Rio Tinto: Feedback from analyst roundtable

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
26 November 2021, 8:30 AM
Sectors Covered:
Mining, Energy

  • Years of significant underspend in the Pilbara have caught up with Rio Tinto (ASX:RIO) with current issues now looking more long term.
  • We boost long-term Pilbara sustaining capex and SP10 volume assumptions.
  • Added red tape post Juukan Gorge and COVID travel restrictions add extra risk. 
  • Lifting long-term sustaining capex and SP10 volumes has seen our valuation - based target price reduced to (login to view). Hold maintained.

Event: Sell-side analyst roundtable

RIO hosted a sell-side analyst roundtable with Simon Trott, Chief Exec. Iron Ore.

Our main feedback is that the meeting deepened our concerns around the long-term impact from what we have long considered a critical underspend in the Pilbara. RIO remains in the peculiar position for an iron ore miner of being mine constrained (with infrastructure normally the key bottleneck), with RIO now facing an increasingly tight schedule to bring on new replacement mines.

This is a key issue in a post Juukan Gorge and post COVID world, with:

  1. New mines facing extra layers of red tape (approvals a material risk),
  2. Fabrication issues with materials used to build its new mines (particularly steel from China), and
  3. Ongoing labour shortages also due to COVID-related travel restrictions.

The implications being RIO is struggling to maintain Pilbara iron ore volumes (particularly of its premium Pilbara Blend product) while sustaining capex is highly likely to remain at levels well above its peers for the foreseeable future.

We had previously viewed Gudai Darri as the solution to RIO’s operational problems in the Pilbara, but with the schedule for replacement mines now compressed it will not be enough on its own to right the ship.

Planned US$1.5bn capex spend on wind/solar power in the Pilbara is expected to remove the majority of RIO’s gas consumption, which makes up ~5% of total opex .

Analysis: Rock and a hard place

We have long considered RIO’s undersized developed reserves as a risk to long-term FCF performance. While this is now playing out it looks worse than expected.

A large and tight replacement schedule now looks likely to remain until at least 2030. After current work replacing 133mtpa of capacity by early 2022, RIO will move on to Western Range, Bedded Hill Top, Hope Downs 2 and Brockman Syncline 1 (with more to follow). This could see some creep but the majority is slated to replace depletion in the system (medium term guidance 345-360mtpa).

Our view is that these issues stem from a strategy of suppressing capex to maximise shareholder returns and capital management over a long period, rather than re-investing more steadily. Another potential contributor could be RIO’s ambition to be an innovator (automation/ESG), which could also have added to the longer-than-expected timeline on critical replacement mines like Gudai Darri.

Forecast and valuation update

We now include sales of lower-grade SP10 product at a 6% of sales mix, previously we had viewed SP10 as a temporary product pre-Gudai Darri. With total shipments unchanged in our estimates this has also seen lower Pilbara Blend sales.

We now forecast total annual iron ore capex to 2030 at an average of US$2.8bn/annum up from US$1.5bn.

Investment view

The difficult operating conditions at RIO’s flagship Pilbara iron ore business is unfolding just as the big miner launches an aggressive decarbonization strategy (US$7.5bn spend to 2030), which will further dent FCF generation.

With these risks in mind and RIO trading near our revised (login to view) we maintain our Hold recommendation.

Price catalysts

Q4 operational result.

Gudai Darri startup.

Risks

COVID risk to commodity demand. Iron ore price risk. Operational risks.

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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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