Rio Tinto: Iron ore price trumps weak Q2

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
19 July 2021, 8:00 AM
Sectors Covered:
Mining, Energy

  • A soft 2Q21 operational result across key divisions, with lower iron ore, copper and bauxite production.
  • The lower output pales in comparison to ongoing robust iron ore prices.
  • Risks across RIO’s business, especially social, need effective mitigation.
  • We maintain our HOLD rating, with a slightly lower target price (login to view).

Event

Rio Tinto (ASX:RIO) reported a soft 2Q21 operational result, with most segments trailing estimates.

2Q21 iron ore production (100%) of 75.9mt (-9% pcp) was the lowest quarterly output from the Pilbara since 2015 (vs MorgansF 85.5mt). RIO is now guiding towards the low end of 325-340mt shipments guidance. And increased Pilbara unit cost guidance to US$18-$18.5/t (was US$16.7-$17.7/t).

Group mined copper production in 2Q21 of 115.5kt (-13% pcp) also disappointed (vs MorgansF 120kt), with RIO producing the least amount of copper since early 2017. RIO now expects 2021 group mined copper also at the low end of 500-550kt guidance. C1 cost guidance was unchanged at US 60-75 cents per pound.

RIO’s ali business was closer to our estimates, alumina and aluminium (both -1% vs MorgansF), while 2Q21 bauxite production of 13.7mt (-6% pcp) led RIO to again lower guidance toward the bottom end of 56-59mt guidance.

TiO2 production guidance for 2021 was removed given the significant security issues at Richards Bay that have seen operations suspended.

Analysis

All around a disappointing 2Q21 result in terms of output across the business, but the market (justifiably) remains more focused in the short term on the ongoing robust spot iron ore price.

The Pilbara performance was particularly disappointing, the second weak quarter in a row. While attributing this to multiple reasons, we believe the material tightness in the WA labour market and exceptional inflationary environment were the major contributors. This highlights additional risk as we head into 2H21.

Copper’s poor performance was more understandable, given the importance of Escondida to RIO’s copper business, which continues to struggle under a sustained COVID impact to its workforce. Kennecott had a smaller impact after an anticipated wall collapse (no injuries or ore dilution).

Forecast and valuation update

We have updated our model for the 2Q21 result, which has brought down our 2021 forecasts in line with RIO’s expectation for a low-end result from iron ore, copper and bauxite. This points to a better performance expected in 2H21.

We had already anticipated higher Pilbara costs, with our 2021 estimate US$18.9/t.

Post 2Q21 our valuation-based target price is lower at (login to view).

Investment view

We maintain our HOLD rating on a TSR basis, but we are sensitive to the capital at risk from the market’s confidence in record iron ore prices.

Long-term investors can still enjoy a high quality of earnings and dividend yield.

Price catalysts

August result, and shareholder return, expected to remain focused on cash dividends given FIRB’s limit on Chinese RIO major shareholder ownership level.

Short-term spot iron ore price volatility.

3Q21 operational performance against 2021 guidance.

Risks

China economic conditions (i.e. steel/iron ore demand drivers).

Changes to WA Heritage Act, a key risk for RIO’s flagship Pilbara operations which are on a tight reserve replacement schedule.

Country risk across portions of its business (Mongolia, South Africa).

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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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