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Blog

Rio Tinto: Strategy shifting gears

Adrian Prendergast

Key points

  • Overall a slightly softer quarter (3Q18) with iron ore marginally trailing.
  • Post the early phase of the cycle, with a stronger balance sheet, RIO is considering possible new avenues for growth (decision next <12 months).
  • Negative net energy exposure remains a point of weakness post coal exit.
  • We maintain our Add rating and increased our price target – Morgans clients only.

Focus on peak competitiveness

Post the divestments of its coal business and Grasberg, RIO will further focus on its strategy of leveraging assets where it is exceptionally competitive (Pilbara iron ore, Canadian ali, Oyu Tolgoi, Escondida, etc).

Until now RIO has prioritised this strategy over diversification or being selective with market exposure, choosing not to diversify outside of iron ore during the early stages of the current resources up-cycle. However that might be changing, supported by a strong balance sheet, RIO is now considering ways to leverage new growth into the business.

3Q18 on the softer side

A lot of RIO's quarterly performance is driven by iron ore given it dominates group earnings.

RIO saw a small decline in mined and shipped volumes out of the Pilbara during 3Q18 due to interruptions from planned maintenance and a fatality, with the big miner shipping 81.9mt (100% basis) versus Morgans estimate of 85mt, although not significant after RIO’s bumper 1H from the Pilbara which is still expected to see the company come out at the upper end of its 330-340mt guidance range.

Meanwhile alumina (actual 1,972kt vs Morgans 2,010kt), aluminium (actual 880kt vs Morgans 907kt), and IOCC (actual 2.9mt vs Morgans 2.9mt) were all close to expectations. Copper (actual 159.7kt vs Morgans 151.7kt) and bauxite (actual 12.7mt vs Morgans 11.9mt) were both comfortably ahead of our estimates.

Ali division still an unexpected downer

Earlier in the year we had become excited by RIO's sizeable ali exposure for the first time since RIO acquired Alcan back in 2007, with environment reforms delivering much needed tightness to supply (particularly to the alumina market).

While this price upside has been realised, RIO unfortunately has not participated in much of the upside due to legacy contracts linked to the depressed LME aluminium price. RIO estimates that this resulted in a negative EBITDA impact of US$178m in the first half of 2018, with a further US$130m loss in 3Q18.

Meanwhile the ali division has also been impacted by cost inflation, with rising raw material and energy costs expected to impact EBITDA by a further US$500m in 2018. Meanwhile bauxite prices (another growth metal) have been held in check by swing supply out of Africa.

Volatility keeps RIO in Add territory

After updating our model for the 3Q18 result, and slowing the assumed rate of cost inflation, we have increased our valuation-derived price target – Morgans clients access only. With a 10% TSR, we maintain our Add recommendation. The key risk to our call remains commodity price risk.

More information

Morgans clients can login to view our detailed report and increased share price target for Rio Tinto (RIO). Alternatively, please contact your nearest Morgans office for access.

Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.