Rio Tinto PLC (LON: RIO) – Lucrative dividend policy and stable outlook

Rio Tinto Plc (LON: RIO) is a FTSE 100 index listed, Metals and Mining Company, which produces Iron Ore, Copper, Borates, Aluminium, Diamond, Salt and Titanium. The Company has a presence in 36 countries with around 60 operations across six continents, with a significant business spread in Australia and North America. It has a substantial business in South America, Africa, Europe, and Asia. Several industries, including the manufacturer of cars, smartphones, household, wind turbines and agriculture products, use the metals and minerals produced by Rio Tinto. It was founded in 1873 in Spain. After almost 150 years, it is counted amongst the largest producers of a range of essential materials and operating with a diverse portfolio.

On 16 October 2020, the Company expects to announce the Q3 FY20 operations review.

 (Source: Presentation, Company Website)

Key Fundamental Statistics

Industry Outlook Dynamics

As per the recent publication from Grand View Research, the market size for the global base metal mining market was valued at US$324.8 billion in 2018 and is projected to register a CAGR of 4.1% from 2018 to 2025. The growth driver includes the increasing demand for base metals from various sectors and the growth of residential and non-residential construction. Mining is a highly capital intensive and competitive industry, which massively impacts the environment and society. Therefore, it is imperative to consider all the stakeholders for sustainable success in the long run. It requires consistent investments in right skills and capabilities, building relationship with technology partners, suppliers and other stakeholders in the supply chain, regular measures to protect the environment and society.

In 2020, the economic turmoil has impacted the commodity supply, while restrictions pertinent to Covid-19 contagion has disrupted the supply chain globally. However, the Company affirmed in their business updated that the demand has started to revamp from China, as demand for iron ore and bauxite increased in the first quarter. Regarding the safety parameter, the RIO group had zero fatalities in 2019.

Growth Prospects and Risk Assessment

Rio Tinto leverages cost-synergies to optimize the operational structure to achieve sustainable growth. It has various value-accretive projects in the pipeline with low risk and higher production capabilities. It is well-positioned to take benefits from growth trends across the energy and industrial markets. It has a world-class portfolio of high-quality assets that perform well in all market conditions. It has a strong balance sheet and disciplined capital allocation, which underpins increasing investments, stable production, and superior returns to shareholders. Moreover, over the longer term, the Board of RIO expects total cash returns to shareholders to be in a range of 40-60% of underlying earnings. Despite the challenging market conditions, it has delivered 4% (year-on-year) higher net cash in H1 FY20 of US $1.1 billion, which reflects that it was able to offset the impact of the lower pricing environment. Furthermore, it has completed the first phase of ISAL smelter’s review in Iceland, which will enhance the competitiveness of smelters.

(Source: Presentation, Company Website)

However, the growth trajectory can be impacted by several factors. The aluminium industry continues to face challenging conditions. The inability to integrate the acquired business successfully could lead to inefficiencies and can impact prospective returns. The financial risk related to interest rates and foreign currency fluctuations may impact the business operations. The inability to sustain exploration and activity of ore reserves and resources. Moreover, the Covid-19 pandemic can impact the production guidance.

Key Shareholders Statistics

Synopsis of Recent Developments

1 September 2020: Rio Tinto reaffirmed first sustainable production from the Oyu Tolgoi project between October 2022 and June 2023.

19 August 2020: RIO expects the restart of the smelter in two months now, which has been delayed due to unexpected issues. Subsequently, the production guidance in 2020 for refined copper is now revised to 135 to 175 kt from the previous guidance of 165 to 205 kt. 

29 July 2020: The Company announced the interim dividend of US$2.5 billion, which means Rio Tinto PLC’s shareholders will receive 119.74 pence per share for the interim dividend.

8 April 2020: It had announced a final dividend for the full-year 2019 to be paid as 177.47 pence per ordinary shares.

Segment Analysis

RIO bifurcates the business into principal product groups. The revenue generation over the last three years can be seen in the image below:

(Source: Annual Report, Company Website)

Further, the consolidated sales revenue by destination is given below:

 (Source: Annual Report, Company Website) 

Financial and Operational Highlights (for the six months ended 30 June 2020, as on 29 July 2020) – Stable global growth with strong demand for premium products

(Source: Company Website)

