Australia | Feb 02 2007
By Greg Peel
It’s after lunch and the Rio Tinto (RIO) share price is down 2% to $76.62. Metals prices were largely lower last night, but adding to Rio’s unpopularity today is that the market had expected Rio to hand out some of its mountain of cash to its loyal shareholders, but didn’t.
Well actually, it did, but not nearly as much as drooling investors had hoped. Following a result that was pretty much in line with everyone’s expectations, Rio announced a full-year dividend of US$1.04 – 30% up on last year. Earnings were up 48% though, and what investors really wanted was a special dividend of some sort. Not happy Jan.
Analysts, however, were expecting nothing exciting, and were even largely surprised by the size of the dividend. US$0.98 was the consensus estimate. Given Rio has a solid track record of positive acquisitions, and commodity prices are supporting the push for more, why blow it all on a hand out?
Traditionally, you don’t buy mining stocks for their dividends. Smaller caps usually don’t even pay one. Commodity prices are meant to be volatile, meaning earnings are volatile, and yields similarly so. Miners are not a yield play. Just because high commodity prices have meant miners are awash with cash is no reason to think they’ll change their spots on that basis.
Only JP Morgan seemed slightly displeased with the lack of capital initiative. A 20% payout ratio is “overly conservative”, the analysts claim, but the general consensus from the rest of the brokers in the FNArena database is that hanging on to the money is a good idea, even if the market’s not going to like it in the short term.
It’s all a bit academic anyway, as the consensus on Rio remains “cheap, cheap, cheap”.
At 9.5x, the stock is undervalued, in many an analyst’s opinion. Hence we have an average target price in the FNArena database of $92.74 – 21% above the current trading price. JP Morgan is the high marker at $105.00.
Nevertheless, the B/H/S ratio, which one might expect to be a perfect score, is only 8/2/0. Both Macquarie and Merrill Lynch recently decided that although Rio is effectively undervalued, a bit of weakness in metals prices (which we’ve now seen) would no doubt cause the market to reduce positions. And so it has. Rio hit a post-May-correction high of about $82 and has bounced around on a lower trend ever since. Macquarie, however, is now forecasting a bounce in the copper price. SB Citigroup concurs.
But outside of Mac Bank and Merrills, everyone else has a Buy rating, in some cases “with ears pinned back”. The fact that Rio only reached $88 at the height of commodity euphoria pre-May, makes one wonder just how the miner is going to reach the average target. Metals prices would have to start going back to the moon.
The same can be said for BHP Billiton (BHP), of course. It, too, boasts an 8/2/0 ratio (yes, Mac Bank and Merrills) and an average target of $33.24 – 29% above the traded price.
Targets are, however, set for 12 months hence, as a rule. But while there are few analysts predicting commodity apocalypse, most are largely circumspect on future increases. Supply will eventually catch up, they argue (although they’ve been saying this for about four years now). In the meantime, global economic strength will keep prices strong, but not spectacular necessarily.
So how are Rio and BHP going to reach their targets?