Rio Tinto: Some big challenges in 2021

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
20 January 2021, 9:14 AM
Sectors Covered:
Mining, Energy

  • A good end to the year for RIO, with 4Q20 result steady vs full year guidance, and with iron ore and copper coming in slightly ahead of our estimates.
  • Some important challenges face RIO in 2021 in its core iron ore and copper businesses.
  • Pilbara iron ore faces an uncertain 2021 with unknowns around the new Heritage Act, which could hamper work to replace reserves.
  • Meanwhile, tension remains in Mongolia with the government not happy with the recent capex blowout, schedule slip and financing options at Oyu Tolgoi underground development (OTUG).
  • We see RIO as trading close to fair value, supported by strong fundamentals and an impressive dividend profile. We maintain our Hold rating.

Good end to the year…

RIO posted 4Q20 Pilbara iron ore shipments of 89mt (vs MorgE 86mt), for 2020 shipments of 331mt (+1% pcp) vs guidance of 324-334mt. Flat 2021 guidance has been set at 325- 340mt, although is still contingent on weather and the outcome of the new Heritage Act. It was also a better-than-expected end to the year for copper, with 4Q20 mined copper of 133kt (vs MorgE 128kt), which was enough to come in above revised guidance of 475- 520kt.

RIO is also expecting flat copper output in 2021 with guidance of 500-550kt. In line with 2020 guidance was aluminium (3.2mt vs 3.1-3.3mt), alumina (8.0mt vs 7.8-8.2mt), and bauxite (56mt vs 55-58mt).

…but challenges remain

It is difficult to measure the risks the new Heritage Act poses to RIO’s reserve replacement plans in the Pilbara, something it badly needs to catch up on. In 2021 RIO aims to bring on new production at Robe Valley, West Angelas and WTS phase 2, while in 2022 it plans to bring on Gudai-Darri (formerly Koodaideri), for a combined 90mtpa in reserve replacement.

The challenges do not get any smaller in copper, where the Mongolian government is pushing back, flagging that it is not happy with the recent capex blowout, slip in schedule, financing options, and overall return profile of Oyu Tolgoi underground expansion (OTUG).

It appears likely the government will push for a larger share of the project’s return, which could drag on the value for RIO.

Changes to estimates

In addition to updating our model for the 4Q20 result, we have trimmed 2021 forecast iron ore shipments (now 334mt, was 352mt), mined copper (now 520kt, was 566kt), and alumina (now 8.0mt, was 8.2mt). These changes were more than offset by mark-to-market on metal prices. Net of these changes our target price (login to view).

Close to fair value

RIO is trading just above our A$109 target price, but still boasts strong fundamentals, on a FY21F EV/EBITDA of 5.8x, ROE of 39% and forecast dividend yield of 6.6%. As a result we maintain our Hold recommendation.

The key risk to our call is related to COVID-19 impact on macro drivers (commodity demand).

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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