2023-04-28 07:00:00 ET
Summary
- Natural resources tied to the energy transition and electrification of the economy are showing signs of tight supply.
- Rio Tinto is a producer of copper that is integral to the wiring of the electrified global economy that is developing.
- Rio Tinto continues to be a global leader in iron ore.
- Rio Tinto's last quarter represented a "kitchen sink" sort of earnings announcement meant to reset expectations.
- I rate RIO shares a hold right now, however, corrections are very buyable, watch for pullbacks to buy.
Rio Tinto ( RIO ) has been our "Very Short List" of stocks to monitor for many years. Typically, miners are cyclical stocks that we can buy on corrections often brought on by recessions. Now, miners tied to the "energy transition," have strong secular tailwinds.
Rio Tinto announced it production and operational update the evening of Wednesday, April 19th. This is somewhat different than the traditional earnings that most companies report. Instead, Rio Tinto discusses their recent quarter's production and operations. Rio Tinto only reports actual earnings twice per year.
So, the 1st and 3rd quarter updates offer a glimpse into what is coming later. The production update offered some very interesting clues to Rio Tinto's future growth and earnings.
While I do not rate the stock a buy right now, if a price drop overshoots to the downside, which has happened periodically in the past, I would become very interested. Today, my thoughts and game plan on Rio Tinto.
Rio Tinto's Core Businesses
Rio Tinto is mining company that also smelts and refines. It has sales, data centers and R&D across 35 countries.
Rio Tinto's core business is its iron ore mining and processing businesses. It owns the world's largest iron mine in Australia and is the leading iron producer in the world.
Rio Tinto also ranks as the world's 2nd largest miner after and BHP Group ( BHP ) and 3rd largest mining conglomerate after Glencore plc ( OTCPK:GLNCY ) and BHP. Glencore owes much of its size to trading operations.
Rio Tinto is also roughly the 10th largest copper miner in the world at 521,000 tons , though handily trails copper leader Freeport-McMoRan ( FCX ) which came in at about 1.9 million tons .
Rio Tinto also produces substantial amounts of bauxite, aluminum and titanium. The company is further expanding into lithium with its Rincon project in Argentina.
Rio Tinto also has lesser, but meaningful production of gold, silver, molybdenum and diamonds, as well as, some zircon, coal and uranium.
Rio Tinto, Clean Energy And Mining
Beyond the normal demands for metals and minerals in the economy, the energy transition is diving massive demand for several metals and minerals.
A recent research report by the International Energy Agency suggests that Lithium, Cobalt, Nickel, Copper and various Rare Earth Elements are likely to face supply and demand imbalances in coming years.
The International Monetary Fund also noted that "Metals Demand From Energy Transition May Top Current Global Supply." They made the case that this could be a driver of inflation for a decade or more until the transition is more complete.
In the year or so since both of those reports were published however, several developments have occurred, all driven by technology:
- Tesla ( TSLA ) has thrown some cold water on Rare Earth Metals demand by announcing they will dramatically reduce their needs by using a different kind of magnet in motors.
- Goldman Sachs ( GS ) has also suggested that technological improvements i batteries and uses for green hydrogen will keep lithium demand from reaching anticipated heights.
- Cobalt appears to be likely replaced in many batteries with nickel, iron and other materials.
Copper is the metal that nobody seems to have a way to reduce demand for though. Used in wiring, there isn't a known cheaper alternative that conducts as well.
Could technology reduce the demand side of the copper equation? It's likely at least to some extent, eventually, but there is the problem. Time. Any technological solution to copper demand appears to be very distant right now, at least a decade, which is far behind the pace of EV and alternative energy adoption.
That makes copper a vital metal for the clean energy transition. The Economist devoted a piece to the copper side of the clean energy transition recently. Mining.com discussed how underinvestment in Chilean mines , home to some of the biggest copper deposits on earth, is struggling to add net new supply.
Rio Tinto's new copper project in the U.S., outside of Phoenix, is running into hurdles despite Federal approvals. Despite a two decade process to be able to mine what is likely the United States largest copper deposit, the Apache are objecting to the destruction of a sacred site.
