Rio Tinto: Pilbara problems continue to build

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
19 January 2022, 8:30 AM
Sectors Covered:
Mining, Energy

  • A disappointing operational result from Rio Tinto (ASX:RIO), with flagship Pilbara iron ore again underperforming and 2022 guidance below consensus in most segments.
  • 2021 iron ore guidance was achieved, but only by boosting its sales of low-grade SP10 product to a significant 18% of sales.
  • RIO remains behind the schedule needed for critical mine replacements in the Pilbara to sustain shipments of its flagship Pilbara Blend products.
  • 2022 guidance also looks softer across most segments versus current consensus.
  • We maintain our Hold rating on RIO, although are highly cautious in the near term.

4Q21 operational result

Iron ore drag. 4Q21 iron ore shipments from RIO’s core Pilbara operations came in at 84.1mt (vs MorgE 84.4mt), which did achieve RIO’s revised 2021 guidance, but only after RIO ramped up its production of low-grade SP10 iron ore product.

SP10 increased to a staggering 18% of shipments, with RIO unable to sustain Pilbara Blend volumes after falling behind on critical mine replacement schedule. Gudai-Darri startup is now expected in 2Q22. RIO expects SP10 shipments to slowly decline over the coming years to a medium-term target of 6% of sales.

RIO set 2022 guidance. While showing some year-on-year improvement versus 2021, this guidance does appear soft, with most segments trailing consensus expectations according to Visible Alpha data.

Lithium exposure at risk. Also disappointing in the 4Q21 result was a further 1- year delay to 2027 to the estimated startup of RIO’s large Jadar lithium project in Serbia. RIO’s recent track record having arguably impacted its reputation as a safe operator, the miner is facing fierce local opposition to the development of Jadar. At this stage RIO is finding it difficult to secure an exploitation licence that would allow it to even conduct an Environmental Impact Study (EIS).

Copper steady. 4Q21 mined copper of 132kt (vs MorgE 127kt) was +6% qoq, with a steady performance from Escondida (Chile) despite an ongoing heavy COVID impact to its large workforce (hampering throughput and recoveries) while a nice beat from both Oyu Tolgoi open pit (Mongolia) and Kennecott operations (US).

Other. 4Q21 bauxite volume of 13.1mt (vs MorgE 12.6mt), with alumina production of 1.9mt (vs MorgE 2.0mt) and aluminium at 757kt (vs MorgE 786kt). While TiO2 production in 4Q21 of 228kt +9% qoq (vs MorgE 214kt) is gradually recovering.

Analysis

While RIO falling behind on mine replacement can be partly attributed to unforeseen factors such as COVID (causing labour shortages and procurement issues) and Juukan Gorge, we would argue that RIO would not be in this position if it had reinvested more consistently in its iron ore business through the previous two cycles. Instead RIO maintained a historically low capex level while maximising shareholder returns.

Despite several consecutive disappointing quarterly results we still see some resilient optimism built into both consensus and RIO’s implied market valuation.

Forecast and valuation update

We have lifted the amount of SP10 in the sales mix for 2022 to an average of 16% (from 9%), with some decline after Gudai-Darri startup in Q2. Trimmed 2022 Pilbara iron ore (now 326mt, was 354mt) and mined copper (now 533kt, was 540kt) production estimates.

Applied upgraded aluminium forecasts (summary of changes further).

Investment view

Net of the changes our target price has reduced to (login to view), with the lower 2022 outlook offsetting our increased optimism for aluminium. The risks facing RIO’s business undermine our optimism, while the stock does appear to be trading close to fair value. We maintain a cautious Hold rating.

We do not agree with the view that RIO is now cheap on a relative basis. And expect the next 12 months could see a further slide in market expectations.

Risks

COVID-19 related risks to operations/demand. Execution risk in Pilbara.

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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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