Australia | Mar 06 2007
By Chris Shaw
In the middle of last month Macquarie upgraded its rating on Rio Tinto to Outperform from Neutral, in part due to an expected improvement in the outlook for bulk commodities.
It seems the broker beat the pack in terms of noticing the change in trend, as JP Morgan has today pointed out the potential upside risk to earnings for the group from an improved iron ore pricing outlook.
The broker notes the market has been anticipating a 10-15% decline in iron ore prices for contracts from April 1 next year, with its forecast factoring in a 10% decline. But the latest figures suggest this may be too pessimistic, as Chinese imports remain very strong to start the year.
While some of this can be attributed to buyers attempting to get set before a tax increase in April the broker points out it was a similar scenario last year, so the 35% year-on-year increase in imports in January must also reflect ongoing growth in underlying demand.
When added to the fact the Indian government has imposed an Iron Ore Export Duty from the start of this month the view is increasingly positive, as the duty will push up contract prices but Chinese buyers are likely to accept the resultant increase as delays to supply expansions in Australia give them little option but to buy from the Indians.
This sets the scene for higher prices for next year’s contracts, the broker estimating a 5% increase in iron ore prices would add as much as 14% to group earnings on a full year basis, or about 10% given it only applies for about 75% of the year.
The broker notes this is about twice the upside available via BHP Billiton’s (BHP) iron ore operations, which supports GSJB Were’s suggestion investors should look for opportunities to switch exposure to Rio from BHP. Given the upside potential, JP Morgan has retained its Outperform rating.
Credit Suisse analysts are similarly positive but for different reasons, the broker noting a recent meeting with the outgoing and incoming CEOs, Leigh Clifford and Tom Albanese, suggests it will be business as usual in terms of the company following its strategy of traditional and prudent management.
Comments by the pair suggest the company’s positive view on China is unchanged, a factor that offers some comfort given the latest market correction globally has occurred as the Chinese stockmarket turned down.
Also positive is the company’s view on the uranium market, where it sees ongoing price strength given growing demand. Again this is good for the company given its exposure through Energy Resources of Australia (ERA), where the earnings outlook is slowly improving as the company moves closer to receiving market price for its uranium sales as old price contracts expire.
The FNArena database shows Rio Tinto as rated Buy eight times compared to two Hold ratings, with around 25% share price upside to reach the average price target of $93.42, which compares to a median price target according to Thomson One Analytics of $90.29.
Rio Tinto shares have rallied this morning in a stronger market, as at 11.00am the stock was 61c higher at $74.20.