• The Company delivered a resilient performance in H1 FY20, with an interim pay-out ratio at 53% of underlying first-half earnings (equivalent to 155 US cents per share). The interim dividend was 3% higher than the 2019 first half.
• Led by strong and stable operations, the Company generated an underlying EBITDA of US$9.6 billion, with a margin of 47%.
• The decrease in revenue was mainly due to lower aluminium prices and volumes for copper.
• Despite the impact of COVID-19, the capital expenditure increased by 13% year-on-year to US$2.7 billion, with US$1.2 billion of sustaining capital and US$1.5 billion of development capital.
• The Company increased the iron ore shipments by 3% year-on-year and was in line with the solid operational performance. This occurred during a period of robust pricing for high-quality products, which was driven by constraints in seaborne supply and strong demand from China.
• In aluminium division, it delivered a substantial increase in cash flow and strong underlying EBITDA, despite significantly reduced demand for the value-added product (VAP) and lower sales prices (due to the impact of COVID-19).
• In Energy & Minerals division, the Company has given a steady performance despite COVID-19 constraints.
• The net earnings were down by 20% year-on-year to US$3.3 billion, mainly reflected a US$0.2 billion higher impairment charge, US$0.3 billion increase in exchange rate losses and US$0.1 billion net additional closure costs for non-operating and fully impaired assets.
• The Group has maintained strength in the balance sheet, with net debt of US$4.8 billion, and free cash flow of US$2.8 billion.
• According to 30 June 2020 debt maturity profile, the reported gross debt decreased to US$13.6 billion, mainly attributable to the EUR 2020 bond redemption. There are no corporate bond maturities until 2024. The Company has shown a strong liquidity profile, with US$7.5 billion of Revolving Credit Facility undrawn throughout the crisis.

Financial Ratios – Strong Profitability Margins versus the Industry Median

Reported profitability metrics for the first half of 2020 were higher against the industry median, reflecting higher revenue generated and better control over expenses as compared to the industry. Also, it has decent fundamental metrics as it has maintained an EBITDA margin above 30% for the last many years.

Rio Tinto Plc has delivered a substantial return for the shareholders’ as return on equity (ROE) of 8.3% was higher as compared to the industry median of 2.7%. The ROE recorded by the Company in the past several years was considerably above the peer’s average. On the liquidity front, Rio Tinto Plc’s current ratio was lower than the industry median of 1.86, but it has sufficient liquidity to meet short-term obligations and has robust liquidity profile to tackle the uncertainty due to COVID-19 outbreak.

On leverage front, the debt-equity ratio was 0.35x, which was lower as compared to the industry median of 0.51x, reflecting that the Company is less leveraged as compared to the industry. 

Share Price Performance Analysis

Daily Chart as on 2 September 2020, before the market close (Source: Refinitiv, Thomson Reuters)

On 2 September 2020, at the time of writing (before the market close, at 8:27 AM GMT+1), Rio Tinto Plc shares were trading at GBX 4,706.00, up by 1.10% against the previous day closing price. Stock 52-week High was GBX 4,991.00 and Low of GBX 2,954.00, respectively.

Bullish Technical Indicators

From the technical standpoint, the shares were trading above the short-term support level of 100 and 200-day simple moving average price, which reflect a  bullish signal for the stock. Also, 14-day RSI seems neutral as it is neither in oversold nor in the overbought zone.

Rio Tinto Plc Vs FTSE 100 Index (1 Year)

(Source: Refinitiv, Thomson Reuters)

In the last one year, Rio Tinto Plc share price has delivered 13.52% return as compared to negative 18.58% return of FTSE 100 index, which shows that the stock has outperformed the index during the last one year.

Valuation Methodology (Illustrative)

EV/EBITDA Approach (NTM)

To compare Rio Tinto Plc with peers, EV/EBITDA multiple has been used. The peers are BHP Group Plc (EV/NTM EBITDA was 6.95x), Glencore Plc (EV/NTM EBITDA was 6.10x), Antofagasta Plc (EV/NTM EBITDA was 7.31x), Kaz Minerals Plc (EV/NTM EBITDA was 5.66x) and South32 Ltd (EV/NTM EBITDA was 5.70x). The Average of EV/NTM EBITDA of the Company’s peers was 6.35x (approx.).

Business Outlook

During H1 FY20, the Company increased iron ore shipment by 3% year-on-year, while maintaining Pilbara unit cash costs of US$14.5 per tonne (H1 FY19: US$14.6 per tonne). The cost guidance for FY20 is US$14 to US$15 per tonne. Despite the challenging market backdrop, the resilience in performance and strong balance sheet are reflected in their final and interim dividend. Moreover, the Board of RIO anticipates delivering total cash returns of 40-60% of underlying earnings over the longer term.

In the long run, the trend of income growth in emerging markets will continue to drive global commodity demand. Also, the evolving manufacturing sector in China will spur commodity demand. Furthermore, the evolving trends of electrification in a low carbon world underpins the potential growth for Rio Tinto.

(Source: Presentation, Company Website)

Moreover, Fitch Ratings had affirmed the stable outlook with Long-Term Issuer Default Ratings at ‘A’. which reflects, strong financial profile and financial flexibility. Therefore, the Company is well-positioned to face weaker demand in commodities markets and economic downturn, to emerge strongly in future.

Considering the decent operating and financial performance, higher profitability margins, lower debt, decent dividend growth rate, and support from the valuation as done using the above method, we have given a “BUY” recommendation on Rio Tinto at the current price of GBX 4,706.00 (as on 2 September 2020, before the market close at 8:27 AM GMT+1), with lower-double digit upside potential based on 6.35x EV/NTM EBITDA (approx.) on FY20E EBITDA (approx.).

*All forecasted figures and Peer information have been taken from Refinitiv, Thomson Reuters.

*Dividend Yield may vary as per the stock price movement.

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