Rio Tinto Interim Lifts Broker Expectations

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By Chris Shaw

Market expectations are for earnings forecasts to fall through the current Australian profit reporting season but Rio Tinto ((RIO)) has bucked that trend by reporting a better than expected interim result that has seen full year forecasts increased.

Rio Tinto reported underlying earnings for the period of US$5.8 billion, a result well above consensus of US$5.5 billion. Driving earnings was the iron ore division, where prices were better than expected following the move to quarterly contracts.

As BA Merrill Lynch notes, this allowed the division to beat expectations by better than 10%. With iron ore accounting for 71% of net earnings the strength here was more than enough to offset weaker than expected earnings in the copper and energy divisions.

RBS Australia expects Rio Tinto will continue to enjoy positive earnings momentum in the second half of this year, pointing out higher iron ore prices in the third quarter bode well for net profits for the division.

On the back of the interim result, RBS Australia has lifted its 2010 forecast by 9% to US$14.1 billion, while Deutsche Bank has increased its full year estimate by 3.4%. Citi has also lifted its full year earnings forecast by 7% to US$13.2 billion, while its 2011 forecast is largely unchanged at US$14.2 billion.

Consensus earnings per share estimates for Rio Tinto according to the FNArena database now stand at 776.9c this year and 873.4c in 2011.

Another highlight of the result was strong margins, while Citi also notes Rio Tinto is taking advantage of currently favourable conditions by strengthening its balance sheet. The broker estimates debt will fall from around US$12 billion to around US$5 billion by the end of the year.

With debt again under control the company is lifting spending on growth capex, Citi estimating total capex this year of US$6 billion, rising to US$9 billion in 2011. The latter forecast is up from US$8 billion previously.

Much of this capex will be directed at iron ore operations, with an expansion at Pilbara to 330 million tonnes per year the feature. Other projects where spending will be significant include the Simandou iron ore project, an expansion of concentrate capacity at Iron Ore Company of Canada and the Eagle nickel/copper mine. BA Merrill Lynch likes the return to a focus on growth and expects more growth initiatives to be announced in the coming months and years.

One potential impact of the increase in growth capex, according to RBS Australia, is a delay in capital management, which the broker suggests is at least one year away from becoming an option. The interim result was accompanied by a dividend of US45c and management has indicated a return to progressive dividend increases after a step back in 2009.

Deutsche Bank sees the return of dividend growth as a clear sign of confidence in the outlook for earnings. BA Merrill Lynch agrees, though it makes the point there will continue to be some volatility with respect to the global economic recovery. As investor confidence improves RBS Australia expects Rio Tinto will be re-rated by the market.

The FNArena database shows no changes in ratings for Rio Tinto on the back of the interim profit result, the company scoring eight Buys and one Hold rating, this courtesy of BA Merrill Lynch. Price targets are relatively unchanged, the average target according to the database now standing at $91.29, up from $90.68 prior to the result thanks to a $5.00 lift in UBS's target to $105.00.

Shares in Rio Tinto today are slightly weaker and as at 11.05am the stock was down 11c at $72.90. This compares to a range over the past year of $55.20 to $81.25 and implies upside of around 25% to the average price target in the database.

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