Quarterly Production Report Confirms Value In Rio Tinto

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

By Chris Shaw

With its recent capital raising behind it market attention has returned to the production side of the ledger for Rio Tinto ((RIO)) and here the company didn’t disappoint this week. Rio Tinto’s June quarter production report, released on Wednesday, broadly met market expectations. Bank of America Merrill Lynch notes this was especially the case for the group’s key commodities of coal, copper and iron ore.

Citi and UBS also comment iron ore volumes were strong in the period, being 16% above the latter broker’s estimate, while Deutsche Bank suggests the result means the company’s target of producing 200 million tonnes of material from its Pilbara assets this year now appears achievable. Such an outcome had appeared to be something of a stretch just three months ago.

Even the group’s aluminium operations matched Bank of America Merrill Lynch’s forecasts, while Citi notes the modest fall in output in this division in the period shows the company is one of the lower cost producers of the metal in the global market.

Minor changes to earnings forecasts have flowed from the result, Deutsche Bank noting currency moves and spot metal prices mean some risk to interim and full year earnings remain. Bank of America Merrill Lynch has adjusted its numbers post the production result, cutting its full year numbers this year, but lifting its FY10 estimates.

The end result is earnings per share (EPS) forecasts by the broker of US253c this year, US286.1c in 2010 and US298.5c in 2011, which compares to Citi at US241.8c, US321.1c and US336.5c respectively and Deutsche Bank’s 2009 and 2010 forecasts of US225c and US307c. Credit Suisse is forecasting EPS of US247.8c in 2009, 231c in 2010 and US323.2c in 2011, showing brokers remain some way apart on their estimates.

Where there is less divergence is in respect of ratings on the stock, the FNArena database showing Six Buy ratings compared to one Hold, with three brokers currently restricted from providing a recommendation. Bank of America Merrill Lynch argues there is value in the stock at current levels as the company is trading on a similar multiple to its diversifed peers, this despite getting virtually no contribution from its aluminium assets at present.

This means the current price gives investors a free option over improved returns from this division, while on relative value grounds the broker sees upside as on its numbers the shares at present are trading at a 13% discount to net present value compared to BHP Billiton ((BHP)) stock at a 16% premium.

UBS agrees there is better relative value in Rio Tinto than BHP at present given the larger discount to valuation, though UBS also notes there may be some shorter-term headwinds the company faces that don’t impact on BHP to the same extent such as the market settling down after the group’s recent equity raising.

Citi as well is among those with a Buy rating on the stock as it suggests the equity raising has repaired the company’s balance sheet, so de-risking the stock from an investment perspective. The broker has a price target of $66.00 per share on Rio Tinto, so with the stock trading below $50.00 as of yesterday’s close on the market there appears value.

The average price target according to the FNArena database is $63.50, with a fairly narrow range given Citi is equal top with its target and the lowest in the market is Credit Suisse at $60.00. Shares in Rio Tinto today are stronger in line with the broader market and as at 11.35am the stock was up $2.22 at $52.30.

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