Rio Tinto: No Soup For You

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While Rio Tinto’s earnings were roughly in line with forecasts, a surprising low dividend payout was the focus of attention.

-Rio Tinto H1 earnings largely in line
-Capex guidance reduced
-Surprise at only a 50% dividend payout
-More M&A?

By Greg Peel

Rio Tinto’s ((RIO)) first half earnings result was equally a bit below, a bit above or a in-line with forecasts from the brokers in the FNArena database.

The result was nevertheless down on the prior first half, reflecting sector-wide headwinds of cost inflation, supply chain constraints, covid absenteeism, weather and so forth, which has been the decisive theme of this month’s June quarter updates from the various miners on the ASX.

But Rio’s cash position came in stronger than most expected, because capital expenditure was lower in the half than forecast. Management has cut full year capex guidance, but the lower figure in the first half still means a step-up in spending in the second.

FY23-24 capex guidance is unchanged.

So with even more cash available than brokers had assumed, and no debt on the balance sheet, it was obvious shareholders would be in for a cracking dividend payout, perhaps including a special.

Not so. Broker forecasts for the payout ratio ranged from 60% to 75% heading into the result. In the first half of 2021, Rio paid out 75%. This half it is paying only 50%.

 Why play Scrooge?

Given current volatility in commodity prices, management explained they wanted to be conservative and see how conditions play out by year-end. We note that commodity prices surged on the Russian invasion, crashed back on Chinese lockdowns, peaked again on Chinese re-openings and then crashed again as recession fears gripped the globe.

Fair enough then. But even with iron ore prices around at half of last year’s peak, Rio and peers are still cash-generating machines.

Brokers suspect management may look to a more handsome payout for shareholders after the second half. Maybe that’s when a special dividend will be delivered. Rio typically exhibits an earnings skew to second half.

But while 2022 capex guidance is lower, there is still plenty to spend in the second half and in 2023-24, so that’s one reason to hang on to cash.

Another is management’s counter-cyclical investment strategy, ie, making acquisitions at lows on commodity prices rather than highs. The balance sheet may be maintained at elevated cash levels in order to exploit further opportunities.

JPMorgan suggests that following the recent Rincon lithium deposit purchase (Argentina), and given community opposition to the Jadar lithium project in Serbia, Rio is likely to pursue further lithium acquisitions.

Recently Rio offered to buy the remaining 49% of Canadian-listed Turquoise Hill it doesn’t own, putting the company in a better position to negotiate with the Mongolian government with regard the massive Oyu Tolgoi copper-gold project. The deal remains outstanding.

JPMorgan wouldn’t be surprised if Rio also looked for other copper projects while prices are low.

There’s little disagreement on the M&A front from other brokers.

Undaunted

Ord Minnett white-labels JPMorgan’s research and the broker has retained its Hold rating, while easing its target to $199 from $102.

Credit Suisse and UBS are yet to update, but among the other database brokers there has been no change to either ratings or target prices in the wake of the surprise dividend announcement.

All of Morgans, Morgan Stanley, Macquarie and Citi have retained Buy or equivalent ratings. Credit Suisse was on Buy and UBS on Hold.

None of the above have changed their targets (yet), with Ord Minnett’s decrease taking the average database target down to $110.79 from $111.36.

At the time of writing, Rio is trading at $59.42, which makes Ord Minnett’s Hold rating on a $99 target seem odd, but the broker feels macro uncertainty, reflected in Rio’s conservative dividend, will keep investors on the sidelines in the short term.

That said, investors have pushed the stock up 0.5% today (so far).

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