INVESTMENT THESIS
Rio Tinto plc (NYSE: RIO), a leading international mining and metals company, is BUY. Rio Tinto has strengthened its operating performance and balance sheet by cutting costs and selling noncore assets. It also continues to return cash to shareholders through dividend increases. The company has traditionally performed well during difficult economic times, and, in our view, has strong long-term growth opportunities. On the negative side, Rio has faced sharp public criticism in recent months due to its destruction of two ancient aboriginal sites in Western Australia. Its CEO and other executives have also resigned over the incident. In addition, the company is involved in a dispute regarding cost overruns at its Oyu Tolgoi mine in Mongolia.
On the fundamentals, RIO ADRs are trading at 12.4-times our 2021 EPS estimate
RECENT DEVELOPMENTS
Rio Tinto has faced a public outcry, as well as a parliamentary inquiry, following its destruction of sacred aboriginal sites in Western Australia. The company destroyed the two ancient caves in May while expanding its iron ore mine at Juukan Gorge in the Pilbara region. Under pressure from shareholders, CEO Jean-Sebastien Jacques; Chris Salisbury, head of the iron ore business; and Simone Niven, group executive for corporate relations, resigned from the company on September 11.
In the wake of this incident, the company recently named Jakob Stausholm as its new CEO, effective January 1, 2021. Mr. Stausholm joined the company in 2018 as an executive director and chief financial officer, and has 25 years of management experience in a range of international businesses.
The company recently announced that it would expand its aluminum recycling capacity by adding a new remelt furnace at its Laterriere plant. The new facility will recycle aluminum cuttings from Rio Tinto’s operations and rolling mill customers, producing rolling ingots for the automotive and packaging industries. It is expected to be operational at the end of 2021.
Rio Tinto Group is based in London and reports results in U.S. dollars. The company posts full results at midyear and year-end, and production updates after 1Q and 3Q. On October 16, the company released its 3Q production results.
EARNINGS AND GROWTH ANALYSIS
The company is organized into four segments: Iron ore (77% of 1H EBITDA), Aluminum (9%), Copper & Diamonds (7%) and Energy & Minerals (7%). We review recent results and outlooks for these businesses below.
Iron ore. Third-quarter iron ore shipments of 82.1 million tons fell 5% year-over-year. The company expects 2020 production of 324-334 million tons, compared to 327 million tons in 2019.
Aluminum. Third-quarter aluminum production of 797,000 tons was up 1% from the prior year. The company expects production of 3.1-3.3 million tons for the full year, compared to 3.2 million tons in 2019. Alumina production of 2.0 million tons was up 7% from the prior year. Management expects production of 7.8-8.2 million tons in 2020, compared to 7.7 million tons in 2019. Bauxite production rose 5% year-over-year to 14.5 million tons in 3Q. The company continues to expect 2020 production of 55-58 million tons.
The company expects 2020 mined copper production of 475-520 thousand tons, compared to 577 thousand tons in 2019.
The company released its most recent financial results on July 29. Underlying EPS for the first half declined 3% to $2.94. Consolidated revenue declined 7% to $19.4 billion. The underlying EBITDA margin widened by 30 basis points to 49.8%.
The underlying EBITDA margin widened by 30 basis points in 1H20 to 49.8%. Although commodity prices were lower overall in 1H, margins benefited from the weaker Australian and Canadian dollars, as well as from lower energy prices.
Our estimate implies a decline of 7% for the year.
FINANCIAL STRENGTH & DIVIDEND
The company’s credit is rated A2/stable by Moody’s, A/stable by S&P, and A/stable by Fitch.
Total debt was $14 billion, and the debt-to-total capitalization ratio was 26%.
Rio Tinto generated operating cash flow of $14.9 billion in 2019, up 26% from 2018. Free cash flow was $9.2 billion, up 31%.
Rio Tinto pays a dividend. Management’s target payout ratio is 40%-60% of underlying earnings. The company pays regular dividends twice a year, in April and September, and occasionally pays a special dividend. The 2018 dividend was $4.08, or $3.08 regular plus a $1.00 special dividend. The 2019 dividend was $4.43, including a regular dividend of $3.82 plus a special dividend of $0.61. We think the company will be more cautious with dividends in 2020. Our 2021 dividend estimate remains $4.10. Our 2020 regular dividend estimate implies a yield of about 4.7%.
MANAGEMENT & RISKS
Jean-Sebastien Jacques, the company’s CEO since July 2016, resigned in September after the company destroyed two ancient aboriginal sites in Western Australia. The company has appointed Jakob Stausholm as CEO, effective January 1, 2021. Prior to joining Rio Tinto, Mr. Stausholm was the chief strategy, finance and transformation officer for the Maersk Group. Simon Thompson is the company’s chairman.
The greatest risk for RIO investors is the cyclicality of the company’s business, as economic downturns can sharply lower demand and pricing for iron ore, copper, and other commodities.
The company is global, and faces a host of different regulatory environments. As noted above, it has faced public and shareholder outcry due to its destruction of sacred aboriginal sites in Australia. It is also in arbitration with Turquoise Hill related to cost overruns at the Oyu Tolgoi mine in Mongolia.
COMPANY DESCRIPTION
Rio Tinto is a leading global mining and metals group. The company’s primary product groups are iron ore, aluminum, copper, and diamonds & minerals.
VALUATION
On the fundamentals, RIO ADRs are trading at 12.4-times our 2021 EPS estimate, compared to an historical range of 8-13.
On December 17, BUY-rated RIO closed at $76.60, up $0.70.
Source: Argus
