Investment implications
The market’s surly reaction to the smaller interim dividend ignores the fall in commodity prices and the weakening global economy. Rio Tinto is taking a safety first approach to its balance sheet while
stepping up the capex on its full dance card of projects. Lower average prices achieved for iron ore were offset by higher aluminium prices. Together with higher inflation and energy costs, this explained most of the fall in underlying 1H22 EBITDA to US$15.6 billion.
Shareholders may be disappointed with the capital management outcome for the half year. The reduced interim dividend was well down on the bumper 1H21 payment, when iron ore prices were much higher, but it was still substantially above the 50% interim ordinary average payout ratio targeted over the cycle. RIO CFO Peter Cunningham noted that the balance of the full year dividend is usually weighted to the final dividend when the Board has a fuller picture of its position.
RIO is still throwing pots of money at decarbonising its business. The company has previously outlaid its requirement to spend US$7.5 billion from 2022 to 2030. Capex for the next two years is being
guided to US$9-10 billion each year of which US$3.5 billion is sustaining capex. The balance sheet is indisputably strong with gearing at -0.5% providing the Board with flexibility. This includes the
proposal to acquire the minority interests in Turquoise Hill (US$2.7 billion) and the initial work on the underground copper-gold mine at Oyu Tolgoi in Mongolia. It also includes the much delayed Simandou
iron ore project in Guinea. In the long term, RIO sees the decarbonisation process as adding
resilience to its business and positioning it for a future where it can provide the materials necessary for a low carbon world. For example, RIO completed its acquisition of the Rincon lithium project in Argentina and has allocated a modest US$190 million to build a small lithium carbonate plant. The project could eventually scale up and this is what attracted the Ford Motor Company to sign an MoU for a significant offtake of Rincon’s production. RIO CEO Jakob Stausholm noted he had met with most of the major auto manufacturers in recent times, highlighting the closer relationships being built with manufacturers.
Pilbara iron ore production is being supported by the ramp-up of the new Gudai-Darri mine. Phase 1 of the mine will reach 43mtpa production by 2023. COVID and labour issues pushed unit costs higher in the period, but RIO sees FY22 unit costs steady at US$19.5- $21.0/tonne. Full year production guidance for the Pilbara region remains 320-335mt after 1H22 shipments of 151.4mt. The Platts Index for 62% iron ore fines was 26% lower than the same period last year.
Investment view
RIO is pointing at a weakening economic outlook due to the Russia-Ukraine conflict, rising inflation
and COVID restrictions in China. Perhaps that is causing the Board to circle the wagons on its capital
returns considerations despite the abundant balance sheet strength.
The company has a full slate of project investments on which to execute, so we do not expect any
acquisition activity in the near term.
Consensus earnings forecasts are likely to slip with the company clearly under cost pressure from COVID, labour, inflation, and supply chain issues.
The share price reaction to the lower dividend was misguided, in our view. Investors could look at this as an opportunity to accumulate the stock based on a sound long term strategy and solid financial position.
Risks to investment view
RIO’s reliance on China as a major ‘customer’ may be an issue of concern. Geopolitical tensions have spilled over in eastern Europe and the same could easily occur between China and Taiwan. We do not know how RIO would be affected if this happened, but it would clearly be material to earnings. We note that Chinese company Shining Prospect is a major shareholder in RIO with 10.3%.
Recommendation
We have retained our Hold recommendation.
Figure 1: EBITDA Sensitivity
Figure 2: EBITDA Factors
Figure 3:CAPEX (US$BN)
Figure 4: RIO Emissions Targets
