Everything at Rio Tinto is big. From the autonomous fleet of gargantuan iron ore trucks to the brontosaurus-sized balance sheet that is now deluging shareholders with capital returns.
Higher commodity prices were once again the principal factor behind the financial windfall. The iron ore price was up 45%, copper 50% and aluminium 46% - RIO’s three most important commodities.
Group underlying EBITDA increased 57.8% to US$37.7 billion and the resulting US$17.7 billion of free cashflow has allowed the company to pay out 79% of underlying earnings which is well ahead of its target 40-60% range through the cycle.
RIO’s capex profile is lifting towards US$9-10 billion in each of FY23/24f as the theme of decarbonisation adds to underlying project spending. Acquisitions would be on top of this amount. The US$7.5 billion of decarbonisation tagged for 2022-2030 is aimed at reducing RIO’s Scope 1 and 2 emissions by half from 31.1mt CO2e in 2021.
With such strong operating earnings and discipline on capex, RIO’s balance sheet has reached a net cash position of US$1.6 billion as at 31 December 2021. That is why the company doled out US$16.8 billion in dividends to shareholders in 2021.
It is important to understand that RIO’s operating earnings are very sensitive to changes in commodity prices. For every 10% change in the iron ore price from the end-2021 price of US$143.8/dmt, RIO’s EBITDA would change by US$3.6 billion. The other commodity sensitivities are shown in Figure 8.
Investment view
RIO’s damascene conversion to free cashflow and shareholder returns instead of the historic tunnel vision acquisition dogma is a theme shared with BHP. Global demand for commodities appears undiminished and, for copper particularly, could become even stronger as renewable energy and transport grows. RIO has dipped its toe into the lithium market with a US$2.4 billion commitment to the Jadar lithium-borates project in Serbia. Other lithium projects may follow.
RIO has a strong position in its segments and is performing at a high level. Where the company needs improvement is at the Board level where the mishandling of the Juukan Gorge destruction two years ago was poor. After 8 years on the Board, Simon Thompson will step down as Chairman and will be replaced by Dominic Barton on 5 May 2022. Mr Barton will have the job of embedding a “change in mindset and behaviours throughout the organisation in line with Rio Tinto’s new values”.
Shareholders will undoubtedly be pleased with the large returns this year which puts the dividend yield close to 10%. We see enough reason to own RIO, but there are some investment risks to consider.
Risks to investment view
RIO’s reliance on China as a major ‘customer’ is becoming an issue of concern. Geopolitical tensions have spilled over in eastern Europe and the same could easily occur between China and Taiwan. We do not know how RIO would be affected if this happened, but it would clearly be material to earnings. We note that Chinese company Shining Prospect is a major shareholder in RIO with 10.3%.
Recommendation
We have retained our Hold recommendation.
Commodity prices continue to dominate the changes in group EBITDA, but the control of operating costs is always a major challenge. Employee costs are 17% of total operating expenses, while shipping and freight (10%) and royalties (12%) are also material factors. RIO does not explicitly separate its energy costs, but we know aluminium is a significant consumer of electricity.
Iron ore prices continue to have the largest impact on earnings (73% of group EBITDA) even though it is only 35% of group operating assets. The average realised price for Platts Index 62% iron ore (FOB) was 45% higher during the year to US$147/dmt. The largest driving force behind this price rise was demand from China which once again produced over 1 billion tonnes of crude steel in 2021 (53% of world production) using RIO’s high quality iron ore. Product sales to China reached US$36.3 billion representing 57% of group revenue. Exports of iron ore shipments from the Pilbara Ports Authority (Port Hedland) have ticked up again after a brief dip late in 2021 to an annualised tonnage of over 550mt with 458mt of that heading to China. After producing 322mt of iron ore in 2021, RIO’s 2022 guidance range is 320-335mt (Pilbara, 100% basis).
The average LME copper price rose 50% in 2021 and that helped to increase RIO’s copper EBITDA by 90% to US$3.9 billion. The company’s main copper assets are located in the US, Mongolia and Chile, with potential big developments in Resolution Copper in Arizona, Winu in Western Australia and the Simandou project in Guinea.
Aluminium enjoyed a bumper year with EBITDA doubling to US$4,382 million on a higher aluminium price (+49%) and modestly lower production, plagued by poor weather.
