Australia | Nov 06 2006
By Greg Peel
Macquarie made a call to dump Rio Tinto (RIO) on September 12 this year as the strategists became alarmed with the possibility of a recession in the US. It was time to reduce resources, they said, and Rio should be the one to go. The stock price has done nothing but go up ever since. (The Macquarie resources analyst held Outperform).
UBS notes today that Rio has also outperformed its major competitor, BHP Billiton (BHP), over the last five months – mainly due to the fall in the price of oil (Rio is not into oil) but also because of better operational performance, as revealed in the quarterly production reports, and capital management announcements.
Nevertheless, UBS sees Rio continuing to outperform BHP as Rio has a greater weighting to the tightening iron ore market and BHP leans to the easing copper market. There is also a chance Rio will announce a special dividend, although other brokers disagree.
Credit Suisse suggests special dividends have “lost their appeal”, and expects Rio to look after its shareholders by growing its ordinary dividends and continuing the buyback strategy.
Rio management is very positive about the company’s outlook as well, and said as much at its investor briefing on Friday – resources analyst attendance was obligatory.
Twelve months ago Rio management resigned itself that the glory days may well be over, and that commodity prices would begin their much-anticipated reversion back to more realistic levels. Last week management explained its change of heart, suggesting that not only would mean reversion take some time yet, peak prices are yet to be seen. This is based on expected 4% global economic growth next year, and particularly 10% growth in China.
Merrill Lynch noted that Rio’s customer base is much more diversified now than it has been in the past, but there’s no denying the story is still all about China.
Management also highlighted its expectation that further supply disruptions would occur, and that cost pressures would be maintained. This has a lot to do with driving prices higher before reversion sets in, and the current time frame expectation – five years for iron ore and two years for copper – will likely be tested.
Those brokers expecting flat or lower iron ore prices at the next round of negotiations are now rethinking their estimates, and will likely join the band expecting price increases (See “Iron Ore Prices Expected To Increase”, 01/11/06). Copper looks likely to hit surplus in 2007, however, but the future still looks bright given Rio’s involvement in new start-up projects.
Management also made note of its expectations for big things in uranium, to which it is exposed through its majority holding of Energy Resources Australia (ERA).
There’s not much positive opinion management could have provided to make brokers rethink their recommendations anyway. All in the FN Arena database hold a Buy rating, with the exception of advisor Aspect Huntley, which pulled back to Hold on the share price run last month.
The share price closed yesterday at $79.45, but the FN Arena average target price stands at $97.74, or 23% higher. JP Morgan is top of the pops with a $105.00 (32% upside) target.
Market observers are polarised between believing the global economic slowdown, driven by the US, but including a pullback in China, will have the long-awaited effect on commodity prices (mean reversion) just as new capacity is coming on line, and between seeing little end to the China/India story, and a dearth of base metals supply in inventories and a lack of quality of new supply in bulks.
With nearly every broker in town calling Rio a Buy, there seems little upside in Rio management – those at the coal face, as it were – talking up its book for the sole purpose of exciting resources analysts.