As iron ore prices tower at record highs the greatest risk for Rio Tinto ((RIO)) will come when they fall, although prices are expected to stand the company in good stead in the second half of 2021 and into 2022.
Enduring high prices have mitigated subdued volumes as rain, the pandemic and technical problems impeded mine production in the second quarter. The company had to contend with shutdowns for tie-ins, cultural heritage issues and a tight labour market, which all impacted iron ore volumes in the Pilbara.
Shipments are now expected to to be at the lower end of guidance of 325-340mt for 2021 although UBS notes this still requires a run rate of 342mt in the second half. Macquarie also highlights the risk of a miss on iron ore volumes and retains forecasts at the bottom end of the guidance range.
Cost inflation has also meant unit cost guidance for the Pilbara has been lifted 6%. This has stemmed from higher labour and diesel costs as well as heritage management and the pandemic.
Morgans was particularly disappointed with the Pilbara outcome as quarterly output was the slowest since 2015, and material tightness in the Western Australian labour market along with heightened inflation add risk heading into the second half.
That said, the broker acknowledges the market is keenly focused on the ongoing spot price for iron ore. Morgans sticks with a Hold rating, as long-term investors can still enjoy high-quality earnings, but remains sensitive to the capital that is at risk from the market’s confidence in record iron ore prices.
Macquarie notes the iron ore division accounts for 65% of revenue and 80% of earnings (EBIT) in its forecasts for the first half. Hence, Rio Tinto is highly leveraged to iron ore’s performance and there is upside to earnings forecasts of 38% and 120% in 2021 and 2022, respectively, in a spot price scenario.
Around 90mt of iron ore replacement projects are on track to be completed this year yet Ord Minnett questions why so much is being replaced at the same time. Commissioning of the 43mt Koodaideri mine will be later than expected because of labour shortages yet ramp-up is still expected in early 2022.
Mined copper and bauxite production are expected to be at the low end of the guidance range at 500-550,000t and 56-59mt, respectively. Rio Tinto attributed the lower bauxite volumes in the quarter to heavy rain on Australia’s east coast.
Aluminium production was slightly higher and pricing premiums remain elevated in the first half. Rio Tinto pointed to a strong performance of the ISAL and Betancourt smelters.
Copper
Mined copper production was down -12% in the quarter because of a slope failure at Kennecott (US) and covid-19 disruptions at Escondida (Chile) and Oyu Tolgoi (Mongolia). Escondida sustained lower recoveries and throughput and the planned relocation of the inter-pit crusher at Kennecott affected production.
There were no injuries from the slope failure at Kennecott, as it had been anticipated and mining restarted progressively in June. Rio Tinto expects to recover material from the slide, which is largely copper-bearing ore. Yet mining rates will be slower and high-grade production scheduled for later this year will be deferred to 2022.
At Oyu Tolgoi delays related to the pandemic and discussions with the government in respect of approvals will have a negative impact on timing and costs. Rio Tinto, so far, estimates incremental development costs of US$100m as a result of the delays.
Various approvals from the Mongolian government are still required for caving and UBS envisages material risk that the October 2022 start-up will be delayed. To comply with pandemic-related restrictions site manning levels were less than 25% of planned requirements.
Targeted production for the Winu (WA) copper project is now 2025, a one-year delay. Titanium dioxide slag production guidance has been removed amid risks associated with the security disruptions in South Africa and the company has declared force majeure at its Richards Bay operations.
Dividends
The focus for the August result will undoubtedly be on cash dividends, Morgans asserts, given the limit on major shareholder ownership levels by the Foreign Investment Review Board.
Citi forecasts a balance sheet that is net cash to the tune of $7bn at the end of the first half, implying at an aggregate pay-out of 95% an interim dividend of US$7.30/share. Macquarie expects record earnings and dividend performance in the first half and anticipates a first half dividend of US$4.65.
Despite a disappointing first half production performance Credit Suisse expects strong free cash flow and assesses the dividend yield alone should be enough to justify its Outperform rating. Yet the broker sounds a note of caution as any prolonged risk to operations, which can be ignored in a high pricing environment, could be more significant if and when markets subside.
FNArena’s database has four Buy ratings, two Hold and one Sell (UBS). The consensus target is $135.43, suggesting 6.2% upside to the last share price. The dividend yield on 2021 and 2020 forecasts is 12.3% and 9.0%, respectively.
