Rio Tinto – Iron ore drives first half
About the author:
- Author name:
- By Adrian Prendergast
- Job title:
- Senior Analyst
- Date posted:
- 30 July 2020, 9:00 AM
- Sectors Covered:
- Mining, Energy
- H20 result was ahead of consensus estimates, with ongoing iron ore strength helping Rio Tinto (ASX:RIO) to plug a gap left by lower aluminium and copper prices.
- RIO's flagship Pilbara iron ore business posted strong 1H20 margin (FOB) of 72% with return on capital employed of 64%.
- Maintained an interim ordinary dividend of US$1.55ps (no special dividend), vs MorgansE of US$1.74ps (which included a forecast for a special).
- Gearing remained a healthy 10%, with RIO keen to stay conservative with its balance sheet in these uncertain times.
- We downgrade to a Hold rating on recent share price strength, while still considering RIO a core holding for a wide group of investor types.
Lands ahead of consensus
A good first half result from RIO, with earnings coming in ahead of consensus estimates. RIO posted 1H20 underlying EBITDA of US$9.6bn (vs MorgansE US$9.0bn vs consensus US$9.2bn). Underlying NPAT in 1H20 was US$4.75bn (vs MorgansE US$4.1bn vs consensus US$4.36bn).
Operational cash flow trailed estimates, attributed to timing differences, leaving free cash flow at US$2.8bn (vs MorgansE US$3.7bn).
As a result RIO announced an interim ordinary dividend of US$1.55ps (53% payout ratio) with no special dividend, which fell short of our US$1.74ps estimate (on an assumed 65% payout ratio that included a special).
Net gearing increased marginally to 10%, with RIO clear it would remain conservative with its balance sheet in an uncertain global-macro backdrop.
Result supported by iron ore
Resilient iron ore pricing helped offset lower aluminium and copper prices in 1H20.
RIO's flagship Pilbara iron ore business posted a strong 1H margin (FOB) of 72% for an impressive ROCE of 64%.
Another result where this helped offset aluminium (23% margin & 3% ROCE) and copper (39% margin & 1% ROCE).
While robust, challenges remain in iron ore as we head into the next capex cycle (rising sustaining/replacement capex) and while the Chinese-backed northern area of Guinea's giant Simandou iron ore deposit (which boasts reserve scale and ore quality) marches towards development (<5 years?).
Copper worth the trouble
A tough year for RIO's copper business, with Kennecott struggling to recover from the March earthquake, and Escondida straining under heavy Covid-19 impact which could extend into future years.
RIO's answer? Rapid development of its 2017 Winu discovery in the Paterson Province, WA.
As recently outlined, we expect RIO may seek to further expand its copper earnings through inorganic options, with the big miner's buoyant iron ore earnings creating an earnings and share price advantage over base metal peers.
Downgrade on share price performance
A good result from RIO, albeit with cash flow trailed. We have adjusted estimates for the result, removed assumed future buybacks, increased CY21 aluminium sustaining capex, and revised up 2H20 Iron Ore Company of Canada (IOC) volumes.
As a result we have seen a net decrease in valuation (Morgans clients can login to view detailed reports and price targets).
As a result, we downgrade our rating on RIO to Hold (from Add). Despite the performance we still see RIO as a core holding for most investor types, with an attractive yield profile, high margin earnings and a strong balance sheet.
The key upside/downside risk is metal price volatility.
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