Brokers Question Rio Tinto’s Guidance

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

-Is the new CEO under promising?
-Subdued outlook for iron ore prices
-Will prices offset lower shipments?
 

By Eva Brocklehurst

Iron ore remains the key commodity in terms of the outlook for Rio Tinto ((RIO)), brokers maintain. The company has held onto its 2016 Pilbara guidance, expecting shipments around 332mt, but has pulled back its 2017 guidance to 330-340mt from 350mt — the main change noted in the March quarter production report.

March quarter iron ore shipments were up 11% on the prior March quarter but down 12% on the December quarter. This did not surprise brokers as port export data pointed to the weakness. Bauxite and copper output were largely better than expected in the quarter, while thermal coal output was down 9%. Copper and coal guidance for 2016 are unchanged.

The company attributed the reduction in Pilbara guidance to the AutoHaul (driverless trains) project, but Deutsche Bank suspects the new CEO may just be re-setting expectations. The broker struggles to envisage how shipments will not exceed 340mt in 2017, considering an additional 20mtpa will be on line from Silvergrass and there is 8mtp of “creep” from other mines.

The suggestion that AutoHaul has encountered technical/implementation issues – if this is the case – puts into question the viability of the project, in the broker's view, given testing has been going on for years. Hence, Deutsche Bank suspects the new CEO may be under promising. The impact of lower production on iron ore price sentiment could be significant, and the broker observes Rio Tinto has the flexibility to beat the new guidance. This will not be known, however, until late 2017, the broker points out.

Credit Suisse believes the stock has reasonable discounted cash flow support but, with iron ore prices forecast to weaken in the second half and into 2017, the valuation metrics increase. The broker considers the valuation is fairly full and, given the subdued outlook for iron ore prices, some caution is warranted.

The Namuldi contribution to iron ore production should increase by 5mt in the December quarter as the second phase of incremental tonnes is delivered, Morgan Stanley observes. An investment decision on Silvergrass is also slated for later this year. Having allowed for construction to start in the second half of 2016, the broker suspects the timing of capital expenditure may need to be adjusted. Still, Morgan Stanley envisages this project will support Hamersley Iron's contribution to iron ore output.

The negative impact on earnings from lower shipments in 2017 should be more than offset by a positive price impact on the business, Ord Minnett contends. The broker cites recent Chinese data which suggests the near term outlook continues to improve.

Ord Minnett is in Deutsche Bank's camp on the AutoHaul technology, suspecting that there is more likely to be either a deliberate “value over volume” strategy or other potential production issues. The broker believes its 2017 iron ore price forecast of US$42/tonne now has upside potential after the company's report and incorporating the positive Chinese numbers.

Macquarie was not surprised at the reduced Pilbara guidance for 2017 and assumes peak production of 341mtpa from 2018. The broker lifts 2016 earnings estimates by 2.0%. Stronger-than-expected iron ore prices are expected to maintain some earnings momentum for Rio Tinto over the course of 2016 and drive material upgrades to consensus earnings forecasts. Macquarie continues to prefer the stock to BHP Billiton ((BHP)).

UBS was also unmoved by the 2017 guidance reduction, having already downgraded estimates on expectations the company would focus on value over volume. The broker suspects this may mean market sentiment turns more positive on price, especially if BHP Billiton downgrades its FY16 guidance in the quarterly report.

Citi is the least hopeful of those brokers monitored daily on the FNArena database, having recently downgraded the stock to Sell because of an ongoing bearish view of iron ore prices in the years ahead. There are four Buy ratings, three Hold and one Sell (Citi) on the database. The consensus target is $50.03, suggesting 2.1% downside to the last share price. Targets range from $42 (Ord Minnett) to $56.30 (Deutsche Bank).
 

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