Raising Our Fair Value Estimate for Rio Tinto

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

Mark Taylor 21 February, 2011 | 6:09PM
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Analyst Note
Rio Tinto (RIO) generated record underlying fiscal 2010 earnings of $14.0 billion that came in 3.5% ahead of our $13.5 billion forecast--a very pleasing result, particularly from iron ore where earnings before interest and tax (EBIT) increased 150% to $15.6 billion. This division performed better than we anticipated, thanks to operating costs and rampaging prices. Iron ore unit costs rose a softer than expected 26% to $38 per metric ton, considerably less in Australian dollars. Compare that to the average $127 per metric ton price achieved--an 80% increase on fiscal 2009--or current $170 per metric ton freight on board spot prices. Iron ore earnings before interest, tax, depreciation, and amortisation (EBITDA) margin rose from an already impressive 57% to 70%. And the first half of 2011 is shaping up even better.

Iron ore more than offset mild underperformance from aluminium, copper and industrial minerals. By underperformance we mean falling short of our forecast. The worst in this regard was aluminium, though copper was more meaningful from a larger base. It should be stressed that both are considerably improved on full-year 2009, copper EBIT up 34% to $4.2 billion, and aluminium turning the corner from negative $1.0 billion EBIT to a $0.8 billion profit. This is still nowhere near good enough for aluminium and Rio has flagged further divestment. That said, we expect the fortunes of the light metal to improve due to delinking of alumina prices, a key aluminium input. A higher alumina price, reflective of underlying fundamentals, will lead to higher aluminium prices, just as higher energy prices will. Every $0.05 per pound move in aluminium price shifts our Rio earnings and valuation by 1% and 4%, respectively.

Group net operating cash flow doubled to $18.1 billion and net debt declined to $4.4 billion, gearing just 7%. Assisting was a decline in capital expenditure from $5.4 billion to $4.6 billion--both years low in the historical context--and a further $2.9 billion in noncore asset sales, a turnaround from a 200% gearing just 18 months ago. With a balance sheet like this, Rio can reward shareholder loyalty which included having to fork out $15 billion in 2009's entitlement issue. The company upped the final 2010 dividend from $0.45 to $0.63, well ahead of expectations, and announced a $5 billion share buyback by end 2012. This is still modest compared to current cash flows and will allow ample for growth expenditure. There is $12 billion of capital works approved, two thirds in the Pilbara. And Rio's $3.8 billion bid for Riversdale remains open. The dividend sets a new benchmark in the "progressive" policy, interrupted in 2009. We raise our valuation marginally and forecast a 30% increase in fiscal 2011 profit.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rio Tinto PLC4,578.50 GBP0.00Rating

About Author

Mark Taylor  is an equity analyst at Morningstar.