Rio Tinto shares fell sharply yesterday as opposition to the proposed $US19.5 billion deal with Chinalco continued and a leading investment bank changed its recommendation on the stock.
The shares fell more than 9% in trading after the new opposition emerged and after Goldman Sachs JBWere said it now rated the giant miner as a sell because of poor prospects for its aluminum business.
Rio fell as low as $46.96, the biggest fall since early December.
They finished down 8.6% at $47.50, a fall of $4.51 on the day.
That was after more bad publicity in Canberra for the proposed deal, with South Australian independent Senator Nick Xenophon seeming to support Senator Barnaby Joyce’s opposition to the transaction happening.
Then Goldman Sachs JBWere analysts said the deal with Chinalco may not go ahead and pointed to “problematic” debt levels at the London-based company. The investment bank cut its rating to “sell” from “hold” in a report dated yesterday.
The comments were made in the context of a long report comparing the aluminium industry assets of Rio and BHP.
The report concluded:
"BHP – BUY – It’s a tough outlook and the stock is not cheap however it is very well placed vs. its peers.
"RIO – SELL – Problematic debt levels and a dire outlook for aluminium.
“There is a risk that the Chinalco deal isn’t approved,” the analysts wrote. “As much as we don’t like the Chinalco deal, if it’s not approved now (after being supported by management and the board), and without an attractive alternative, we would see this as negative for the share price.”
"RIO’s debt levels are high – without the Chinalco deal debt levels are ~US$38bn. With the Chinalco deal debt levels drop to ~US$19bn plus the US$7.2bn convertible bond. Proforma earnings with the Chinalco deal of sub US$3bn with debt of US$26bn including the convertible bond is not attractive. On our forecasts there is little spare cash for growth.
"We value BHP’s assets at US$4.2bn and US$4.1bn for alumina and aluminium compared to RIO’s at US$12.4bn and US$4.9bn (our valuation of RIO’s aluminium smelters is now very low and is influenced by significant losses for the next two years and capex spend from 2012-2015 of US$10bn which is not valueaccretive.
"We think RIO would not spend this cape under our price forecast which would add to the NAP however RIO may need to close operations and take significant closure costs).
"The outlook for aluminium is weak and we are forecasting losses in this division for the next 2 years.
"There is potential that the industry takes many years to recover from excess inventory and mothballed operations that can be switched back on with any glimmer of improved conditions.
"The confidence on cost levels in the Aluminium division is low – this may provide a positive surprise but we feel a negative surprise is more likely. We believe there will likely be closures, closure costs and further significant write-downs in the Aluminium division."
Goldman Sachs JBWere remains close to a listed investment company, Australian Foundation, which earlier this week revealed its strong concerns about the Chinalco deal.
AFI is in fact the largest local investor in the Australian and UK arms of the Rio empire. Its chairman Bruce Teele and board member, Terry Campbell, have long associations with JBWere.
The Senate inquiry will be controversial, but it will be a way for allowing opposition to the proposed deal to emerge into the open in a managed way.
It does contain problems for the federal government which has a strong pro-China stance.
The problem for investors is separating all the deals with Chinese investors from the Chinalco-Rio situation.
OZ Minerals will collapse if a senate inquiry and Senator Joyce’s opposition forced Minmetals to abandon its $2.8 billion savior bid for OZ.
Any investigation by the Senate Economics Committee can call executives from companies, including Rio and Chinalco, to give evidence and will make recommendations in June.
But the government doesn’t have to accept the recommendations.
Australia’s Foreign Investment Review Board this week extended a probe into the deal by up to 90 days.
Senator Joyce’s strident criticism of the Chinese deals was echoed in part yesterday by Senator Xenophon.
He told the ABC yesterday "The Chinalco bid is a real concern.Im not against foreign investment, but this is a strategic stake that effectively an arm of the Chinese government is taking in a major resource company in this country.
"I think we should be very, very wary about it," he told ABC Radio.
Senator Xenophon acknowledged there was extensive foreign investment already in Australian resource firms.
"But this is quite different," he said.
"Chinalco…is not an ordinary company. It is not an ordinary arms-length commercial transaction."
