Rio Tinto: Big earnings cushion headwinds

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
24 February 2022, 3:30 PM
Sectors Covered:
Mining, Energy

  • A full year result mostly as expected. With lower 2H21 earnings from falling iron ore prices and broad cost pressures, albeit remaining at healthy levels.
  • RIO lifted its payout ratio for a final dividend of US$4.79ps (vs MorgE $4.94).
  • 2H21 C1 iron ore costs of US$19.3/t now sit above both BHP (US$14.74/t) and FMG (~US$16.61/t), with RIO guiding to US$19.5-$21.0/t in 2022.
  • Unique conditions, with RIO posting record earnings but now facing operational and cost pressures on multiple fronts and stubbornly high capex (mostly not linked to growth).
  • We maintain our Hold rating with a (login to view) target price.

In line earnings and dividend

In 2021 RIO posted record annual underlying EBITDA of US$37.7bn (vs MorgE US$38.2bn vs Visible Alpha consensus US$38.5bn). Underlying NPAT of US$21.1bn (vs MorgE US$21.4bn vs consensus US$21.7bn).

Segments wise: 2H21 iron ore EBITDA declined -29% hoh to US$11.5bn (vs MorgE US$14.3bn vs consensus US$12.0bn) on lower benchmark prices and rising costs; Aluminium had a strong year, with ali EBITDA of US$4,382m +104% on pcp (vs MorgE US$5,014m vs consensus US$4,641m) although costs were a drag; RIO’s copper business was solid and in line with consensus at 2H21 copper EBITDA of US$1,969m (vs MorgE US$1,438m vs consensus US$1,999m); Minerals were also slightly ahead at US$1,205m (vs consensus US$1,075m).

Supported by the strong earnings, RIO flexed its payout ratio to 84% for a final dividend of US$4.79ps (vs MorgE US$4.94 vs consensus US$4.57).

2H21 C1 costs in iron ore averaged US$19.3/t, sitting above close peers BHP (US$14.74/t) and FMG (~US$16.61/t). This could get worse in 2022 if further delays occur due to supply chain issues or other COVID-related constraints.

Interestingly of the US$7.4bn in capex spent during 2021, only US$0.6bn was on new growth. The remainder consisted of US$3.5bn of maintenance capex and US$3.3bn of mine replacement spend. RIO reaffirmed that capex would step up to ~US$8bn in 2022, and US$9-$10bn in 2023/24.

2022 could be more difficult for RIO, we guidance pointing to some volume gains from iron ore and copper vs a material step up in opex. Iron ore cost guidance this year has increased from US$18.00-$18.50/t to US$19.50-$21.00/t. While copper opex is set to jump 70% to US$1.30-$1.50/lb (from US$0.82/lb in 2021, which was just above guidance).

Analysis

Despite having reported record earnings, the focus now is shifting to headwinds, with questions on whether RIO can:

  1. Deliver Gudai-Darri startup in 2Q22 as any further delay would likely see guidance downgrades;
  2. Make progress on labour and procurement constraints in WA;
  3. Contain the expected 70% increase in copper unit costs in 2022;
  4. ‘Right the ship’ in lithium after having its permits revoked by the government;
  5. De-risk Oyu Tolgoi underground (development and fiscal terms); and
  6. Maintain an attractive yield if metal prices moderate.

Having seemingly lost its Jadar lithium project, and facing years of US$8-$10bn pa in capex (a minority of which will be spent on growth), we see potential for RIO to consider pursuing new growth through M&A.

Forecast and valuation

We have updated for the 2H21 result and new 2022 guidance. Making a number of adjustments to production, unit costs and capex across the business.

Investment view

Still enjoying robust FCF generation and dividend profile, but managing some nearterm risks and typically under pressure once ex-dividend, we maintain a Hold rating on RIO with a revised (login to view) target price.

Price catalysts

Ex-dividend date; 1Q22 operational result; Gudai-Darri startup.

Risks

Execution risk in the Pilbara and Mongolia; COVID risk to operations/demand.

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