Rio Tinto: Have the good times ended?

About the author:

Author name:

By Adrian Prendergast

Job title:

Senior Analyst

Date posted:

28 July 2022, 7:00 AM

Sectors Covered:

Mining, Energy

• Rio Tinto (ASX:RIO) posted a reasonable 1H22 earnings result, although surprised us on pulling back its interim dividend to 50% payout with no special dividend.
• We do not view the cut in dividend as a signal of the end of bumper earnings, with 1H22 the third strong strongest EBITDA result ever reported for RIO.
• RIO CEO flagged market caution, but also a preference from the board to keep its powder dry on paying extra dividends at least until its full year result.
• We maintain our Add rating, with an unchanged (login to view) target price.

1H22 recap

Not a bad earnings result on balance, but the market will likely focus on the surprise drop in dividend. RIO posted 1H22 underlying EPS of US532.7 cents which was - 29% vs pcp, versus an interim dividend of US267 cents.

We had expected a special dividend. Instead RIO allowed its dividend payout ratio to fall to 50% (vs 75% pcp).

1H22 revenue of US$29,775m (-14% vs pcp) was +5% vs consensus and +3% vs MorgansF. Underlying EBITDA of US$15,597m (-26% vs pcp) was -2% vs consensus and +10% vs MorgansF. 1H22 underlying NPAT of US$8,627m (-29% vs pcp), which was +1% vs consensus and +5% vs MorgansF.

While 1H22 EBITDA margin of 52% fell short of consensus expectations of 57%, it was not down at our expected 49%. We had stepped up assumed iron ore and aluminium opex post the recent quarterly, but took these increases too far.

Free cash flow generation in 1H22 of US$7.1bn was actually ahead of our estimate of US$6.3bn, with 2022 capex more weighted to 2H22.

RIO reduced its 2022 capex guidance to US$7.5bn (from US$8.0bn), although this still flags a larger step up in 2H22 spend rate.

No updates yet on Simandou, with RIO and the Chinese-led consortium working hard to try and bridge the current gap with the Guinea government.

Analysis

RIO’s CEO outlined on the earnings call that when it came to its dividend it preferred to remain conservative in its first half result and see how market conditions settled by year end.

While reasonable, we also expect RIO is preparing for the 2H22 step up in capex to ~US$4.5bn, which will remain at that run rate also in 2023 and 2024 with guidance of US$9-$10bn per annum.

This was still a robust result with solid earnings quality. RIO reported the third highest EBITDA ever, with the third highest EBITDA margin since 2007.

RIO continues to maintain its 2022 iron ore shipments guidance at 320-335mt (MorgansF 322mt), with Gudai Darri so far ramping up smoothly.

Forecast and valuation update

Minor adjustments to our 2022 earnings estimates post the 1H22 result, leading to a 4% increase in forecast 2022 underlying NPAT. 

We have reduced our assumed dividend payout ratio for RIO to 50% out to FY25.

Investment view

With productivity issues, cost pressures and high sustaining capex, we expect RIO’s share price in the short term to remain dominated by benchmark iron ore price moves.

There is room for further weakness in some metals such as iron ore, but ultimately we expect a better end to the year from a stimulus-fuelled China recovery.

While further volatility in metal prices would likely see further selling pressure, we view RIO’s current share price as undervaluing the substantial FCF RIO will generate from its core assets. We maintain our Add rating and (login to view) target price.

Price catalysts

• 3Q22 operational result 17 October.
• Full year earnings and dividend 22 February.

Risks

• COVID-19 related risks to metal demand drivers and opex.
• Execution risk on the next wave of mine replacement in the Pilbara.

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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.