RTNTF - Rio Tinto: A Cheap Stock With An Attractive Dividend Yield

2023-12-05 02:35:30 ET

Summary

• Rio Tinto is a financially healthy mining company that produces key metals for the green revolution, making it an attractive long-term investment.
• The stabilizing economy and increasing demand for key metals, driven by the Green New Deal and climate neutrality goals, will benefit Rio Tinto's profits and long-term demand.
• As long as the global economy remains stable, Rio Tinto's fundamentals are favorable. Consequently, earnings and cash flows will rise again after declining for two years.
• Rio Tinto's stock is fundamentally cheap and offers an attractive dividend yield of 5% with room to grow.

Investment Thesis

Rio Tinto ( RIO ) is a British-Australian mining company which primarily produces iron ore, aluminium and copper. These metals are key components for the green revolution, especially for wind farms and photovoltaic systems which is an excellent pre-condition for an increasing long-term demand. Furthermore, Rio Tinto is a financially healthy company and the stock seems to be cheap. All in all, Rio Tinto can be a very attractive investment for the next decade.

Business environment and operational performance

The global economic growth is largely dependent on nations like China, India, Brazil, the USA and the EU. Although all regions will show growth in 2024 , the OECD expects a stronger recovery not before 2025. However, major commodity price indexes for iron ore and copper have recovered lately. This is not only good news for mining companies, it is also a sign for a stabilizing economy with a healthy demand for key metals. Higher commodity prices will help Rio Tinto to increase profits again after a sharp decrease over the last two years. During the third quarter, Rio increased its output for the most important metals iron ore ( +5% YoY ), aluminium (+9% YoY) and copper (+1% YoY). The combination of higher output and higher price realisation will boost its earnings and free cashflows.

The Green New Deal in the USA and major countries of the European Union aims at climate neutrality by 2050. Enormous investments into green technologies will be needed to achieve this goal. Iron ore and copper are important elements of modern wind turbines as well as aluminium and copper which are needed for photovoltaic systems. Both technologies are part of the government's plan to reduce carbon dioxide emissions as fast as possible. This politically-driven demand will help to increase the long-term demand and prices for Rio Tinto's metals and will serve as a strong fundamental tailwind.

Fundamentals and valuation

As long as the global economy does not fall back into a recession, the fundamental situation for Rio Tinto remains favorable. As a consequence, revenues and earnings will probably stabilize near-term and rise to the highs of 2021 again. Looking at the earnings‘ history of the company, the recovery potential seems to be big. Because the company is listed in the UK and Australia, EPS figures are stated in British pound £.

Despite volatility, the overall development of the company's earnings is positive. For the first six months in 2023, Rio earned £2,79 per share. Taking into account the recent iron ore rally, Rio can easily achieve £5 per share for 2023. An expected dividend payout of £2,80 results in a current yield of 5.1% with a share price of £55,4. With 1.662 bn shares outstanding the market cap stands at £92 bn. According to the half-year results in July, Rio's stock shows the following fundamental ratios for 2023:

While the P/S- and P/B- ratios are moderate, P/E- and P/FCF- ratios do not look extraordinarily cheap. However, Rio Tinto is a cyclical company which means that fundamental ratios tend to be higher in cyclical downturns. As shown before, the company has been in a downturn for more than two years now but shows signs of a longer stabilization. A payout ratio below 60% and an equity ratio above 50% are indicators for a financially healthy company with no problems to cover its dividend and has more room to increase payments supported by rising commodity prices. The company had net debt of just £3.5 bn. which is a very small amount compared to annual free cashflows of £6 bn.

Furthermore, Rio Tinto is increasing its output this year and has major projects for further capacity increases. For example, the Oyu Tolgoi underground project in Mongolia will be one of the biggest copper mines by 2030, producing 500,000 tonnes of copper every year. The Western Range iron ore project will add further iron ore output by 2025. The total approved costs of current projects are £8.95 bn. which is 1.5x of current annual free cashflow.

All in all, Rio Tinto is investing in important future projects which will help to increase future output to cover the rising demand from green investments. Manageable costs and a healthy balance sheet will be a good environment for increasing profits and cashflows. As a consequence, it is likely that future dividends will also be higher than today.

Risks

A major risk for Rio Tinto is inflation as it could put pressure on costs for its projects and on operational costs in the near-term. However, as Rio has relatively low amounts of investments, even sharp price increases cannot severely hurt its earnings.

A second major risk is an economic downturn or recession with a decreasing demand for iron ore, copper and aluminium. A sharp recession can also hit future investments in green energy like wind parks and photovoltaic components which recently have also become popular among private investors. Although some countries are struggling, the general outlook for the global economy is positive at the moment.

Another risk are political implications which could hurt local productions. The company mostly operates in many politically stable and reliable countries like Australia, Canada, the USA, Chile, Brazil or Iceland. But investors always have to keep in mind that political decisions can hurt operations and limit Rio Tinto's total output.

Conclusion

Rio Tinto is a mining giant with many important metals which are key components for a decarbonising economy. The combination of increased demand, higher production outputs and limited investment costs will boost Rio's earnings, cashflows and dividend over the next decade. A dividend yield of 5% and an earnings yield of 9% are attractive ratios after a downturn. Because of its moderate valuation, the stock is a compelling investment opportunity in the commodity sector and for dividend hunters for the next decade.

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