Australia | Jan 21 2019
This story features RIO TINTO LIMITED. For more info SHARE ANALYSIS: RIO
Broker views centre on how Rio Tinto will carve up the cash pie stemming from asset divestments, as revenue continues to benefit from strong commodity prices.
-Brokers suspect a combination of more buybacks, special divs likely at the miner's February results
-Alumina division remains vulnerable to raw material price inflation
-Strong fundamentals have been matched by share price performance
By Eva Brocklehurst
Rio Tinto ((RIO)) performed strongly in the December quarter, particularly in terms of healthy volumes in both copper and iron ore. Copper production was the main surprise for brokers, exceeding forecasts because of an unexpected contribution from Grasberg, a resurgent Escondida and higher grades at Kennecott.
Iron ore guidance for 2019 indicates shipments of 338-350mt, which Macquarie notes is a wider range than has been the case historically. Mined copper production was 20% above what the broker expected because of a stronger performance from Oyu Tolgoi and the unexpected contribution from Grasberg, which has now been sold.
Mined copper guidance for 2019 is 550-600,000t. Guidance for the energy and minerals division is in line, bauxite is at the lower end of expectations. The results provided no game changers, in Credit Suisse's view. Iron ore continues to hold up a better than expected and should drive free cash flow. The broker expects the company will be slightly net cash into 2018.
Capital Management
Interest centres on capital management at the upcoming results announcement. Proceeds from asset sales during 2018 totalled US$8.6bn. Macquarie assumes the company will declare a US$2 special dividend and return US$3.3bn to shareholders from the sale of Grasberg.
UBS calculates there is US$4.4bn in divestment proceeds still to be allocated and this could be returned to shareholders by topping up the buyback, with either a special dividend or an off-market buyback of ASX-listed stock, although the latter would require shareholder approval at the April/May AGM.
Credit Suisse assumes a forecast 65% pay-out of second half earnings, noting there is an incremental US$1.7bn in existing programs that is still to be bought back. The broker suspects pursuing acquisitions would be viewed cautiously by the market unless there was a strong upside investment case.
Deutsche Bank expects another $4bn boost to shareholder returns at the February result, unless M&A arrives sooner than expected, and this will most likely be proportionally shared across the dual listing.
Citi also points to the US$1.7bn in existing buybacks, suspecting this will increase, given the sale proceeds from assets such as Grasberg, Kitimat Wharf/land and Dunkerque were not reflected in the prior announcements.
Commodities Outlook
Prices are buoyant for the key commodities the company produces and this is driving earnings momentum. Macquarie envisages an earnings upgrade cycle that will support the share price, maintaining an Outperform rating. Citi's Buy rating is driven by upside risk to estimates for spot commodity prices, particularly iron ore, and the potential for additional capital management.
On the other hand, Deutsche Bank, while positive about the stock, finds limited upside potential. The broker highlights the potential for a boost to copper volumes via acquisitions and remains positive on aluminium, expecting profitability to return over 2019 to this, the company's second largest business.
Citi also pulls back estimates slightly to allow for lower-than-expected realised aluminium prices. Nevertheless the broker still envisages upside to forecasts. UBS points out the weakness in the division reflected the transition from East Weipa to Amrun, although the company has noted a continuation of raw material price inflation, particularly in aluminium. The focus will now be on the ramp up at Amrun.
Credit Suisse downgraded the stock in December to Neutral, based on the macro environment, amid considerable concerns around China's steel markets. The broker asserts the call remains appropriate, expecting the next move in iron ore prices will be down. That said, Credit Suisse acknowledges there is plenty to like as a holder of the stock, most notably the balance sheet but also continued discipline on M&A and capital allocation.
Volumes in the alumina division, outside of bauxite, were flat and Morgans highlights weak prices and persistent cost pressures as a focus for the next result. Rio Tinto has built up a strong position, the broker accepts, after several years of refining and streamlining its business.
While there is some uncertainty about the future direction of the company's strategy the stock is, in the meantime supported by strong fundamentals that are matched by a positive share price performance. As a result the broker downgrades to Hold from Add.
FNArena's database has four Buy ratings and three Hold. The consensus target is $86.08, signalling 6.9% upside to the last share price. Targets range from $79 (Credit Suisse) to $94 (Macquarie). The dividend yield for 2018 and 2019 forecasts, at present FX values, is 5.6% and 5.0% respectively.
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