RIO - Rio Tinto: Optimizing For A Better Future

2023-12-05 02:53:54 ET

Summary

• Rio Tinto's technological advancements in mining position it as an attractive investment opportunity with financial resilience and operational efficiency.
• The company's advanced operating model and emphasis on automation and big data analytics give it an edge over junior miners.
• Rio Tinto's adoption of advanced technology and automation has led to significant cost savings and productivity improvements, making it a leader in the mining industry.

Investment Thesis

In light of mining technological evolutions, Rio Tinto ( RIO ) stands out as an attractive investment opportunity with its robust performance and pioneering technological advancements. While in the first half of 2023 Rio Tinto's revenue declined 10% to $26.7 billion year over year, from the same period in 2022, the company's earnings did see a turnaround in Q3 with revenue growing 4.9% year over year, beating estimates for 4.4% growth. While revenue volatility and a high interest rate environment have given some investors pause, with the stock now down 2.83% YTD , I think this could be the trough. Given their return to revenue growth, I think the market should start to place a premium on their technological optimizations. Their 'Mine of the Future' program, emphasizing automation, big data analytics, and machine learning, is the key to the next leg up for Rio Tinto. As the company becomes technologically more sophisticated, the advantages will compound.

The company's edge over junior miners I believe will become particularly noteworthy. Rio Tinto's advanced operating model, characterized by heightened safety and cost efficiency, distinguishes it within the mining sector. As I wrote recently with their partial competitor, Freeport-McMoRan (FCX), technology innovations (that are only possible at scale) are going to allow firms like Rio Tinto to leave junior miners in the dust. Rio Tinto, like any company, is not without its flaws but I strongly believe that the risks outweigh the rewards. The company appears cheap compared to competitors. In my opinion, the stock is a buy.

Background

Rio Tinto's advancements in mining technology have played a pivotal role in shaping its operations. The company is a leader in the mining industry, partially due to its innovation-centric operating model through automation, big data analytics, and machine learning.

Rio Tinto’s transformation began in the mid-late 2000s and was driven by labor shortages for hiring qualified employees in remote mining locations. To address this, Rio Tinto initiated the 'Mine of the Future' program, which began with trials of autonomous vehicles in 2008 to help mitigate talent shortages.

By 2010, the company opened an Operations Centre in Perth, Australia, to manage much of its Western Australian operations centrally, using technology to operate what were previously in-person mining operations. This center allows over 400 operators to track 3D visualizations of vast mining operations, covering 15 mines, 31 pits, four ports, and a 1,600 km rail network. This sophisticated setup harnesses the power of real-time big data analytics to track productivity and safety on a much larger scale??. Much of this has become a case study at Harvard. It's a fascinating read, I recommend you check it out.

The benefits have been twofold. With less employees means less accidents, which has resulted in less downtime. Downtime in a mine can be exponentially more expensive the longer it goes on due to the high fixed costs associated with running a mine that is paired with no revenue when operations are frozen. Automation seeks to minimize much of this.

Furthermore, with automation comes increased data. The extensive use of remote sensors provides rich data that can be analyzed by machine learning algorithms for continuous operational improvement, adding billions of data points for productivity enhancements??. This in itself is exponential growth, with models improving on each other each day and then using improved operating to create better data.

With these technological innovations, Rio Tinto has positioned itself as a frontrunner in the mining industry, capable of meeting the evolving demands of the global market while ensuring safety and efficiency. It’s technological advancements like these that allow investors to look farther into the future.

Why Mining Innovations Are a Big Deal

Rio Tinto's approach to mining innovation is an important example of how technology can revolutionize an industry. A prime example of this is their Koodaideri iron ore project, which is a part of their broader 'Mine of the Future' initiative. The Koodaideri project, featuring over 70 design innovations including autonomous trucks, trains, and drills, is set to become a production hub with an annual capacity of 43 million tonnes of iron ore, representing a major leap in mining efficiency and automation??. Mines like Koodaideri are allowing Rio Tinto to take in data from 98% of their mining locations and learn from them to better their operations.

Rio Tinto's adoption of advanced technology and automation in its mining operations has led to significant cost savings and productivity improvements. Notably, in 2018, Rio Tinto's autonomous trucks operated an average of 700 hours more than conventional haul trucks, achieving 15% lower costs ??. These 15% improvements add up. One example is a cost-cutting campaign the company began in 2015, where management had cut $641 million in expenses by the first half of 2020, much of this due to operational optimization (partly thanks to big data)??.

