Lower commodity prices have dragged RIO’s 1H23 result below last year but broadly in line with consensus forecasts. The Chinese economy is yet to recover meaningfully but RIO remains confident its iron ore earnings are in good shape. The big Simandou iron ore project in Guinea is now chewing into some serious growth capex as group capex heads towards US$10bn pa over the next few years.
Group EBITDA for 1H23 was US$11.7bn, below consensus of US$11.9bn with lower commodity prices the main drag together with higher operational costs. Capex of US$7bn left free cash flow of US$3.8bn to cover the US$2.9bn interim dividend of US177cps. Net debt sits at US$4.4bn.
Commodity prices reflected slower global economic growth. Iron ore was down -14% compared to 1H22, aluminium down -25% and copper down -10%. In aggregate, this carved US$3.3bn from EBITDA in the half year (Figure 1). Higher cash costs snipping a further ~US$900m although these costs are beginning to diminish.
Iron Ore. RIO shipped ~140mt and averaged US$107.2/dmt. C1 unit costs of US$21.2/t plus other costs of US$17.7/t left a margin of US$68.2/t equating to EBITDA of US$9.5bn. Operationally, the Pilbara iron ore business is performing strongly. Alongside medium term capacity to produce 345-360mtpa, RIO has growth options at Rhodes Ridge (RIO 50%) in WA which is a 6.7bt high-grade resource sitting adjacent to RIO’s existing rail, port and power infrastructure. The Simandou iron ore project in Guinea (Atlantic Coast of Africa) is one of the world’s largest known undeveloped high-grade low-impurity iron ore deposits in which RIO has ~45% interest. RIO reported expenses of US$318m (100% basis) in 1H23 for this project and it will account for almost half of RIO’s ~$3bn growth capex over the next few years.
Aluminium. Lower western market demand led to a 24% lower LME price for aluminium. Higher input costs for caustic soda, coke and pitch are beginning to ease but this will show up in 2H23. 1H23 EBITDA for aluminium was therefore down -60% to US$1.1bn. RIO reported a pre-tax impairment charge of US$1,175m relating to the Queensland alumina refineries (Yarwun and QAL) to recognise the newly legislated costs for Scope 1 emissions together with the cost of decarbonising these assets.
Copper. The highlight for RIO was the first underground production from the Oyu Tolgoi project in Mongolia. This project is expected to triple production to 500ktpa from 2028 to 2036 and RIO now has 66% interest. OT is one of the world’s largest copper and gold deposits.
Kennecott dragged on divisional performance and now faces a full rebuild of the smelter and an expansion of the underground mine to add ~250ktpa of mined copper over the next ten years.
Capex and Financials. Group capex for FY23 is guided to ~US$7.0bn and increasing to ~US$10bn over FY24 and FY25. Sustaining capex forms about US$3.5bn of the total over that period. Other than Simandou, RIO has a packed bench of enticing projects that adds appeal to the long term investment theme for RIO.
In copper, the Resolution (Arizona, USA), Winu (WA) and La Granja (Peru) projects have a range of hurdles to clear, but offer substantial growth assuming things go well.
In aluminium, the ELYSIS joint venture with Alcoa to create a new inert anode technology to eliminate all greenhouse gases in the smelting process is close to a commercial production stage. This could substantially impact the decarbonisation cost of RIO’s most challenging emissions issues.
In lithium, RIO has two projects at early stages of development – Jadar and Rincon - in Serbia and Argentina respectively.
The Rhodes Ridge and Simandou iron ore projects can expand and diversify the group’s largest earnings division well into the future.
With the balance sheet geared at 8% as at 30 June 2023 with US$4.4bn net debt, there is capacity to fund organic growth as described above. We note that RIO decreased its ‘clean up’ funding (close down and restoration costs) to US$14.8bn as at 30 June 2023. Free cash flow in 1H23 was obviously reduced by the lower operating earnings but left plenty of room for the dividend.
Figure 1: RIO Divisional Earnings
Investment View
For analysts fixated about next year’s earnings, the picture looks mixed for RIO. But obviously the company plans its business over a much longer time frame and in that respect, it presents a much brighter picture. If the global energy transition and decarbonisation theme plays out, demand for copper, iron ore and aluminium will be much higher than today. Decarbonisation is an internal cost to RIO, but an external opportunity given the product demand profile.
RIO wants to double its annual copper output by the end of the decade through brownfield and greenfield projects. The dominant (earnings) Pilbara iron ore division is humming and although Chinese demand is less than vigorous currently, the company remains confident.
RIO looks fairly valued at under 6x EV/EBITDA, similar to its peers (BHP, FMG). With a free cash flow yield of 7% in FY23 and dividend yield around 5%, this supports our Hold recommendation.
Risks to Investment View
Changes to commodity prices have the largest impact on earnings. RIO is also exposed to a variety of regulatory and environmental issues that could change. Global demand for raw materials may change depending on economic growth trends. Financial risks include funding access for growth investment which may become harder to secure on ESG grounds.
Recommendation
We have retained our Hold recommendation.