This is indicative of just how difficult it is to get new mining projects off the ground. Much like building pipelines, if the go ahead eventually happens, and eventually can be a long time, there has been a lot of debate and review on every project. While this might generally be good, it is also expensive and often disruptive to our economic well being. Balance is hard to find.
The simplified conclusion: copper supply will struggle to meet copper demand the next decade.
For a deeper dive on the topic read Leo Nelissen's piece:
Rio Tinto Stock: Net Zero Is A Huge Tailwind
I will note that he and I come to different conclusions about whether or not to buy Rio Tinto at the moment.
Rio Tinto And Mining Consolidation
Currently, there is huge M&A going on in mining with more to come. According to S&P Global, total mining deal value in 2022 was over $24 billion spanning at least 56 deals.
Mining Deals (S&P Global)
What's driving the deal making? It's primarily the anticipated demand jump described above and that costs to mine are rising for a number of reasons.
M&A was a core topic at the meeting of copper producers in Chile the same week that Rio Tinto updates its
Big copper deals to take centerstage in Santiago as demand heats up
Rio Tinto recently sold its majority stake in the La Granja copper mine in Peru to First Quantum Minerals ( OTCPK:FQVLF ). Their stated goal was to be able to focus on projects in the U.S. and Mongolia.
We should expect consolidation in mining similar to what we have seen in oil the past several years as companies try to find economies of scale and focus on their most profitable projects.
Ultimately, that is good for share prices, we'll see how it reflects on consumer inflation.
RIO Key Production Metrics
In Rio Tinto's April 20, 2023 production update, they reported year-over-year quarterly iron ore production that was up 11% to 79.3 million tons. That also represents an 11% decrease from the prior quarter, which was caused by an equipment failure and weather.
Shipments rose year-over-year quarterly by 16% to 82.5 million tons, which represents a drawdown of stocks with shipments exceeding production.
Iron ore pellets saw a 5% year-over-year quarterly increase, though was flat quarter-over-quarter. It is a significantly smaller, though important part of Rio Tinto's iron mix.
Aluminum and titanium saw year-over-year quarterly comparison increases in production. Aluminum was flat quarter-over-quarter, and titanium showed a 12% decrease.
Aluminum is benefitting from additional smelter capacity and should resume a slow growth path into 2024 as the smelters are fully ramped up later in the year.
Titanium operations in Quebec, Canada and Richards By Minerals, South Africa are both showing efficiencies. South Africa is suffering from energy issues and could show stagnant or falling production short term.
Longer term, titanium is vital for high-tech and renewable energy. It is being used in solar panels, heating pipes and renewable infrastructure due to its strength and light weight. This is in many ways a very complimentary business to iron and aluminum. In conjunction with the Canadian government, Rio Tinto is looking to improve efficiency, decarbonize and expand capacity. I would expect growth in this segment over time.
Bauxite saw declines year-over-year and quarter-over-quarter. Q4 2022 to Q1 2023 generally showed declines in production or no growth. Bauxite though was hampered by both weather and equipment issues that should normalize allowing for slow growth in the immediate future.
Overall growth is challenged for 3 reasons:
- supply chain issues.
- increasing difficulty in mining depleting assets.
Supply chain issues are largely resolving over time. The ability to find economically minable resources appears to be getting more difficult year to year even with better technology.
With supply likely to remain tight and demand increasing with the clean energy transition, metals prices should remain relatively firm.
What To Learn From RIO's Earnings
In the January semi-annual earnings, management went out of their way to reset expectations lower. It was a sort of "kitchen sink" report that included In our opinion that was done to give room for the next move up on mild growth, but firming margins.
A key focus was on a shift to greater research and development. In particular, better using technology to develop projects. This is in direct response to challenges facing mining in general.
Expectations for Q1 2023 were essentially pushed down. And, that's generally what happened from our review of the numbers above.
Rio Tinto's "market value added" (the spread between the firm's overall market value and its balance sheet capital) results slumped $14 billion.
Rio Tinto's earnings have tightened over the past year-and-a-half as costs rose and production became more difficult for multiple reasons from supply chain to harder to exploit minerals.