All this technology allows Rio Tinto to optimize for better scale and better costs when producing raw metals. Since Rio Tinto operates in a commoditized industry, the real variable you can control is costs (not price).

Why this gives Rio Tinto a Competitive Advantage to Junior Minors

Rio Tinto's edge over junior miners stems from its substantial investments in technology and scale of operations, which junior miners often cannot match. The cornerstone of this advantage is productivity, driven by technology that minimizes variable costs per unit of production, mainly labor and energy, and maximizes throughput. This approach, exemplified in Rio Tinto's 'Mine of the Future' initiative, includes autonomous vehicles and a centralized Operations Centre in Perth, managing vast networks of equipment and personnel across multiple sites with real-time analytics for productivity and safety????.

In a future where metals prices are increasingly efficient and more commoditized, optimizing for cost is key. Cost optimizations, however, typically only happen after a mine has been in operation for a while and management has time to use big data to find the places to be more efficient.

Contrast this with Junior miners and their business model is more flawed. Junior miners are still in the early stages of exploration and mining meaning costs are more volatile. While this is not a new part of the business model, what is new is the technological costs required to optimize a mine now for a commoditized market. This further raises the barrier to entry which could result in some firms not entering the junior mining space. Mining is becoming a game of big data as much as it is looking for big mineral reserves.

Why Rio Tinto Is a Better Buy Than FCX

While I recently wrote and rated FCX as a hold, I believe Rio Tinto ( RIO ) presents a more attractive investment opportunity than Freeport-McMoRan ((FCX)), particularly when examining the implications of FCX's innovative copper leaching technology. While this technology, developed in collaboration with Jetti Resources, demonstrates FCX's leadership in copper extraction and has the potential to revolutionize copper supply by efficiently processing challenging ore types, it also introduces market risks. The rapid evolution of this technology might lead to an oversupply of copper, disrupting the industry's long-term supply-demand equilibrium??.

FCX's low-cost advantage, thanks to the copper leaching technology, could undermine the viability of new copper mines. With this, FCX's valuation seems high, trading at 29.42 times forward GAAP earnings for the next year, FCX's stock is priced higher than some industry counterparts (including Rio Tinto), reflecting a potential overvaluation amid a volatile market??.

I’m making an important note of this because some readers will note that I believe Rio Tinto is a buy due to technological innovations while Freeport is a hold due to the same catalyst. I think Rio Tinto’s innovations do not have a route to harm the company if they were adopted industry-wide. I do fear that Freeport’s innovations could, however.

Valuation

While Rio Tinto’s stock has underperformed the S&P 500 index ( SPY ) and the SPDR® S&P Metals and Mining ETF ( XME ) this year, I think this is a stock investors should dive into as a value play with technological optimizations.

Rio Tinto currently trades at 9.23x forward GAAP earnings. This compares to a sector median forward GAAP PE of 16.87. In my opinion, the company is offering best-in-class automation innovations that will bring productivity improvements for years to come. These are improvements that will make costs lower, and profits more stable. Yet, at the same time, the company trades below the sector median forward PE. This feels underpriced in my opinion.

If the company’s technology optimizations allowed the market to reprice the shares to sector a level PE multiple, this would imply ~80% upside. This would imply a fair market share price of around $125-$130/share.

In the meantime, investors are getting an over 6% dividend yield over the trailing 12 months and are on track to get a 5+% dividend yield over the next 12 months (this is because Rio Tinto has committed to paying out 50% of earnings as a dividend). A 5% dividend yield for a stock that could appreciate over 80% is a compelling buy for me. I think it is undervalued.

Risks to Thesis

Rio Tinto is navigating through a complex landscape of risks that have impacted its operations and profitability. Fluctuating iron ore prices have led to the lowest first-half underlying earnings for Rio Tinto in three years, prompting a cut in dividend payments. This financial strain is exacerbated by a shortage of skilled workers and supply chain disruptions , which have led to operational challenges and increased unplanned absences. In response, Rio Tinto is experiencing rising input costs and facing disruptions in growth projects??.

In spite of this, management is well-positioned to excel in the market fluctuations. Their focus on efficiency and costs means the firm is well-positioned to flourish. As further cost optimizations come online, I expect management to

Big Takeaway

Rio Tinto's strategic technological advancements firmly establish it as a leading player in the mining industry. Despite revenue volatility in the 3 quarters of 2023 and fluctuating iron ore prices, the company is focused on efficiencies which I think will pay metaphorical (and hopefully literal) higher dividends in the future. With a below-sector forward PE, I think the stock is a compelling buy.

For further details see: