RIO - Rio Tinto Can Handle Changing Markets

2023-07-03 05:23:28 ET

Summary

• Rio Tinto's share price has been impacted by a decline in commodity prices impacting the company's ability to drive dividends.
• The company has a fortress balance sheet, which means that after fairly manageable capital expenditures, it can drive strong returns.
• We expect the company to drive strong high-digit returns through its dividend going forward, making it a valuable investment with increased commodity demands.

Rio Tinto ([[RIO]], [[RTPPF]], [[RTNTF]]) is one of the largest mining companies in the world, with a market capitalization of more than $100 billion. The company has a strong portfolio of assets, regardless of a changing market, which will enable strong shareholder returns. As we'll see throughout this article, the company is a valuable long-term investment.

Commodity Demand

Fortunately, the transition to a lower emittance world means increased demand for high value metals.

Steel might be less in demand as the economy transitions. Copper, aluminum, and lithium or rare earth metals will all have dramatically increased demand. Both traditional and energy transition demand are expected to increase dramatically by 2035. Energy transition demand is expected to more than triple during this time.

Rio Tinto is well positioned to take advantage of these developments. China's steel demand might decrease dramatically, but the rest of the world demand will increase.

Rio Tinto Financial Performance

Financially, with a $100 billion market capitalization, Rio Tinto is well positioned to generate strong returns.

The company generated $9 billion in FCF in the most recent year, but paid $11.7 billion in dividends. The company has consistently maintained a high dividend yield, enough to justify its valuation almost by itself, as the company has focused on shareholder returns. The company has generated incredibly strong overall earnings but 2022 was a weaker year.

The company has an incredibly modest debt position which makes such shareholder returns very affordable.

Rio Tinto Volatility

Rio Tinto saw strong volatility in its prices from 2021 to 2022.

The company's underlying EBITDA dropped 33% from iron ore, 16% from aluminum, 40% from copper, and 7% in minerals. However, the company is continuing to ramp up new assets and maintain strong operations. Inflation is a strong driver of costs but the company is doing its best to manage it with scale operations.

Iron ore prices averaged $121 / dry metric tonne in 2022. The 2022 average price for aluminum was $2705 per metric tonne. Copper prices spent 2022 at just under $4 / pound. Since then, some prices are worse but others have improved. Copper prices are now at more than $3.75 / pound. Iron ore prices are at $115 / metric tonne and aluminum is at $2200 / metric tonne.

There continues to remain fear over a potential recession and slowdown in building from rising interest rates. However, prices have also recovered off of their lows. The tones are shifting and the FED is actually predicting a soft-landing versus a recession now . We expect prices to outperform the market's current low predictions.

Rio Tinto Balance Sheet

The company maintains one of the strongest balance sheets in the industry despite price volatility.

The impact on prices in 2022 did push the company to a -$4.2 billion net debt position. The company generated $16.1 billion in net cash from operating activities. It spent $6.8 billion in capital expenditures, down slightly YoY but still up over 2020 as it's a capital expenditure level that the company can comfortably afford.

The company paid $11.7 billion in dividends, down from its record 2021 levels, but still a dividend level that by itself justifies the company's valuation and potential shareholder returns. The company maintains strong cash and an 11-year debt maturity is massive for the minimal debt. Overall this fortress balance sheet will enable strong shareholder returns.

Shareholder Returns

The company has a long history of deploying cash to shareholders through its dividend.

The company has continued to maintain its high ordinary dividend with a 60% payout ratio. Over the past 7 years though the company has averaged a 72% total payout ratio, well above its 40-60% ratio. The company has declared $3.7 billion in H2 dividends, which means $8 billion in FY dividends. That's consistent with the company's high-single digit historic dividends.

That's enough to justify investing in the company by itself.

Thesis Risk

The largest risk for Rio Tinto's share price is volatility in commodity prices. The company has already dealt with a partial slowdown in commodity prices, and current fears over a recession along with a delayed reopening of China are having a substantial impact. The company has strong operations but it can't completely avoid low prices.

Conclusion

Rio Tinto has seen its share price impacted by continued weakness in the commodity markets. However, commodity demand is increasing, especially with the energy transition. The company has extremely well positioned assets as demand for the full suite of its commodities is going up. That combined with the balance sheet will enable strong returns.

The company has generated incredibly strong high-single digit dividends in recent years. That alone justifies investing in the company. The FED is now expecting a soft-landing and despite a slow reopening for China we expect the expected recession not to happen. That combined with continued cash flow, makes the company a valuable investment.

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