RTNTF - Rio Tinto Has Become Very High-Yielding And Attractive Again

2023-06-27 08:00:00 ET

Summary

• Rio Tinto Group is a leading mining company that will benefit from expanded spending in China and overall infrastructure investments, including for green energy, around the world.
• The macro picture looks good for Rio Tinto's core products for the foreseeable future, with several megatrends resulting in substantial demand for important basic materials, including copper and iron ore.
• RIO stock is currently trading at a substantial discount compared to how the company was valued in the past, despite positive macro trends likely working in its favor over the coming years, making it an attractive investment option.

Article Thesis

Rio Tinto Group ( RIO ) is a leading mining company that will benefit from expanded spending in China and from overall infrastructure investments, including for green energy, around the world. Enthusiasm for the company has cooled in recent months, which has made Rio Tinto cheap again -- and the dividend yield has risen to a very high level once again.

Rio Tinto: Benefitting From Multiple Megatrends

Rio Tinto Group is a mining company that is active in different commodities, including iron ore, copper, aluminum, titan, diamonds, and so on. Iron ore and copper are the two biggest and most important business units for Rio Tinto. Not surprisingly, the company is thus widely exposed to global demand and supply trends in these commodities.

Looking at supply, the macro picture looks good: Since getting approvals for new mines has become harder and harder in many countries, and since building out new mines is becoming ever more expensive, there is not a lot of supply growth, for both iron ore and copper. The same principle holds true for many other commodities and basic materials as well. ESG measures that make it hard to expand via greenfield projects further add to the weak supply growth picture.

At the same time, the demand situation is pretty solid, and it looks like demand for core basic materials will grow in the coming years and possibly decades. This demand growth will be driven by several contributing factors.

First, economic growth in fast-growing markets such as China and India will result in the build-out of infrastructure. Wealthier consumers in these markets will want to live in larger homes and apartments, will travel more (thus more bridges, airports, and so on are needed), and more economic activity will also result in more power plants, fabs, and so on being built.

Second, infrastructure in many countries, including the US and much of Europe, is aging. More and more of this aging infrastructure will need to be replaced, which includes bridges, power transmission infrastructure, and so on. This will require steel, copper, and other basic materials.

Third, green investments will require large amounts of steel, copper, lithium, manganese, aluminum, and so on. Windmills require hundreds or even thousands of tons of steel, concrete, and so on. Large-scale solar power plants require large amounts of steel as well. And green power generation requires additional power transmission lines, e.g. in order to move electricity from wind-rich areas to the markets where this electricity is consumed. Smart grids, electric vehicle charging infrastructure, electric vehicles themselves, and so on require materials that need to be mined. No matter what one thinks about green investments, they are here and will most likely grow, and they will require many of the materials that Rio Tinto and its peers are producing.

All in all, the macro picture does thus look good for Rio Tinto's core products for the foreseeable future, I believe. Of course, economic activity will experience ups and downs, and thus prices will move up and down to some extent as well. A potential recession in the second half of 2023 or in 2024 could hurt demand and commodity prices, but the longer-term picture is positive. There is not a lot of supply growth, as bringing new assets online has become quite complicated and costly. And at the same time, several megatrends will result in substantial demand for important basic materials, including copper and iron ore.

Rio Tinto: Executing Well

Rio Tinto does not report quarterly results in the same way US-based companies report their quarterly results. Instead, Rio Tinto reports H1 and FY results and announces quarterly updates in between, where it showcases how its production volumes looked during the quarter. The most recent such presentation was announced in April. Rio Tinto reported that volume growth was compelling across almost all of its operations:

- Both iron ore shipments and iron ore production were up by double-digits compared to the previous year's quarter, rising by 16% and 11%, respectively.

- When it comes to Aluminum, a material that is important for EVs in order to bring down their weight, Rio Tinto's production rose by 7% compared to the previous year's period.

- Copper production was flat compared to the previous year's quarter -- which was not a great result, but not a bad one, either.

- Other segments such as titanium also experienced volume growth during the period.

When it comes to the company's production guidance for the current year, there are a lot of things to like. Iron ore production will rise compared to 2022, looking at the midpoint of the announced guidance range. Aluminum production will climb as well, while mined copper will explode upwards, with volumes expected to climb by around 30%, using the midpoint of the guidance range. Rio Tinto expects lower diamond production levels, but this is not a very large business unit, thus the impact on a company-wide basis should be pretty small, I believe.

We still don't know yet how much Rio Tinto will generate in terms of revenue, profit, and cash flow, of course, as commodity prices play a large role here, and since those are hard to forecast. Looking at the prices as reported here on Seeking Alpha (iron ore ( SCO:COM ) and copper ( HG1:COM )), we see that prices are mostly flat from where they were twelve months ago, although there was considerable volatility over the last year.

Last year, i.e. in 2022, Rio Tinto generated $56 billion in revenue, which was good for $26 billion of EBITDA. Analysts expect somewhat lower revenues for the current year, but lower expenses, e.g. due to lower fuel costs (oil prices are down) could help with Rio Tinto's EBITDA margin. Let's still assume that EBITDA will fall in order to be conservative. A 10% hit to EBITDA would make for around $23 billion in EBITDA for the current year -- considering the fact that Rio Tinto is trading with an enterprise value (the company's market capitalization, adjusted for debt and cash held on the balance sheet) of $108 billion, that's still a pretty good result. With a 4.7x EV to EBITDA multiple, Rio Tinto arguably is pretty inexpensive -- the 10-year median EV to EBITDA multiple is 6.5, according to YCharts. Rio Tinto thus currently trades at a substantial discount compared to how the company was valued in the past, despite positive macro trends likely working in its favor over the coming years.

For 2022, Rio Tinto has paid out GBP4.07 (British Pounds) per share in dividends. That's equal to around $5.15 per share. With Rio Tinto trading for just $64 per share today, that makes for a dividend yield of 8.1% -- which is pretty attractive. Depending on where commodities trade during the second half of the year, dividends in 2023 could be lower, but even if they were to decline by 20%, the dividend yield would still be pretty attractive, at around 6.5%. And this could be a rather conservative estimate, as Rio Tinto's dividend stood north of GBP4.00 per share during four out of the last five years. A dividend of exactly GBP4.00 would translate into a dividend yield of 7.9% at current prices.

Rio Tinto has a compelling total return track record, as its shares have delivered a 90% gain over the last five years, including dividends. Importantly, the vast majority of these gains were driven by Rio Tinto's dividends, which, when accounting for dividend reinvestment, contributed around 80% of the company's total return over that period, while price appreciation of Rio Tinto's shares was a relatively minor total return driver. Going forward, the dividend will remain important as well

Final Thoughts

Rio Tinto is an attractive mining company, and the sector, overall, looks promising over the coming years, due to positive macro developments. We downgraded Rio Tinto from a previous buy rating in January when shares had soared and were somewhat expensive. Since then, shares have pulled back considerably, and are now rather cheap again. With a high expected dividend yield and with RIO trading at a substantial discount to its historic valuation range, I believe that the company is attractive once again and I thus give it a buy rating right here.

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