Delays, Missteps Jolt Confidence In Rio Tinto

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Delays stemming from the pandemic amid ebbing demand conditions confront Rio Tinto, while there is also work to do to improve perceptions about its cultural sensitivity.

-Easing demand conditions suggest commodity inventory may build
-Risk mounts at Oyu Tolgoi
-Is the market underestimating potential changes to WA Heritage Act?
 

By Eva Brocklehurst

Rio Tinto ((RIO)) has called out an expansion of lockdowns stemming from the second wave of coronavirus that may threaten a global recovery. The company has indicated most economies are starting to slow as pent-up demand eases back.

While anticipating a strong performance in the fourth quarter from major seaborne iron ore producers, easing demand conditions are likely to mean inventory builds. Shaw and Partners asserts, if stock is building at Chinese ports, then the situation needs to be closely monitored.

Consumer demand remains the biggest risk for the December quarter, UBS believes, and Europe and the US could pay the price for "summer mobility" during which several countries lost control of coronavirus case numbers.

This is key to the outlook, Morgans agrees, as the potential for further global macro economic weakness stemming from the pandemic may impinge on demand for commodities.

Rio Tinto has also flagged weakening demand for iron ore as China's consumption eases back from record highs and scrap consumption increases. Pilbara shipments fell -5% in the quarter, to 82.1mt, largely because of port maintenance.

Mined copper production was down -2%, stemming from lower grade at Kennecott (US). Refined copper was -57% lower, primarily because of delays in restarting the Kennecott smelter. Titanium dioxide production was down -9% because of pandemic restrictions in Quebec and South Africa, and lower demand.

Attention is riveted on Mongolia, Morgans observes, as its government has rejected an updated feasibility study for the Oyu Tolgoi copper/gold mine without a reason, and there is material political risk for this important copper asset.

Goldman Sachs also envisages technical issues at Oyu Tolgoi, noting partner, Canadian-listed Turquoise Hill Resources, has provided a recent update that was negative compared with its estimates.

There are potential delays to first production from Winu (WA) copper because of discussions with traditional owners that have only just resumed since the pandemic halted travel. The company has re-started talks with the Guinean government to look at infrastructure sharing at Simandou, while the Zulti South (South Africa) mineral sands project extension is on hold.

Meanwhile, Morgans notes demand conditions are better for aluminium, which is encouraging, and the price environment for alumina/aluminium has improved. Still, Rio Tinto's Pacific Aluminium operations remain uncertain, experiencing sustained losses. The company has indicated if it cannot secure affordable energy sources it will have to take further steps to mitigate the impact.

Iron Ore

Buoyant iron ore prices are the main driver of the stock, Macquarie asserts. Free cash flow yields increase to more than 15% in the spot price scenario for 2021/22. Iron ore shipments are expected to be 324-334mt for 2020.

Rio Tinto has indicated all four Pilbara replacement mines are on schedule. Pilbara's production increased 4% in the September quarter with higher volumes from Yandi and Hope Downs. Cost guidance is US$14-$15/t and unchanged, although Macquarie notes there is some risk because of a stronger Australian dollar.

Ord Minnett believes the stock is trading on an attractive price and points to the dividend yield but acknowledges the short-term challenges in navigating cultural heritage that could have consequences in terms of production, capital expenditure and reserves. Nevertheless, the broker believes the likely impact will be small relative to the size of the company.

Cultural Sensitivities

There are likely to be ramifications for Rio Tinto from the reform of the Aboriginal Heritage Act in Western Australia and  the company is changing the way it approaches such heritage sites.

Shaw assesses it will require time to reinvigorate shareholder confidence. While Rio Tinto was a pre-eminent global miner for decades it has, since 2000, sustained several missteps which have, both culturally and in terms of dubious acquisitions, tarnished its reputation.

Rio Tinto is consulting on the range of options and supports an appeal to give greater voice to traditional owners in the decision-making relating to mining on their land. Several brokers believe the market is underestimating the potential effect on production and costs from this reform.

Goldman Sachs envisages elevated risk for the company in this area, with possible impact on future approvals in the Pilbara as well as production and capital expenditure. Citi points out an update on any potential impact is unlikely until late January 2021.

Shaw and Partners, not one of the seven stockbrokers monitored daily on the FNArena database, has a Hold rating and $99.99 target while Goldman Sachs, also not one of the seven, has a Neutral rating and $97.10 target.

There are three Buy ratings and four Hold on the database. The consensus target is $107.14, signalling 11.5% upside to the last share price. Targets range from $95 (Credit Suisse) to $121 (Ord Minnett). The consensus dividend yield on present FX values for 2020 and 2021 is 6.4% and 7.4%, respectively.

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