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Sin Stock Special: Rio Tinto is Undervalued

Analysts have reduced the 'fair share price' of Rio Tinto due to a stronger pound and moving commodity prices - but the mining giant is still significantly undervalued 

Mark Taylor 17 October, 2013 | 5:30PM
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Read more on ethical and sustainable investing in Morningstar's Ethical Investing Week 2013.

We have decreased the share price at which we consider Rio Tinto (RIO) to be fairly valued estimate from £42.50 to £41.65, factoring in the stronger British pound. We only recently reduced our fair value estimate from £46.65 after revisiting capital and operating cost forecasts and consequently reassessing Rio's growth prospects. Iron ore, copper and aluminium remain the three largest segments for Rio, accounting for a little changed 95% of group fair value. However, the relative weightings have changed considerably. In Rio's case the majority stems from taking a hatchet to the aluminium segment for which we reduced fair value by more than half after cutting growth projections and increasing operating costs. Aluminium's contribution to fair value falls from 31% to 15%, a level more in line with copper's importance. Our copper fair value estimate is unchanged and its weighting increases marginally by virtue of the pie shrinking overall. Similarly, the iron ore segment fair value is unscathed, though weighting increases from an already high 56% to a dominant 70% share. Rio is by and large an iron ore story.

The 22% reduction in our Rio fair value chiefly reflected decline in the aluminium segment, the second-largest contributor to fair value overall. The contribution from most of the lesser segments, including energy coal, rises marginally with higher margins factored, but these are near immaterial to Rio's earnings. Copper and iron ore fair values are stable.

Rio Tinto is a top-tier global miner along with BHP Billiton (BLT), Brazil's Vale (VALE), and U.K.-based Anglo American. A world-class asset base and capable management make Rio Tinto one of the few miners to earn more than its cost of capital through the commodity cycle. Geographic and product diversification give the company relatively stable cash flows and lower operating risk than many of its mining peers. Most revenue comes from the relative safe havens of Australia, North America, and Europe, though operations span half a dozen continents.

Through selective acquisitions and grass-roots exploration, Rio Tinto has assembled a large portfolio of long-lived, low-cost assets. Operations include world-class hubs in aluminium, coal, copper, diamonds, gold, iron ore, industrial minerals, and uranium. This competitive resource base sets Rio Tinto apart from most of the rest of the pack and supports above-average returns for both the resource industry generally and its more select diversified mining peers.

This article is an extract taken from an analyst note. To read the full report Premium members can click here. Not a Premium member? Get instant access when you take a 14-day free trial.

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The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
BHP Group PLC2,443.00 GBX1.88Rating
Rio Tinto PLC5,569.00 GBX2.48Rating
Vale SA ADR15.57 USD0.26Rating

About Author

Mark Taylor  is an equity analyst at Morningstar.

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The Morningstar Star Rating for Stocks is assigned based on an analyst's estimate of a stocks fair value. It is projection/opinion and not a statement of fact. Morningstar assigns star ratings based on an analyst’s estimate of a stock's fair value. Four components drive the Star Rating: (1) our assessment of the firm’s economic moat, (2) our estimate of the stock’s fair value, (3) our uncertainty around that fair value estimate and (4) the current market price. This process culminates in a single-point star rating that is updated daily. A 5-star represents a belief that the stock is a good value at its current price; a 1-star stock isn't. If our base-case assumptions are true the market price will converge on our fair value estimate over time, generally within three years. Investments in securities are subject to market and other risks. Past performance of a security may or may not be sustained in future and is no indication of future performance. For detail information about the Morningstar Star Rating for Stocks, please visit here

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