Rio Tinto PLC (LON: RIO) - Increased focus on work culture and governance after Juukan incident

Rio Tinto is a metal and mining company that produces iron ore, aluminium, copper, diamonds and other minerals. The Company has operations in close to 36 countries, and it has 60 operations and projects. The Company operates mines, smelters and refineries, and it is the only mining company that does not produce fossil fuels. The Company mainly produces iron ore from the Pilbara region in Western Australia and aluminium is produced in Canada, Australia and New Zealand. In 2019, the Company generated revenue of USD 43.2 billion, an underlying EBITDA of USD 21.2 billion and the net cash generated from operating activities was USD 14.9 billion. Rio Tinto is included in the FTSE-100 index.

On 19 January 2021, Rio Tinto would release the fourth-quarter operational review.

Growth Prospects and Risk Assessment

Rio Tinto has delivered strong growth during the pandemic, which signifies the strength of its business assets. The Company is focussed on the Oyu Tolgoi project, and it would invest in high-quality assets in Pilbara, Kennecott and Zulti-South. It is also evaluating a programme at Winu for long-term growth prospects. The Company has maintained a strong shareholder return, which defines its growth pipeline and robust liquidity headroom. The demand for premium metals underpins stable growth, but it is exposed to volatility in the commodity prices. Adjacently, the Company is engaged in leading industry innovation as it uses technology at its core. The deployment of the right kind of technology has helped in identifying world-class assets, and it has also helped in tackling critical industry challenges.  

The Company caused heritage disturbance to Puutu Kunti Kurrama and Pinikura people as Rio Tinto destroyed the Juukan rock shelters in May 2020. The incidents that took place in Juukan Gorge landed the Company into legal obligation, and it also revoked the performance bonus for some of its senior employees for 2020. Any such incident in the future that harms the environment or heritage value of any community, while exploration and mining can lead to enormous fines, affect goodwill, or it can also cause cancellation of the mining license. Moreover, the external risks like foreign currency fluctuations, political uncertainty, change in government regulations and Covid-19 mayhem could impact the business operations in the near term. 

Industry Outlook Dynamics

The global economic activity in the third quarter was better than the previous quarter as most of the economies reopened. The current activity has build-up recovery in 2021. The stimulus measures in China have supported the demand for commodities. The current iron ore demand in China is strong and healthy volumes are expected in the fourth quarter. But as the steel consumption eases from the record consumption, the demand for iron ore would grow modestly. The countries such as Japan, South Korea, Taiwan and Europe have shown a mild sign of recovery, but the consumption is lower as compared to last year. The value-added aluminium products that are mainly used in the automotive sector have witnessed some demand; however, it is still below the pre-covid level. Adjacently, the rate of recovery in most economies have slowed, and the new lockdown measures can pressurize recovery.

After understanding the industry dynamics, we will analyse some key fundamental and shareholders statistics of Rio Tinto PLC

Recent Developments

On 11 September 2020: The Company stated that J-S Jacques would step down from his role as a Chief Executive and executive director of Rio Tinto. J-S will remain in his role until 31 March 2021. Chris Salisbury will also step down as Chief Executive, Iron Ore with an immediate effect. Chris will leave the Group on 31 December 2020. Ivan Vella will replace Chris Salisbury on an interim basis.

On 10 September 2020: Rio Tinto and Turquoise Hill Resources have entered into a MOU (memorandum of understanding). This MOU provides a pathway to progress the financing for the Oyu Tolgoi Underground Project. It also addresses Turquoise Hill Resources’ funding position.

