Rio Tinto: Uncertainty creates better entry

About the author:

Author name:

By Adrian Prendergast

Job title:

Senior Analyst

Date posted:

18 July 2022, 7:30 AM

Sectors Covered:

Mining, Energy

• Metal price weakness and cost pressures have put considerable pressure on Rio Tinto's (ASX:RIO) share price, as RIO tries to work through operational and productivity issues.
• We expect current volatility to moderate later this half as growth in China starts to recover post lockdowns heading into 2023.
• Post the recent sell off, we upgrade our rating on RIO to Add (from Hold), with a target price of (login to view).

2Q22 snapshot

Iron ore steady. 2Q22 iron ore shipments of 79.9mt (100% basis), were +5% pcp and just ahead of expectations (vs MorgansF 79.1mt vs consensus 79.4mt). Cost pressure remained a key feature, with 2022 guided Pilbara unit costs of US$19.5- $21/t only unchanged after RIO slashed its AUD assumption to $0.71 (from $0.75). In addition to ongoing cost headwinds, RIO reported a surge in unplanned COVID-related leave amongst its Pilbara workforce.

Ali softer. A weaker result for RIO’s aluminium business, with 2Q22 bauxite production of 14.1mt (vs MorgansF 13.8mt vs consensus 13.6mt), alumina output of 1.86mt (vs MorgansF 2.0mt vs consensus 2.0mt), and aluminium production of 731kt (vs MorgansF 781kt vs consensus 776kt).

Copper lower. Also a softer result for copper, with group 2Q22 mined copper of 126kt (vs MorgansF 131kt vs consensus 137kt) although better than a year ago at +9% pcp. A steady quarter from Escondida supported the result, producing 82kt in 2Q22 (vs MorgansF 71kt vs consensus 80kt).

Other. Iron ore pellets/conc in Canada (-4% pcp), titanium dioxide slag (-2% pcp) and salt (-29%) volumes were all lower in 2Q22, while borates (+9% pcp) and diamonds (+35% pcp) did better pcp.

Guidance. Other than the underlying increase in iron ore cost guidance, RIO downgraded its 2022 production guidance for alumina (now 7.6-7.8mt was 8.0- 8.4mt), aluminium (now 3.0-3.1mt was 3.1-3.2mt) and diamonds (now 4.5-5.0mct was 5.0-6.0mct). All other guidance was maintained.

Analysis

Given iron ore drives most of RIO’s earnings, a steady result in the Pilbara carries the result overall.

While RIO maintained 2022 shipments guidance, the 2H22 ramp up of critical replacement mine Gudai-Darri will be essential to keeping RIO on track and increasing its proportion of high-grade products and keeping a lid on costs.

Weakening metal prices into 2H22 represent some downgrade potential to expectations, but we also expect key demand drivers to stabilise driven by China.

Forecast and valuation update

We have made minor changes to our assumptions post the 2Q22 result and rolled forward our model. Our valuation-based TP is revised to (login to view).

Investment view

We upgrade RIO to an Add rating (from Hold), with a (login to view) target price. Given current headwinds we recommend opportunistic accumulation on weakness.

Lower metal prices and cost pressures are powerful headwinds, but we see a better outlook for metals by late 2022 and heading into 2023 as Chinese growth starts to stabilise and recover.

A short-term downgrade cycle for commodity forecasts could weigh on the stock in the meantime, but we would view this as presenting a longer-term opportunity given the resilience of strong cash flow.

RIO’s flagship iron ore division is feeling pressure at both ends, with benchmark prices falling and costs continuing to rise. Still, it should see a better relative performance in the second half from increasing Gudai-Darri volumes and is still likely to generate substantial FCF and a healthy dividend.

Price Catalyst

1H22 financial result 27 July. 3Q22 operating result (iron ore) 17 October.

Risks

COVID risk to metal demand drivers. Execution risk on guidance.

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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.