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Rio Tinto - Iron Ore holding up

Emilie Stevens, Equity Analyst | 29 July 2020 | A A A
Rio Tinto - Iron Ore holding up

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Rio Tinto plc Ordinary 10p

Sell: 4,797.50 | Buy: 4,800.00 | Change 0.00 (0.00%)
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First half revenues were 7% lower at $19.3bn, with underlying EBITDA (earnings before interest depreciation and amortisation) 6% lower at $9.6bn. That reflects a challenging first half for the Copper and Aluminium divisions, while Iron Ore remained stable.

Coronavirus is providing a challenging backdrop through commodity prices volatility and operation disruption. However, Rio's production guidance for the year remains unchanged.

Rio declared an interim dividend of 155 cents, 3% higher than last year.

The shares were broadly flat following the announcement.

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Our view

Rio might technically be a diversified miner, but iron ore is really what it's all about - accounting for three quarters of cash profits this half. And thanks to strong Chinese demand and supply constraints - propping up the iron ore price - being mostly about iron ore is working well for Rio at the moment.

With production costs at the flagship Pilbara mines under $15 a tonne, Rio has the potential to produce at incredibly low costs. Average market prices are currently in excess of $80 a tonne - digging up some dirt and selling it for five times what it costs is an attractive proposition by anyone's standards.

Of course sensitivity to commodity prices is a curse as well as a blessing. When prices collapsed in 2015/16 as demand from key growth markets like China dried up, Rio was forced to embark on a brutal cost cutting exercise.

The group remained profitable, but had a mountain of debt on the balance sheet. Since then debt has been reduced to more manageable levels. Organic cash generation has played a part, boosted by a rebound in prices, and the sale of coal assets also brought in much-needed cash.

That's just as well because coronavirus is proving to be a turbulent time.

Demand for industrial commodities, like iron ore and copper, rises and falls with the economic cycle. This played out over the first half as the outbreak and subsequent government restrictions that followed put the breaks on many economies - demand and in turn prices dropped. China's push to get building again quickly, meant the dent to Iron Ore was short-lived. But over the first half Copper and Aluminium dragged.

The start of the second half is seeing theory and reality diverge somewhat. Commodity prices have recovered significantly despite the fact this year is set to see the biggest contraction in the global economy since WW2. The bull case says other governments will follow China's lead in trying to spend itself away from deep recession, thus supporting commodity prices.

The more cautious argument suggests that at the moment optimism is running ahead of reality, fuelled by waves of cheap money from central banks. And that significant economic contractions are still a very real risk. The result could bring theory and reality back in line, with commodity demand taking a hit and prices and profits likely following suit.

The economic outlook is still not immediately clear and as a result we'd expect price volatility to persist. Positive or negative that volatility has direct implications for profits, which is important to bear in mind because the group says it'll pay out around half of earnings as a dividend every year. If profits fall dividends will too.

Rio Tinto key facts

  • 12m forward Price/Earnings ratio: 12.1
  • Ten year average 12m forward Price/Earnings ratio: 10.4
  • Prospective yield: 5.2%

We've introduced this section in response to recent survey feedback.

Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Half Year Results (underlying figures used)

Iron Ore revenues and EBITDA nudged up 2% to $11.5bn and $7.7bn respectively. The rise reflects increased volumes and lower operating costs, with Iron Ore prices remaining stable over the period $85.1 per tonne - reflecting continued strong demand from China together with constrained seaborne supply.

Aluminium revenues fell 12% to $4.5bn with EBITDA falling 18% to $925m, reflecting weak global demand and a 13% decline in the aluminium price. These results were somewhat offset by higher bauxite sales and lower operating costs.

A "challenging first half" in the Copper & Diamonds division saw revenues drop 28% to $2.1bn with EBITDA following suit falling 45% to $670m. The drop reflects significantly lower prices (Copper down 11%, Diamonds down 39%) and lower production volumes - reflecting lower quality output and significantly lower Copper volumes at Kennecott due to an earthquake and planned shutdown.

Energy & Minerals revenue fell 8% to $2.3bn and EBITDA fell 23% to $739m, reflecting lower pricing across the portfolio, despite a "resilient" performance operationally in light of coronavirus related restrictions.

Lower profits meant cash from operations was 12% lower than last year at $5.6bn. This decline together with higher capital expenditure (up 13% to $2.7bn) meant free cash generated in the first half fell 28% to $2.8bn. Rio continues to spend on development opportunities and expected capital expenditure to be around $6bn this year.

These declines together with a distribution to shareholders of $3.8bn, meant net debt rose by $1.2bn in the half to $4.8bn - in line with the prior year.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.