- 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
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.
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.
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.
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