Summary
- Rio Tinto has started balance sheet repair and increasing shareholder returns after the excesses for the commodities boom.
- Rio Tinto has interests in iron ore, diamonds, coal, copper, uranium and miscellaneous industrial minerals. But only two generate 90% of profits - iron ore and copper.
- With competitors halting the expansion of iron ore projects - Rio Tinto is the "last man standing".
In the 1990's and early 2000's Rio Tinto (NYSE:RIO) was one of the most respected companies on the Australian stock market, its capital discipline was evident when it paid $3 billion for the forestry and mining group - North Limited in a cash takeover in the year 2000. This cemented its dominance of the iron ore industry just before the huge demand from China.
Since then its reputation has slipped with the poorly timed acquisition of Alcan at the top of the boom, development problems of greenfield coal sites in Mozambique and an attempted takeover by BHP.
Since these low points, Rio Tinto has engaged in an ongoing balance sheet repair job and increased returns going to shareholders in terms of higher dividends and lower CAPEX costs.
My contention is that Rio Tinto is now a reasonably priced dividend stock, with some capital appreciation potential.
The Company's five product groups include Aluminum, Diamonds & Minerals, Copper, Energy and Iron ore. Assume all but Copper and Iron Ore broke even - the net result to profits would be negligible.
Iron ore is 49% of the revenue and 80% of the profits; Aluminum is 17% of the revenue and 5% of the profits and finally, Copper is 10% of the revenue and 8% of profits.
The impact on the total bottom line of everything but iron ore and copper is a rounding error. The other commodities belong in the footnotes for determination whether Rio is a buy or not.
Commodities of importance
Iron ore:
The majority of Rio's revenue and profits comes from its iron ore efforts in the Pilbara region in Australia, and this is the lowest cost producer of iron ore in the world.
FOB break-even price for 62% Fe (in $AUD) per tonne
Rio Tinto $35
BHP (NYSE:BHP)$35
Fortescue Metals Group $44
Roy Hill $50
Vale (NYSE:VALE) $40
2nd tier producers $60-90
It costs an average of $US23 a tonne to ship iron ore from Brazil to China. From Australia this figure drops to only $US9. The cost from Brazil has fallen due to shipping cost reductions over the past year due to a collapse in the Baltic Dry Index. The biggest drop was in charter rates for Panamaxes, the largest to navigate the Panama Canal, which fell 11 per cent to $4,392 - Bloomberg noted.
Recently iron ore prices in China went above $USD 60 for the first time in a year, with BHP and Vale announcing pauses in their production increase plans. Rio has stuck with their production increases which remain on target to reach 330 million tonnes' export capacity by 2015 and 350 million tonnes by 2017. Annual global seaborne trade totals 1.4 billion tonnes, of which China accounts for 65%, the main driver of demand.
Your opinion on whether Rio is a good stock to purchase will depend on your opinion of steel demand in China/economic management in China.
Recently both Rio Tinto and BHP were ridiculed for sticking with demand forecasts that showed China producing one billion tonnes of steel a year, despite the downturn in construction and industrial demand, including attempts to clean up air pollution from blast furnaces.
Commentators suggest car manufacture and other manufacturing uses will absorb the output from steel mills. Even if Chinese demand has hit a permanent plateau, Rio can still make money. Their other main competitors have blinked and lowered production increases on fears on permanently lower prices.
Copper
Dr Copper has recently gotten up off its sick bed and started walking around. Prices have risen from lows of $USD 5500 a tonne to $6600 a tonne recently.
Image obtained from here.
The main demand again, was China. This time building stockpiles of the metal on price weakness.
Mine closures due to repairs, water restrictions and low prices crimped production in the last six months - Bloomberg reported.
Whether demand will continue for copper is another matter, as LME stockpiles are increasing and China's State Reserve Bureau (SRB) is only interested in buying below $6000 USD.
Long term forecasts suggest further price weakness in the short term but picking up after 2017 with higher demand and lower mine production.
Valuation:
Typical valuation metrics for multi-commodity miners consist of:
9-10 times free cash flow, or 16 times earnings
On these valuations Rio is valued at $USD 126 Billion or $148 Billion. An upside of 20% or 50% on current market price.
Year to 31 December
|
2014
| ||
Underlying earnings (US$ millions)
|
9,305
| ||
Net earnings (US$ millions)
|
6,527
| ||
Net cash generated from operating activities (US$ millions)
|
14,286
| ||
Capital expenditure (US$ millions)
|
8,162
| ||
Underlying earnings per share (US cents)
|
503.4
| ||
Basic earnings per share (US cents)
|
353.1
| ||
Ordinary dividends per share (US cents)
|
215.0
| ||
Net debt (US$ millions)
|
12,495
| ||
Gearing ratio5
|
19%
|
Summary:
Come for the dividend yield of 4.6%, stay for the capital growth potential.
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