Rio Tinto Mostly Unscathed By Current Volatility

This story features RIO TINTO LIMITED. For more info SHARE ANALYSIS: RIO

Rio Tinto has a strong balance sheet and margin advantages, which should enable the resource leader to weather the current volatile environment.

-Copper outlook deteriorating amid weak industrial demand
-Aluminium market remains highly challenged
-Strong cash flow being generated from iron ore
 

By Eva Brocklehurst

So far, Rio Tinto ((RIO)) has escaped most of the ravages of the coronavirus pandemic as its operations continue with minimum curtailments. Still, the company has issued cautious guidance for 2020, particularly in the case of developments.

Most of the disruptions from lockdowns are in mining operations at Richards Bay in South Africa, and aluminium operations in Canada and New Zealand. Rio Tinto has investigated ways to mitigate the impact of the pandemic via roster changes, and is investigating and assessing the fabrication of long lead items in China and Europe.

Credit Suisse assesses there was nothing significantly different with the production report but there is undoubtedly a lot happening behind the scenes to respond to changing market conditions.

The company has signalled recovery rates may differ across regions and it will update the market once the situation stabilises. The main change to guidance for 2020 is a reduction in copper production, reduced by -50,000t to 475-520,000t.

While this may be a volatile year for commodities, Morgans considers the company's flagship Australian operations should avoid any major impact from the pandemic and allow Rio Tinto to benefit from its balance sheet and margin advantages.

There are minor labour-related delays across projects as a result of the pandemic and this comes amid the benefits of a weaker Australian dollar. Hence, capital expenditure is now expected to be lower in 2020, at US$5-6bn.

Rio Tinto notes major projects at Koodaideri (iron ore, Western Australia) and Oyu Tolgoi (copper/gold, Mongolia) are on track. UBS is more confident about the former, as the Australian government has supported ongoing operations, whereas Oyu Tolgoi appears more at risk because of its reliance on experienced expats to progress the works.

Macquarie found cuts to capital expenditure larger than expected, as nearly half is attributable to a reduction in discretionary sustaining expenditure in iron ore. The broker calculates the cut to guidance is split 50-50 between delayed expenditure on Zulti South (mineral sands, South Africa), Kemano (aluminium, Canada) and Oyu Tolgoi and reductions in discretionary expenditure within the sustaining budget for Pilbara refurbishments.

Copper

Rio Tinto has pointed out the outlook for copper is deteriorating, and indication of negative industrial growth expectations globally. Mined copper production was -8% lower in the quarter, reflecting the lower copper grades and partially offset by higher throughput.

Citi points out although demand was reasonable in the first quarter a decline in the copper price reflects deteriorating industrial growth expectations. An earthquake at Kennecott (US) has meant operations are still getting back to normal but the mine, tailings storage and refinery have all resumed safe operations.

Rio Tinto has reduced 2020 mined and refined copper guidance by -16% and -10% respectively, because of a potential reduction at Escondida (Chile) in the second half and repairs from the earthquake damage at Kennecott.

Aluminium

Rio Tinto has acknowledged the aluminium market remains highly challenged, largely because of lower automotive production, and is changing the product mix to reduce proportion of primary metal being produced as a value-added product. The reviews of both the Iceland and New Zealand smelters are ongoing.

Iron Ore

The March quarter was seasonally softer for iron ore, with 72.9mt shipped, but since Cyclone Damien Pilbara production has recovered. The company has also boosted concentrate in the mix from Iron Ore Co (Canada).

Demand for high-quality iron ore products is robust, amid disruptions to seaborne supply and firm demand from China's steel mills. UBS notes iron ore inventory at Chinese ports is around 113mt compared with 140mt this time last year.

At least the Chinese steel industry is running, Shaw and Partners notes, and this is consuming iron ore, which is likely to account for more than 90% of 2020 earnings. The broker, not one of the seven stockbrokers monitored daily on the FNArena database, has a Buy rating and $94 target.

Morgans asserts the low point for bulk resources is likely to be down the track, concerned that demand destruction for iron ore in areas outside of China may overwhelm that country's recovery.

Marketability of Rio Tinto's products with be the important safeguard in this respect, the broker adds. Morgans ascertains the resources sector offers a more attractive dividend profile at this juncture versus several of the traditional high-yield sectors.

The database has three Buy ratings, three Hold and one Sell (Credit Suisse). The consensus target is $97.79, signalling 6.9% upside to the last share price. The dividend yield on 2020 and 2021 forecasts is 6.1% and 5.8% respectively.

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