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Rio Tinto - Put your money where your mouth is

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December 18, 2015 – Comments (0) | RELATED TICKERS: RIO , FCX , BHP

Today we saw one of the world biggest miners Rio Tinto tell the market of its proposed $4.4bn bet on copper prices (clearly they are bullish longer-term, taking a multi year approach and putting their money where their mouth is)

http://www.investegate.co.uk/rio-tinto--rio-/rns/oyu-tolgoi-signs-project-finance-agreement/201512150700290619J/

Whilst only the most stubborn of commodities followers still believe in the long term commodities cycle thesis, we believe that this has now run its course and instead a series of mini cycles will occur and that key commodities will trade in range bound bands unless significant supply is taken out of the market (similar to that which we saw in the Zinc market from Glencore) or demand increases.

Oil and Iron ore will be range bound between $35 - $60 (unless OPEC/Saudi Arabia caves into to member pressure). Copper we see as having less of an oversupply in the medium term as larger mines grades decline rapidly and we see bauxite and alumina prices actually recovering as aluminium is used increasingly in the auto and aerospace sectors and China stops flooding the market with low grade product.

In regards to Rio what does this all mean? Peer BHP with lists 4 (possibly 5) pillars (Iron, copper, coal, oil and gas and maybe potash) was supposed to outperform the more Iron ore pure play Rio Tinto. BHPs make up was supposed to offer it a degree of protection via not being overly reliant on any one key commodity. Unfortunately it was exposed to the wrong 5 and was not the lowest cost producer in any of these. In Iron Ore it is a key player but Rio Tinto can undercut it and Vale is closely on its heels, In copper it has clout but again FCX etc can match it punch for punch, its fortunes in coal are tied to that of Iron Ore and thus Chinese steel demand, it bought oil and gas assets at the top of the market and these are yet to turn a profit and it has been rebuffed in its ambition to become a larger player in the global potash sector (key price cartels breaking up also haven’t helped).

 

 

However the principle of this diversification is sound. 

So instead of investing (or maybe alongside) $4.4 billion expanding a mine it already has the rights to could it maybe consider striking a deal with the likes of Freeport-McMoRan Inc (once it has spun off its oil and gas assets and depending on how much group debt it puts into this entity) for its world class copper assets. This would leave RIO as the lowest cost Iron Ore producer, have some of the best copper assets in the world, and hold via Rio Tinto Alcan first quartile Aluminium assets the virtues of which we have mentioned above and we are increasingly positive on. It would also by virtue of having increased copper exposure gain increased gold production (often found alongside copper).

If it changed its dividend policy from being progressive to a ratio based pay-out it could use part of this saving to fund any acquisition depending on if stock or cash was used. Given peers Anglo American, Glencore, FCX and likely BHP have cut dividends/changed policy there is no need for Rio to buck that trend.

Iron Ore, Copper, Aluminium and Gold seem to us a more attractive prospect and have greater synergies we would suggest than BHPs Iron Ore, Copper, Coal, Oil and Gas and Potash.

FCX is also trading at distressed levels due to its debt burden and management of Rio Tinto may find an ally in the likes of Carl Icahn whom owns a large stake in FCX.

We still need to crunch a lot of numbers on this idea to see where debt levels would rise to and if there would be any concentration in geographies or metals that may cause issues to global regulators. The whole commodities space looks in disarray at present but for cash flow generative firms with management teams with truly longer term outlooks value may appear. However with 2016 expected to be another year of weak demand from China there may be scope to wait on any potential deals.

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