Shareholder Returns In Focus At Rio Tinto

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While Rio Tinto's 2020 outlook remains buoyed by commodity prices, copper production guidance is lower than expected. The focus for brokers at the 2019 results in February will be shareholder returns.

-Analysts see scope for further substantial capital management
-December quarter iron ore seasonally strong, benefit from strong pricing
-Main disappointment is copper outlook at Kennecott

By Eva Brocklehurst

Rio Tinto ((RIO)) achieved on most production fronts in the December quarter, albeit the outlook for copper is somewhat weaker than many were expecting. The main focus for the February results will be a continuation of shareholder returns. Credit Suisse assesses the company can provide further substantial capital management at this time.

Macquarie, too, believes there is scope for a special dividend to be announced, expecting free cash flow yields will remain a proxy for cash returns to shareholders. The broker forecasts a US$1 special dividend on top of an ordinary US$2.50 dividend assumption.

2020 iron ore shipments are guided at 330-343mt, a number assessed to be conservative by Ord Minnett. Iron ore is a key commodity for Rio Tinto, as it drives a significant majority of earnings and the December quarter was seasonally the best for the company's exports.

Koodaideri is on track for first ore in late 2021 and the broker believes this project could allow Rio Tinto to blend product back to the Pilbara specifications. Material movements over in 2019 were the highest on record and an increased attention to waste material movement and pit development will continue in 2020.

The iron ore price achieved of US$79/t for the year was slightly higher than Ord Minnett forecast, albeit still below the benchmark. Macquarie assesses buoyant iron ore prices will underpin upgrade momentum and drive free cash flow yields of more than 10% at spot prices.

Ord Minnett downgrades to Accumulate from Buy, largely because of the strong run up in the share price. The broker remains attracted to the strong shareholder returns, expecting dividend yields of 5-6% over the coming year. Additionally, positive macroeconomic sentiment should be supportive.

Kennecott

The main disappointment for brokers are the copper grades at Kennecott. A higher, more consistent grade is not anticipated until late 2020 and the smelter will be shut for half the June quarter for standard maintenance.

This caused copper numbers in guidance to be around -10-20% below Morgan Stanley's estimates and is a driver of a negative revision to 2020 revenue estimates. Mined copper guidance is in the range of 530-570,000t, with refined copper at 205-235,000t.

A -US$200m provision will be charged to Escondida in Chile from cancelling the coal contracts after the signing of the renewable power agreements. Escondida production was -3% lower in 2019 on lower grades.

Oyu Tolgoi

There was no further insight for Oyu Tolgoi (copper/gold) and cost and schedule ranges are similar to what was announced in July last year. However, the company has decided to remove two of the three mid-access drivers, retaining one on the level of panel 0. UBS considers this quite a material re-design of the mine plan and Rio Tinto has acknowledged an unfavourable impact on the scheduling.

First sustainable production from Oyu Tolgoi is expected in May 2022 through to June 2023, having been delayed 16-30 months compared with the 2016 feasibility study. Capital expenditure of US$6.5-7.2bn has been outlined which does not include a US$1.5bn power plant.

Oyu Tolgoi may be less than 5% of the company's net present value but is strategically important, in the broker's opinion, given it is a flagship growth project that diversifies medium term production.

Bauxite production is forecast to be 55-58mt, along with alumina at 7.8-8.2mt and aluminium at 3.1-3.3mt. Continuing challenges have been noted in Pacific aluminium. The company has highlighted the challenges the industry faces and is currently in discussions with stakeholders, in particular with a view to energy pricing, in order to ensure global competitiveness. A decision on Tiwai Point in New Zealand is still to be made.

Meanwhile, a phased re-start of Richards Bay Minerals commenced at the end of December and normal production of titanium feedstock is expected early this year. Construction at Zulti South remains on hold. Titanium dioxide production guidance is 1.2-1.4mt in 2020.

The decline in diamond production is occurring at a more rapid pace than Macquarie anticipated, with Argyle expected to close in the fourth quarter of 2020 and Diavik in 2022. Guidance has been lowered to 12-14m carats in 2020 from the 17m carats produced in 2019.

There are two Buy, four Hold and one Sell rating (Credit Suisse) on FNArena's database. The consensus target is $99.27, suggesting -6.3% downside to the last share price. Targets range from $86 (Credit Suisse) to $112 (Ord Minnett).

The dividend yield on 2019 and 2020 forecasts is 6.5% and 5.4% respectively. Shaw and Partners, not one of the seven stockbrokers monitored daily on the database, has a Buy rating and $100 target.

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