Q3 FY20 Production Update released as on 16 October 2020

(Source: Company Website)

• The Company has delivered decent operational performance across most of the assets, particularly in iron ore.
• All Injury Frequency Rate (AIFR) improved through 2020 (0.35) versus 2019 (0.42).
• Pilbara iron ore production stood at 86.4 million tonnes, down by 1% against last year comparatives.
• In Q3 FY20, Bauxite production was up by 5% year-on-year to 14.5 million tonnes, with increased production across all sites (on year on year basis).
• With stable operations across the smelter portfolio, the Company aluminium production for Q3 FY20 was 1% higher than the third quarter of 2019.
• Led by lower grade at Kennecott, the mined copper decreased by 18% year-on-year in the third quarter. During the third quarter, the refined copper was 57% lower than the same period of 2019, primarily due to delays in restarting the Kennecott smelter.
• 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.
• Due to Covid-19 restrictions in South Africa, Quebec and lower market demand, the titanium dioxide slag production was 9% lower than the third quarter of 2019.
• In pellets and concentrate at Iron Ore Company of Canada (IOC), the production was 21% lower than the third quarter of 2019, driven by an annual maintenance shutdown deferred from June 2020 to September 2020 (due to COVID-19 travel restrictions).
• According to the market, Global economic activity was generally strong in the third quarter, with a widespread recovery in 2021. Further, the copper prices have reached a two year high with solid Chinese consumption supporting cathode imports.
• On 13 October 2020, the Company wrote a letter to Traditional Owners in the Pilbara for review all heritage disturbance and also shared the intention to modernise the agreements.
• Rio Tinto has shown great resilience, with a strong focus on capital discipline and value over volume approach. In the short, medium and long term, the Company continues to generate superior returns to shareholders.

Financial and Operational Highlights (for the six months ended 30 June 2020, as on 29 July 2020)

• 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%.
• 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 Group has maintained strength in the balance sheet, with a net debt of US$4.8 billion, and free cash flow of US$2.8 billion.
• The Company has shown a strong liquidity profile, with US$7.5 billion of Revolving Credit Facility undrawn throughout the crisis.
• 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.

Share Price Performance Analysis  

On 28 October 2020, at the time of writing (before the market close, at 11:13 AM GMT+1), Rio Tinto Plc shares were trading at GBX 4,298.50, down by 2.90% against the previous day closing price. Stock 52-week High was GBX 5,175.00 and Low of GBX 2,954.00, respectively.

From the technical standpoint, the shares were trading above the short-term support level of 200-day simple moving average price, which reflects a bullish signal for the stock. Also, we could see a positive movement in the share price based on the 50-day RSI level.

Based on 1-year performance, RIO has outperformed the FTSE All-Share Metal index and FTSE-100 index. RIO generated a return of 5.4%, whereas FTSE All-Share Metal index return was -4.04% and FTSE-100 return was -23.49%. The Company’s stock has delivered a positive return of around 17.36% in the last six months. In the last two years, Rio Tinto Plc share price has delivered 25.45% return as compared to negative 18.58% return of FTSE 100 index, which shows that the stock has outperformed the index during the last two years. 

Valuation Methodology: Price/Cash Flow Approach (NTM) (Illustrative)

Business Outlook Scenario

The mining and exploration have resumed to a normal level as the countries eased lockdown and the Company is managing the supply chain issues. The construction of the Gudai Darri is in progress, and the production is expected to ramp-up by early 2022. The Robe River joint venture is expected to deliver its first iron-ore in 2021. Rio Tinto would make a capital investment of USD 6 billion in 2020 and close to USD 7 billion in 2021 and 2022. The main focus is to enhance the asset base through completion of the original planned sustaining investment.

For full-year 2020, the Company expects Pilbara iron ore production in the range of 324 to 334 (Mt). The bauxite, alumina and aluminium production lie between 55 to 58 Mt, 7.8 to 8.2 Mt and 3.1 to 3.3 Mt, respectively. The mined copper output would be 475 to 520 kt, and refined copper production is expected in between 135 to 175 kt. The diamond yield would be 12 to 14 M carats. The Pilbara iron ore cost would be between USD 14 to USD 15 per tonne that includes the covid-19 cost of USD 0.50 per tonne. The copper C1 cost guidance is at 125 to 135 USD cents.

(Source: Company website) 

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 4,298.50 (as on 28 October 2020, before the market close at 11:13 AM GMT), with lower-double digit upside potential based on 6.90x Price/NTM Cash Flow (approx.) on FY20E cash flow per share (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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