1.55 per share at a pay-out ratio of 53%. The dividend payable to Rio Tinto Limited shareholders is fully franked.

Source: Rio Tinto

Cash generated from operating activities came in at US$5.6 billion which was lower by 12% compared to the year-ago period, primarily due to lower pricing for aluminium and copper and lower dividend yields from minority interests.

Capital expenditure came in at US$2.7 billion and was 13% higher compared to the corresponding prior-year period and was split up into US$1.2 billion meant for sustenance of current level of operations and US$1.5 billion of development capital, out of which US$0.6 billion was utilized for creation of new assets.

Free cash flow came in at US$2.8 billion which was 28% lower than in the first half of 2019 primarily due to lower commodity prices.

Net debt increased by US$1.2 billion from the end of 2019 to reach US$4.8 billion at the end of the first half of 2020. This was driven by US$3.8 billion cash returned to shareholders in the first half of 2020, partly offset by free cash flow of US$2.8 billion.

Considerations

  • The group’s earnings have only dipped slightly as contributions from iron ore have offset the reduced traction from other base metals. Iron ore, which accounted for over 90% of the group’s earnings and 80% of its EBITDA, is trading high at US$100 per ton. Competitor Anglo American Plc’s iron ore business in South Africa has forecasted a price level closer to US$90per ton in the second half of the year. But that’s hardly a dampener as Rio has cash costs of US$14.5 per ton.
  • The underlying earnings in the first half of the year were affected by impairments largely from the aluminium business. Iron ore has cushioned the impact of worse performances in aluminium, copper and diamonds.
  • The iron ore market remains resilient in an otherwise turbulent world economy. There was resounding recovery in China’s overall demand for steel and production, which rose to record levels in June 2020. Steel markets were weaker in US, Europe, Japan, Korea and Taiwan. However, the diverted iron ore was absorbed in China. There was also a solid seaborne supply from Australia. The company aims to produce 324-334 million tonnes of iron ore in 2020.
  • Seaborne supply scenario for iron ore is highly uncertain not only for this calendar year but also for the next, in term of aggregate and quality profile. With Brazil still unable to come to terms with the outbreak of Covid-19, the recovery curve for exports is under cloud. The normalization process could spread over multiple years under this backdrop. The disruption in Brazilian exports could result in volatility in mineral prices.
  • There was weak demand of aluminium from automotive and transport industries, where product mix shifted from value added product (VAP) to commodity grades. The commodity also witnessed limited disruptions to supply from Covid-19. Aluminium prices fell 13% year over year up to June 2020.
  • Copper prices have also declined by 11% year over year while late recovery was witnessed in May 2020 driven by rebound in demand from China. There was significant impact on supply from South American mines. Investors switched from net short to net long at the end of the June quarter.
  • The company has declared the Inferred Mineral Resource at the Winu copper-gold project in Western Australia of 503Mt at 0.45% copper equivalent and announced the discovery of a new zone of gold dominant mineralization around 2 kilometers east of Winu. The company is targeting first production from Winu in 2023. This could pave the way for diversification of revenue streams for the company.
  • In May 2020, international credit rating agency Fitch Ratings has reaffirmed the long-term issuer default rating for Rio Tinto Plc at ‘A’ with a stable outlook. The outlook draws upon the company’s strong financial profile and flexibility at the commencement of the pandemic, with both the funds from operation as well as the net leverage at comfortable levels. To address the uncertainties arising out of the prolonged effects of the pandemic, the company has deferred some its planned capital expenditures and has lowered its capex guidance for FY 2020 by US$1 billion –US$2 billion, from its original estimate of US$7 billion.

Recommendation

Rio Tinto is geared up to face the effects of weaker demand in commodity markets as well as an economic downturn not only aided by its strong financial position but also as the considerable proportion of its earnings are derived from the iron ore segment. The company’s large scale coupled with a low-cost base and an undersupplied iron ore market leads us to the expectations of a continued robust cash flow generation.

The company is one of the world’s top three miners, with a diversified asset based located mostly in OECD countries and with products based on a number of bulk commodities. It derives benefit from economies of scale and proximity of its operations to important end markets, especially North America and China.

The management of the company has targeted a payout of 40%-60% of underlying earnings on an average for the foreseeable period. The company has delivered a satisfactory result for the first half of 2020 which included the period covering the onset of the pandemic along with its associated impact on the business sentiment and outlook and the situation from here can only get better. Shareholders were rewarded with an increase in the interim dividend payout. The company continues to generate free cash flow in order to fund its growth initiatives.

Our recommendation is a Hold for the investors who are already exposed to the stock.

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