Rio Tinto Lifts Capex In Renewed Focus On Growth

This story features RIO TINTO LIMITED, and other companies. For more info SHARE ANALYSIS: RIO

By Chris Shaw

Yesterday Rio Tinto ((RIO)) held its annual investor seminar and analysts at Macquarie have returned with the view that the key message from management was lacking in bells and whistles, but it offered an optimistic outlook as there is a new commitment to growth on the back of a far stronger balance sheet position.

The numbers offered by management show Rio Tinto’s gearing has fallen to 33% as at the end of the September quarter, while net debt now stands at US$22.3 billion. According to Macquarie net debt should be below US$20 billion by the end of this year thanks to strong margins in copper and iron ore adding to cash flows.

This improvement has allowed for an increase in capital expenditure to as much as US$6 billion in 2010, well above the previous sustaining level of US$2.5 billion, but an amount broadly in line with Macquarie’s existing forecast. The reinvestment of funds is expected to be highest in iron ore, coal and uranium, with little change to the level of funds being invested in the aluminium business.

Iron ore in particular will be a focus, Rio Tinto indicating its target is to expand capacity to an annualised rate of 330 million tonnes from its Pilbara operations by the end of 2015. Macquarie notes the plan implies only around 10 million tonnes per year of added capacity by the middle of 2012 before a more material 50 million tonne increase by the end of 2013.

It is this limited increase in the shorter-term that sees Macquarie remaining positive on the iron ore outlook as it notes the modest increase through to mid-2012 means no significant easing of pressure in an already tight market, which should be good for pricing in the sector.

Management also reiterated their commitment to the iron ore joint venture with BHP Billiton ((BHP)), which is expected to be finalised by the middle of next year. Credit Suisse sees scope for synergies from the joint venture to go beyond initial expectations, while the fact both companies are looking to lift production of iron ore into the seaborne market is likely to be well received by regulatory authorities.

In contrast to the plans to expand production in iron ore, Macquarie notes the focus for the aluminium business will be on delivering synergy targets and cutting costs, with actions to include further reductions in staff and the closure of some high cost capacity. Credit Suisse points out part of the increased capex money will also be spent on coal projects such as Clermont, Kestrel and lifting production in the Hunter Valley operations.

As Citi notes, Rio Tinto’s growth options don’t stop there as new developments also offer potential upside, with projects such as Simandou (iron ore), Oyu Tolgoi (copper and gold) and La Granja (copper) set to be developed in coming years. One feature is management now will allocate capital by the quality of each asset’s opportunity, not on a portfolio approach to commodity selection.

Maquarie saw nothing in the details of the investor seminar to cause it to change its earnings forecasts for Rio Tinto, which in earnings per share (EPS) terms stand at US285.7c this year, US348.4c in 2010 and US417.6c in 2011. Credit Suisse also kept its previous forecasts of US269.2c, US300c and US420c for 2009-2011, while Citi is forecasting US287.4c, US385.2c and US463.6c respectively.

Citi and Macquarie see enough upside to rate Rio Tinto as a Buy, while Credit Suisse retains its Neutral rating. Overall the FNArena database shows a total of seven Buys and two Hold ratings. The aveage price target according to the database stands at $68.36, while Rio Tinto shares today are higher and as at 12.45pm the stock was up 49c at $63.28. Over the past year the shares have traded in a range of $29.91 to $86.60.

Click to view our Glossary of Financial Terms