Iron ore had barely increased 1% last quarter and looks to be reaccelerating after the H2 2022 slowdown. Indeed, based on the production report, we could see significantly higher iron ore output by year-end.
Aluminum production had been challenged and as noted above, is set to rebound. A positive tailwind from a negative headwind.
Copper expectations were set low, but now they have approval to dig outside Phoenix and any surprises should be positive. So, while the company sold off its La Granja copper project in Peru to First Quantum for $105 million just several weeks ago, that allowed the pivot to focus on the Arizona Rio Vista mine.
Rio Tinto Forward Earnings Expectations
Consensus earnings estimates for Rio Tinto in 2023 are $8.25 with a range of $7.32 to $9.00. This is down slightly from 2022.
The industry average P/E is 9.5 and Rio Tinto's 5-year range has been from 5 to 13, in line with the industry.
The higher earnings numbers are supported by the company's strong return on capital as noted by top rated analyst on this stock ISS-EVA. As such, Rio Tinto's "economic value added" is strong compared to peers and in general and trending upward. That is, they get good return on the money they invest into the company's operations.
The improving EVA is likely from the corporate lean into better technology to drive efficiency. And, it is likely to help Rio Tinto reclaim the decline in market value added loss noted above. Most likely by eventually increasing market cap faster than the balance sheet improves from higher earnings, i.e. valuation expansion.
Rio Tinto's recent 2022 ROC was 19.7% slightly above their 5-year average of 18%.
At the low end of both earnings and valuation, Rio Tinto has a low-end price support around $36. At the high end of both earnings and valuations, the high-end price resistance is around $117.
Based on some acceleration in iron ore and additional copper output, I expect Rio Tinto to be closer to the top range on earnings, even with a slightly recessionary macro environment looming.
Where we see a problem is valuation in a tighter financial conditions regime, at least for this year.
I don't expect a P/E above the norm, but do expect a rebound to around 9.
And, I expect EPS to be closer to $8 than the lower estimates.
That gives us a fair value around $72 a year out.
Given the range of potential outcomes though, that is not a large enough margin of safety to interest me in buying.
RIO Stock Is A Hold Now, Buy Later
Rio Tinto as a major supplier stands to benefit with smart spending and moderate production growth. Similar to how oil producers have managed for profits the past few years.
Our 4-step process for stocks includes:
- Recognizing secular trends (clean energy)
- Analyzing government and central bank policy (tighter financial conditions).
- Studying and comparing industry and company fundamentals (harder to find and mine minerals, but better technology thus maintaining and even improving margins from recent bottoms).
- Overlaying technical and quantitative factors with valuation measures (some weakness in charts and volume weighted price movements).
Our 4th step points us to a hold for now on RIO, but also to some interesting buy zones.
At the moment Rio Tinto shares are priced in the middle of its valuation range the past five years which is roughly a P/E of 5 to 13 according to Ford Equity Research. So, from a valuation standpoint, it's middle of the road at the current forward P/E of about 8.
A share price in the low $50s would push the forward P/E below 7 near the low-end of the 5-year range. Given firm pricing for metals and managing towards profitability over growth and some negative factors unlikely to completely repeat, a buy price appears to be the low $50 based on long-term supports.
A buy price in the middle $40s could also manifest if negative events, i.e. recession, lead to a loose megaphone pattern solidifying to a lower low versus the previous two.
RIO Support Zones (Kirk Spano)
Our Elliott Wave and Harmonics analyst saw a confirmed low and then a divergent low.
It's that divergent low that makes me wonder about loose megaphone pattern. We would need to see price break below the 200 day moving average to really put that in play.
RIO broke below its 200-day moving average right after the above chart was built. In RIO's strongest case scenario, we would see it bounce back above its 200 day moving average by the end of next week. If it doesn't rebound, then we'll likely see a breakdown to the lower $50s in our opinion. We'll see what the next week plus brings.
For now, we rate Rio Tinto shares a hold. But, declines to the lower $50s and middle $40s would really get our attention as those would also stretch the valuations to the low-end of the 5-year range and with the expectation that earnings and the balance sheet both trend in the right direction for the next several years on tight supply and demand for what Rio Tinto produces.
For further details see:
Rio Tinto Production Update Points To Continued Success