Business Overview
Rio Tinto Plc (LON: RIO) is a metal and mining company operating at a global scale with a focus to explore, mine and process the Earth's mineral resources. The company is headquartered in London, United Kingdom and is a globally renowned leader in aluminium. The group has presence across 35 countries across six continents with significant business spread across Australia and North America. The company also has a significant business in South America, Africa, Europe and Asia, and its major products are uranium, iron ore, industrial minerals (borates, titanium dioxide and salt), gold, diamond, copper, and aluminium. The company is listed on the London Stock Exchange and is a constituent of the FTSE 100 index. The business of the company started when the “Rio Tinto Company” turned Rio Tinto (Red River) mines in Spain into the number one copper producer in the world from 1877 to 1891 after the mine was sold to a British-European syndicate, led by a Scottish entrepreneur by the Spanish Government. After almost 150 years, it is counted amongst the largest producers of a range of essential materials, operating a diverse portfolio which employs 47,000 people around the world.

On 26^th February 2020, the company will announce the 2019 full-year results.

Management

The current Chairman of the company is Simon Thompson. He has been with the board since April 2014 and was appointed as a Chairman in March 2018. J-S Jacques holds the responsibilities of the Chief Executive Officer, and he joined the group in 2016. Jakob Stausholm is the current Group Chief Financial Officer and was appointed in September 2018.

Key Statistics



Top Shareholders 

 

Revenue Segmentation by Destination and Commodity

(Source: Interim Reports, Company Website)

The company generates highest revenue from China which constitute 50 per cent. North America comprises of 18 per cent of the total revenue. Other parts of Asia comprise of 11 per cent. Japan and Europe contribute 9 per cent and 8 per cent respectively. Other parts of the world contribute around 4 per cent of the total revenue of the company.

Iron ore is the main revenue contributorfor the company. It contributes 59 per cent of the total revenue. Aluminium, Gold and Minerals constitute 24 per cent, 7 per cent and 5 per cent respectively. Diamond contributes 1 per cent of the total revenue while the other commodities contribute 4 per cent of the total revenue of the Group.

Industry Overview

Mining companies have a window of opportunity to demonstrate that they are essential to resourcing the future and that they have what it takes to respond to the rapidly changing world around them. They should use their strong balance sheets and cash generating ability to make the difficult yet essential transformations for a low carbon, high tech and consumer-centric future. The top five companies contribute 50 per cent of total top 40 market capitalisation. Overall, production is expected to increase by approximately 2%. The outlook remains extremely sensitive to commodity prices. As a guide, if resultant prices are at the more conservative end of the expected range, then revenues would drop to 3% below 2018- year levels and EBITDA drops even further to 2017 levels. Conversely, if the top end of the range was achieved, then revenue increases by more than 3% and EBITDA by 10% (compared with 2018).

Operations Update Q4 FY2019 (31^st December 2019)

On 17th January 2020, Rio Tinto released an update for production in the fourth quarter. Despite few challenges at operations level, the company had ended year with good momentum, primarily from Pilbara iron ore operations. The company is increasing its investment in high-return projects with USD 2.25 billion. To strengthen its opportunities pipeline, the company has increased its evaluation and exploration expenditure to USD 624 million in FY2019. The company’s shipments from Pilbara iron ore declined by 3 per cent to 327 million tonnes versus FY2018 data. The decline was due to operational challenges in H1 FY2019 and challenging weather conditions. Driven by the ramp-up of Queensland, Australia based Amrun mine, the production of Bauxite increased by 9 per cent to 55 million tonnes versus 2018 data for the same period. Due to planned pot relining at British Columbia based Kitimatin H2 and preventive safety shutdown in Iceland, the Aluminium production declined by 2 per cent to 3.2 million tonnes versus FY2018 data. Due to lower copper grades, the copper production declined by 5 per cent to 577 thousand tonnes versus FY2018 data for the same period. Driven by operational improvement, the production of Titanium dioxide slag went up by 8 per cent to 1.2 million tonnes for the period.

Financial Highlights (for the six months period ended 30 June 2019, USD, million)


(Source: Interim Reports, Company Website)

In the first half of the financial year 2019, as higher iron ore prices helped in offsetting the impact of lower volumes and lower aluminium prices, excluding the $0.8 billion contributions by the coking coal assets divested in 2018, consolidated sales revenue of $20.7 billion was 9 per cent higher than 2018 first half. The operating profit in the first half of the fiscal year 2019 was $5.2 billion versus $6.4 billion in the H1 FY2018 due to the increase in impairment charges. Lower volumes and higher costs in iron ore was more than offset by an increase in iron ore prices, which drove underlying EBITDA to $10.3 billion, which was 19% higher than 2018 first half, and led to an EBITDA margin of 47 per cent. Even as lower sales volumes declined underlying EBITDA by $232 million, commodity price movements increased underlying EBITDA by $1,878 million in 2019 first half. Profit before finance items and taxation was $5.5 billion while profit before taxation was $5.2 billion. Underlying earnings in the H1 FY2019 was $4.9 billion, up by 12 per cent than the same period last year due to a strong contribution from Iron Ore. Basic earnings per share was 252.5 cents, while the underlying earnings per share increased by 19 per cent to 301.5 cents. The group declared dividend per share of 151 cents, which totalled to $2.5 billion, and announced a special dividend of 61 cents, which totalled to $1 billion.

