Rio Tinto: One step forward, two steps back?

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
16 March 2022, 9:30 AM
Sectors Covered:
Mining, Energy

  • A lot of developments continue to roll off at Rio Tinto (ASX:RIO), with the big miner experiencing a mix of positive and negatives across its asset portfolio.
  • On the positives, RIO has announced a non-binding proposal to buy out the remainder of Turquoise Hill (TSX-listed owner of Oyu Tolgoi in Mongolia).
  • Amongst the negatives, the military junta now ruling Guinea has reportedly ordered a halt to all activities at Simandou (giant iron ore deposit RIO is invested in).
  • The overriding factor for RIO has been rising metal prices, which so far has been enough to offset disappointing results in productivity, cost, culture and portfolio. But we remain cautious given an expectation RIO could underperform against volatility.

Non-binding offer for Turquoise Hill…

RIO has made a non-binding all-cash offer of US$2.7bn for the remaining 49% of outstanding shares in Canadian listed Turquoise Hill Resources (TRQ.TSX, not rated). TRQ is the majority owner of the Oyu Tolgoi copper operations in Mongolia.

The all-cash offer of C$34 per share comes at a 32% premium to TRQ’s last share price, although implies an Oyu Tolgoi valuation that sits 2% below our estimate after adjusting for TRQ’s debt load.

The acquisition would increase RIO’s interest in Oyu Tolgoi from an indirect ~34% to a majority 66% stake, with the Mongolian government owning the remainder. The offer for TRQ follows a December agreement between TRQ (RIO) and the government on a way forward through the forgiveness of US$2.3bn of debt owed by the Mongolian government.

Typical approvals are required, including a TRQ shareholder vote.

…meanwhile in Guinea

Unsettling reports over the last week of the ruling military junta, which took power through a coup in September 2021, demanding a halt to all activities at Simandou.

If reports are accurate, activities have been suspended while talks continue between the joint ventures of Simandou’s four blocks and the new government. The situation in Guinea is not unlike the one in Mongolia, where a greater share of value was demanded by the government which negatively impacted the valuation.

The implications of Simandou potentially stalling are not straightforward for RIO. On one hand it has already invested >$1bn towards its 45% interest in Blocks 3 & 4, while Simandou’s development would drag on long-term iron ore prices (i.e. hurting the value of RIO’s flagship iron ore business in the Pilbara).

Analysis

If successful in its offer for TRQ, the increased stake in Oyu Tolgoi would deliver an extra ~52ktpa of copper to RIO (+9% group volume) from the existing open pit operation, and as much as an extra ~160ktpa from the underground expansion (circa 2028). While arguably value neutral, the diversification of earnings and growth in copper (where RIO has an undersized exposure) are important positives.

On Simandou, RIO has not commented on the developments, but if reports are accurate it is not hard to expect a low case of Simandou going ahead but under worse fiscal terms. We await further developments.

Investment view

We remain cautious in our view on RIO in the near term. Acknowledging the considerable earnings strength delivered to it by soaring metal prices, but also recognising negatives across productivity, costs, culture and portfolio (/growth) which we expect will see RIO underperform if any metal price volatility emerges.

No change to our Hold rating and (login to view) target price.

Price catalysts

China steel activity. TRQ offer. Attempts to recover Jadar. Talks in Guinea.

Risks

COVID risks to operations in WA and key end-market China. Execution risk on growth portfolio. Political risk in Australia (heritage related), Mongolia and Guinea.

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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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