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Rio Tinto Plc Q3 Update – 16 October 2014

 

Company Overview:

Rio Tinto is one of the world’s largest, diversified mining organisations with core businesses in iron ore, copper and aluminium. The company boasts what is often described as a world class asset base and experienced management team.

The company also has a significant CSR (Corporate Social Responsibility) footprint, developed through pioneering annual tax paid reports, developing and publishing clear human rights policies as well as contributing to a number of environmental initiatives.

Index FTSE 100 Ticker RIO.L Latest Close 3092.00
52 Week High 3680.56 52 Week Low 2926.50 P/E 9.8
Dividend Yield % 4 Dividend Cover 2.79 CEO: Sam Walsh
CFO: Christopher Lynch


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Q3 Operations Review – Key Points

Following a volatile period for Rio shares, management delivered the Q3 operations review in mid-October.

In detail, the group reported another surge in iron ore production and shipments, which rose by 12% and 15% respectively. For the second time in 2014, demand outstripped production resulting in another net reduction to inventories for the period.

In addition to the jump in iron ore volumes, copper production also increased during the nine months to October with a 15% jump in mined output.  

On a less positive note, production volumes across bauxite, aluminium, coking coal, thermal coal and titanium dioxide all fell during the quarter although these divisions represent only a small portion of earnings each year.   

Perhaps most importantly for some investors, management also reiterated their pledge to continue focusing on “low cost and long life” assets in order to support plans to return greater levels of cash to shareholders going forward.

On this note, we anticipate that the full year dividend will provide a best in class cash return to shareholders that tops the previous 4%.

Despite what were largely positive production figures across the group’s core operations the market remained un-enthused with shares closing the week lower at 3,100.00 pence.

Rio Tinto Plc Share Price // 8 Hour Intervals

RIOTINTO17OCTOBER

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Iron Ore Remains under Pressure, Further Downside Potential Exists

The Chinese iron ore demand outlook remains uncertain for the near to medium term, with conflicting views across the analyst community over both global prices and Asia import demand going forward.

On the one hand, we have a comatose Chinese housing market and construction industry depressing demand. On the other hand, rapidly slowing economic growth could well force Chinese policy makers back to the infrastructure investment-driven stimulus measures of the past in order to prop up the economy.

Despite intermittent spells of resilience to pressure, prices broke briefly below the $80 level during early October and could fall further still if Chinese GDP, Industrial Production and Manufacturing figures disappoint next week.

With the raw material already in a bear market, the only thing that is for certain is that nobody knows exactly where the bottom is likely to form over the near term and that weakening demand from China could weigh more heavily upon the prices than we had initially anticipated.

In addition to weaker demand, production has also increased notably at the global level as many miners have struggled to maintain revenues and profits.

While much of the net increase in global supply is attributable to the big three (Rio, BHP & Vale), local Chinese mainland producers have also increased output by some measure year to date. With this and little sign of any mine closures in the region taken into account, it is not possible to say exactly when the price tolerance limits of small and higher cost producers will be reached.

Looking past production, a strengthening US dollar has been a hindrance to commodity demand over recent weeks and based upon the current outlook is likely to continue as such for the foreseeable future.


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Longer-Term Outlook for Demand Continues to Offer Hope to Investors

Despite the gloomy near-term outlook for prices, hope may be on the horizon for investors over the medium to longer-term. On this note, we take recent noises made by European policy makers regarding infrastructure investment as a means of stimulus to be positive for the raw materials outlook.  

Here, both French and Italian government ministers have called for centrally-funded infrastructure investment across the continent as a means of providing stimulus to the region’s economies.

While a proposed list of viable projects will not be ready until December, Mario Draghi, the President of the ECB Governing Council, has already lent a cautious blessing to the idea.

At the annual IMF meeting in Washington at the beginning of October, he was reported as saying that where there are budget surpluses, governments should work to support their economies through growth-friendly investment in infrastructure projects.

Last but by no means least, we continue to see an eventual consolidation within the large cap segment of the industry as quite likely over the longer-term, given the pressure upon managers to grow earnings.

On this note, recent events indicate that a consolidation may already be underway, with Rio reporting in October that it had rejected an offer from Glencore to merge earlier this year. (Subsequently ruled out by both Rio and Glencore).  

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Summary

All in all, the near-term outlook for Rio has darkened slightly since our last update. This is mostly due to further weakness in iron ore prices and a continued uncertain outlook for the Chinese economy. With the demand from the world’s largest importer yet to find a new base and supply increasing at the industry level, downside risks to both iron ore prices and investor sentiment toward the sector continue to exist.

For this reason, Rio has failed to sustain the few fleeting breaks above the 3,300.00 level that it has made since we initiated coverage at 3,130.00 pence. While we continue to see strong support for the shares around the 2,900.00 pence level, we view ongoing pessimism toward the sector as being likely to constrain any notable upside for the time being.

Consequently, we reduce our price target for the shares to 3,360 with strong support expected at the 2,900.00 pence level. This is for shares currently trading at 3,100.00 pence, implying a considerable deterioration in the available risk reward ratio.

The next scheduled event of significance in the financial calendar for Rio Tinto is the release of its fourth quarter operations review on 20 January 2015.

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