Commodity Segmentation – Financial Highlights (H1 FY 2019)

Iron ore


(Source: Interim Reports, Company Website)

The revenue increased by 21 per cent to USD 11 billion in H1 FY2019 as compared to H1 FY2018. EBITDA grew by 34 per cent to USD 7.5 billion during the period. ROCE was 63 per cent during the first half of the fiscal year 2019.

Aluminium


(Source: Interim Reports, Company Website)

The revenue declined by 17 per cent to USD 5.1 billion in H1 FY2019 as compared to H1 FY2018. EBITDA declined by 38 per cent to USD 1.1 billion during the period. ROCE was 4 per cent during the first half of the fiscal year 2019.

Copper and Diamonds
 

(Source: Interim Reports, Company Website)

The revenue declined by 2 per cent to USD 3 billion in H1 FY2019 as compared to H1 FY2018. EBITDA declined by 11 per cent to USD 1.2 billion during the period. ROCE was 6 per cent during the first half of the fiscal year 2019.

Energy and Minerals


(Source: Interim Reports, Company Website)

The revenue increased by 33 per cent to USD 2.5 billion in H1 FY2019 as compared to H1 FY2018. EBITDA grew by 113 per cent to USD 1 billion during the period. ROCE was 15 per cent during the first half of the fiscal year 2019.

Key Performing Indicators



(Source: Interim Reports, Company Website)

The company has delivered a strong ROCE historically. In the first half of the fiscal year 2019, the Group reported a ROCE of 23 per cent which shows the robust financial performance of the company. The company has improved its production substantially and accelerated its EBITDA margin significantly at a CAGR of 2.5 per cent from H1 FY2016 to H1 FY2019. On the safety point of view, Rio Tinto was ahead than the ICMM, having 0.41 all injury frequency rate per 2 lakh hours than compared to 0.68 of ICMM. 
 
Financial Ratios

 

The reported EBITDA margin in H1 FY19 was 47.7 per cent against the industry median of 30.6%. The reported operating margin was 25.5 per cent for the H1 FY19. Net margin reported was 14.1 per cent for the first half of 2019, higher from the industry median of 6.8%. Return on equity for the current first half stood at 9.9 per cent, higher than the industry median of 4.1 per cent. On the liquidity front, Rio Tinto PLC’s current ratio stood at 1.51x. On leverage front, the debt-equity ratio of the Rio Tinto Plc’s was 0.36x which was lower as compared to the industry median of 0.57x, reflecting that the company is less leveraged as compared to its peers.

Share Price Performance

Daily Chart as on 19^thFebruary 2020, before the market closed (Source: Thomson Reuters)


On February 19, 2020, at the time of writing (before the market close, at 10:25 AM GMT), Rio Tinto PLC shares were trading at GBX 4,189, up by 0.47 per cent against the previous day closing price. Stock's 52 weeks High and Low are GBX 4,979.14/GBX 3,900.50. The group’s stock is reflecting significantly higher volatility as against the benchmark index based on the company’s beta of 1.49. The outstanding market capitalisation was around £71.44 billion, with a dividend yield of 6.16 per cent.

From the technical standpoint, its shares were trading well above its short-term level of 15-day simple moving average price, which reflects an uptrend in the stock and carrying potential to move up further. Also, 14-Relative Strength Index of the stock also hovering in the oversold zone, which is strengthening the upside move.

Valuation Methodology

Method 1: EV to EBITDA Approach (NTM)



To compare Rio Tinto Plc with its peers, EV/EBITDA multiple has been used. The peers are Fresnilo Plc (NTM EV/EBITDA was 7.82), Antofagasta Plc (NTM EV/EBITDA was 5.70), BAE System Plc (NTM EV/EBITDA was 9.35), Glencore Plc (NTM EV/EBITDA was 5.92), Goldfields Ltd (NTM EV/EBITDA was 4.43) BHP Group Plc (NTM EV/EBITDA was 6.07), Anglo American Plc (NTM EV/EBITDA was 4.72), Kaz Minerals Plc (NTM EV/EBITDA was 4.84) and Ferrexpo (NTM EV/EBITDA was 3.59). The Average of EV/EBITDA (NTM) of the company’s peers was 5.69x (approx.)

