Rio’s Quarterly Production Report Well-Received

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

By Chris Shaw

The December quarter has proved to be a solid one for production at Rio Tinto’s ((RIO)) mining operations, the diversified miner delivering a result UBS notes was at the upper end of guidance. Iron ore and copper are the standouts.

Iron ore production for the period was enough to lift full year output to 218 million tonnes, slightly above guidance of between 210-215 million tonnes. It was a similar story in copper, full year output of 805,000 tonnes being better than guidance of 780,000 tonnes. UBS notes all other commodities were within their guidance range.

Morgan Stanley notes the lift in copper production was achieved through improved operating performance at Kennecott and Grasberg, while in aluminium it notes the recent improvement in market conditions has allowed the company to restart idle capacity at its Vaudreuil refinery in Quebec.

In iron ore, JP Morgan notes the successful implementation of new infrastructure and control systems has lifted output in Rio’s Pilbara operations, with the system consistently operating at above nameplate capacity in the second half of 2009. Overall, the result was enough for JP Morgan to lift its 2009 profit forecast by around 5%, meaning in earnings per share (EPS) terms it is now forecasting an outcome of US387.9c.

This should grow to US428.6c in 2010 and US514.4c in 2011, while UBS also lifted its estimates post the result and is forecasting EPS of US347c, US486c and US529c respectively. Morgan Stanley is at US227c, US449c and US593c for the same periods. This makes the stock relatively good value in Morgan Stanley’s view as on its mid-cycle numbers the shares are trading on a price to earnings ratio of around 10 times, which compares to BHP Billiton ((BHP)) at 14.3 times and its long-term average of around 15.5 times.

Most brokers covering Rio Tinto agree as the FNArena database shows the shares are rated as Buy seven times and Hold and Underperform once each, JP Morgan sharing the view the shares appears cheaper than BHP Billiton at current levels. On JPM numbers Rio is trading on a FY10 multiple of around 17.1 times compared to BHP at 22.1 times.

The other attraction, according to Bank of America Merrill Lynch, is as Rio Tinto continues to dispose of non-core assets and thus its balance sheet is strengthening, to the extent debt levels could be back down to around US$10 billion by late this year. BA-ML sees this as potentially putting capital management initiatives back on the agenda, something that would add to the attraction of the stock if it were to occur.

Cit however has downgraded to a Hold rating post the production report, taking the view while iron ore and base metals offer scope for upside earnings surprise, this is now priced into the stock. This suggests a period of share price consolidation is more likely and if the stock were to continue to rally Citi would consider becoming sellers of the stock. Supporting its downgrade is Citi’s calculation that on current forecasts the spot price to earnings ratio for Rio is bang in line with its historical range, meaning the stock is fairly priced without a further rally in commodity prices.

Post the quarterly result the average price target on Rio Tinto, according to the FNArena database, stands at $81.49, up from $77.63 prior to the result. Shares in Rio today are weaker and as at 11.10am the stock was down 52c at $78.63. This compares to a trading range over the past year of $36.01 to $80.14.

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