Rio Tinto: Half a decade of bumper returns

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
18 February 2021, 2:00 PM
Sectors Covered:
Mining, Energy

  • A solid 2H20 result from Rio Tinto (ASX:RIO), with underlying EBITDA 1.4% ahead of consensus and underlying NPAT a more meaningful 6% ahead of expectations.
  • With a strong balance sheet and undemanding capex profile, RIO is paying out all of its FCF generated in 2020 in ordinary and special dividends.
  • Significant cost headwind with a stronger AUD pushing Pilbara unit costs from US$15.4/wmt in 2020 to an expected range of US$16.7-$17.7/wmt.
  • A difficult outlook for RIO’s flagship iron ore business, with risks to 2021 reserve replacement from the new Heritage Act, and dynamics around Simandou.
  • Our target price is revised from A$113 (login to view), we maintain our Hold rating.

Strong end to the year

RIO posted FY20 consolidated revenue of US$44,611m (vs MorgE US$44,865m vs consensus US$46,345m), with iron ore and copper price strength major contributors to the strong result. Underlying EBITDA of US$23,902m (vs MorgE US$24,554m vs consensus US$23,583m) was slightly ahead of consensus estimates.

Underlying NPAT was US$12,448m (vs MorgE US$11,746m vs consensus US$11,788m). This saw RIO produce US$9.4bn in free cashflow, which is close to the amount paid out in dividends during the year.

Growing cost pressures, particularly in its flagship iron ore business, were also a highlight with RIO battling a high AUD and transitioning some operations.

Several balls in the air

RIO is navigating through a new Heritage Act while delivering 90mtpa of reserve replacement, deciding what to do with Simandou, combating cost pressures across the business, re-negotiating with the Mongolian government on Oyu Tolgoi underground, and deciding which growth projects to support (Gudai-Derri, Jadar, OTUG, Winu, Resolution and further mine development in the Pilbara (Gudai-Derri Phase 2 and Western Ranges).

While overall wanting to remain conservative, RIO did comment in the result that it is aware it must be willing to take some risks.

Big dividend profile could stay

Looking at 2020, RIO will pay out almost all of its FCF in ordinary and special dividends with an average payout ratio of 73% in 2020. This appears reasonable with an already strong balance sheet (net debt ~US$0.6bn), bumper iron ore and copper earnings, and a very manageable capex profile.

Interestingly 2020 was the fifth consecutive year RIO has paid out more than the 40-60% of underlying earnings outlined in its dividend policy.

Hovering around fair value on TSR basis

We see RIO in a strong position fundamentally with group ROCE of 27%, EBITDA margin of 54%, and estimated dividend yield of 5.5%.

Although it is clear the company has its work cut out for it in terms of progressing some of its growth projects (OTUG, Pilbara reserves replacement, Simandou, Winu, Resolution, etc), we are impressed with the lengths RIO is taking to meaningfully improve its ESG profile.

Comparing its iron ore reserves to production highlights that RIO has the greatest dependency on reserve replacement during a time of increased risks given the upcoming new Heritage Act. After updating our estimates for the result our target price has been adjusted (login to view).

We maintain our Hold rating on a TSR basis, believing RIO still offers attractive resource sector exposure. The key risk to our call is China macroeconomic related.

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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.

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