Method 2: Price to Earnings Approach (NTM)



To compare Rio Tinto Plc with its peers, P/E multiple has been used. The peers are Petra Diamonds Ltd (NTM P/E was 17.19), BAE System Plc (NTM P/E was 13.24), Glencore Plc (NTM P/E was 12.64), Goldfields Ltd (NTM P/E was 12.50) BHP Group Plc (NTM P/E was 11.55), Anglo American Plc (NTM P/E was 9.80), Kaz Minerals Plc (NTM P/E was 6.57) and Ferrexpo (NTM P/E was 4.90). The Average of P/E (NTM) of the company’s peers was 10.84x (approx.)

Valuation Metrics


(Source: LSE)

As on 31^st January 2020, the Price to Earnings multiple of the Rio Tinto Plc’s was 6.6x, which was slightly lower as compared with the Mining industry of 7.7x, reflecting that the company is trading at a lower multiple as compared to its peers.

Du Point Analysis


(Source: LSE)

This analysis is a useful technique to decompose the different drivers of ROE. It can be further examined through three financial metrics which are: net profit margin, asset turnover and financial leverage. This analysis helps to deduce whether the company’s profitability, use of debt or assets that’s driving ROE. In 2020, the ROE is increasing as compared to its peers.

Rio Tinto V/S FTSE-100  - Price performance in last 6 months


(Source: Thomson Reuters)

In the last six months, Rio Tinto share price has delivered 2.63 per cent return which is in line with the FTSE-100 index return of 2.68 per cent.

Dividend Yield


(Source: Thomson Reuters)

Rio Tinto has dividend yield of 6.21 per cent which is higher than the industry dividend yield of 6.05 per cent and sector dividend yield of 5.62 per cent.

Rio Tinto V/S Industry V/S Sector
 

(Source: Thomson Reuters)

In the last year, Rio Tinto shares price declined by 4.48 per cent which is significantly lower than the industry decline of 34.8 per cent and sector decline of 8.84 per cent.

Rio Tinto Total return


(Source: Thomson Reuters)

In the last two years, Rio Tinto has delivered a total return of 20.96 per cent while the FTSE All share index has delivered a total return of 11.33 per cent.

Growth & Risk Assessments

The company has been carefully reviewing its costs and level of investments made to enhance financial and operational performance. The company has many value-accretive projects in the pipeline with low risk and higher production. The company using its cost synergies, has optimized its operational structure to achieve sustainable growth in the future. The company has taken a note of potential disruption in operations due to the technological advancement and has started its transition accordingly. The prices of various commodities can be subject to significant fluctuations, and as the prices are affected by global supply and demand, the company does not have any influence on the market prices, which can lead to a significant impact on the financials and affect the business assumptions. Also, since the company has operations in diverse regions, adverse exchange rate movements can impact the bottom-line numbers. Demand for products can also be impacted by the decelerating economic growth in China, which is a leading importer of many commodities, and its demand is a strong driver of price.

Conclusion

The company is no longer under the threat of monetary policy normalisation, and a successful resolution to US-China trade negotiations would provide a significant boost to the company. The successful operations of the group have enabled it to deliver sector-leading cash returns to shareholders, which is backed by its strong portfolio and balance sheet. The company expects the cash returns to shareholders to be in a range of 40-60% of underlying earnings over the long run, indicating the confidence of the board in the performance of the company. Despite weather impacts, the company expects the run-rate to be around $0.5 billion from its mine-to-market programme in FY 2019, while the capital expenditure is expected to be approximately $6.0 billion in 2019 and around $6.5 billion in the next two years. However, driven by increasing requirements for renewable energy, industrialisation and urbanisation, global demand for copper is set to grow, which augurs well for the company. Despite the threat from the US-China trade war, the Chinese economy has remained healthy, fuelled by an increased share of domestic consumption and supported by positive policy decisions and reforms.

Over the course of 3 years (FY15 - FY18), the company’s revenue surged from USD 34,829 million in FY15 to USD 40,522 million in FY2018. Compounded annual growth rate (CAGR) stood at 5.18 per cent.

Based on the decent prospects and supported by valuation undertaken using the above two methods, we have given a “BUY” recommendation at the closing price of GBX 4,172 (as on 18th February 2020) with lower double-digit upside potential based on 5.69x NTM EV/EBITDA (approx.) on FY20E EBITDA (approx.) and 10.84x NTM Price/Earnings (approx.) on FY20E earnings per share (approx.). 
 
*All forecasted figures and Peers information has been taken from Thomson Reuters.
* The “Buy” recommendation is also valid for the current price as covered in the report as on 19^th February 2020.
*Currency exchange rate taken for 1 US Dollar = 0.7701 GBP.

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