Rio Tinto - In great shape in uncertain times
About the author:
- Author name:
- By Adrian Prendergast
- Job title:
- Senior Analyst
- Date posted:
- 14 July 2020, 2:40 PM
- Sectors Covered:
- Mining, Energy
- We review how RIO is positioned ahead of the upcoming June quarter result and half year earnings result.
- Lifting short-term iron ore, copper and ali opex, and a mark-to-market on metal prices, has seen a net reduction in our earnings estimates for FY20-FY22. With Covid-19 restrictions likely to drag on RIO's cost performance, even with a weaker Australian dollar.
- Boasting a strong investment profile, RIO is trading on EV/EBITDA of ~6.5x, with a 5% dividend yield, steady earnings, 43% EBITDA margin, and no dilution risk.
- We maintain our Add rating, with a revised target price (Morgans clients can login to view detailed reports and price targets).
Listen to the podcast
Key income source for investors
In difficult economic conditions, where even the 'big 4' banks are expected to not pay any dividends, we view RIO with its robust earnings and large dividend profile as offering significant investment appeal.
While metal prices are volatile, we view the strong restart of China's economy combined with global synchronised stimulus as key sources of support for demand fundamentals.
Depending on the commodity pricing scenario, we forecast RIO to sustain dividend yields of 5-7% over the next three years.
We view this yield profile as likely to see RIO's market valuation remain supported over the next year, with further upside potential.
Narrowing our focus on JuneQ and H1'20 results
RIO is due to release its June quarter operational result on 17 July, and its half year earnings on 29 July.
For its quarterly we expect a strong performance from RIO's flagship West Australian iron ore business, supported by strong iron ore export data.
While we also anticipate a strong set of numbers from RIO's first half earnings: 1H20F NPAT US$3,680m (vs consensus US$4,183m) and interim dividend of US$1.59 per share (vs consensus US$1.45).
With gearing already at low levels and CY20F capex guidance recently reduced to US$5-$6bn, we see little gaps in RIO's robust earnings and free cash flow (FCF) generation.
Virus costs vs weaker dollar
In terms of operating cost performance, we expect this half will see a case of rising costs from operational changes stemming from Covid-19 restrictions, versus a weaker Australian dollar and some incremental efficiency gains.
Net of factoring in these changes, we have lifted our medium-term forecasts for operating expenses across RIO's iron ore, copper and aluminium operations.
This has seen our EPS forecasts reduced in CY20F -27%, CY21F -13%, and CY22F -6%.
Maintain Add rating
We have also mark-to-market metal prices, rolled our model forward, and trimmed RIO's WACC to 8.5% (from 9.3%).
The resilience of iron ore prices has remained a core support for RIO's strong earnings in recent years.
While we see some potential for iron ore to moderate in the second half (recovering Brazil supply, lingering economic fallout from virus, etc.) we expect RIO to continue to generate substantial FCF.
We maintain our Add rating with a revised target price (Morgans clients can login to view detailed reports and price targets). The key risk to our call remains demand conditions (metal prices).
For further analysis on resources stocks, Morgans clients can browse our latest research by logging in. You can also listen to more podcasts and our 'Sector Updates' playlist on Soundcloud. Alternatively, contact your Morgans adviser or nearest Morgans branch.
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.