In its annual general meeting, mining giant Rio Tinto (NYSE:RIO) reiterated its focus on king iron ore and copper despite prices coming under pressure. Instead of returning much cash to shareholders, it would continue to boost production capacities.((Rio Tinto backs iron ore in dicey global environment, Reuters, May 10)) The move could irk many, who have been questioning the long-term outlook of the iron ore as well as copper. Below we take a look at iron ore affects the value of the company. The slowdown in China’s economic growth has resulted in lower demand, which has added to the worries of miners like Rio Tinto, Vale (NYSE:VALE) and Freeport McMoran (NYSE:FCX).
We currently have a$82 price estimate for Rio Tinto, about 60% upside to its current market price. We are in process of revising our model due to changes in the reporting structure of the company.
Not Deterred Despite Weak Iron Ore Prices
The prices of iron ore, primarily used in steel production, have come under pressure owing to slowing construction activity in China leading to a piling up of inventories and a resulting decline in demand. We expect iron ore prices to remain weak in the near-term due to additional capacity expected to come online over the next two years.
Iron ore demand from the world’s largest iron ore consumer China may have taken a toll. But, the company is still bullish on the long term outlook of the company. Rio Tinto believes that iron ore shipments can rise by more than 50% by 2015, the demand primarily coming from developing nations like India and China. To meet the expected rise in demand, the company is ramping up its various production facilities.
Further, Rio Tinto has a competitive advantage with cost of production being lower than other small miners and new entrants. Iron ore producer from China and India will find it difficult to supply iron ore at lower prices.
Recently, Rio Tinto had invested more than a billion dollar in Pilbara, Australia including fuel and power supply projects and develop a sustainable water supply using the coastal water in order to accommodate the expansion of annual production capacity up to the planned 283 million tons a year and to 353 million tons thereafter. Rio Tinto’s forecast for 2012 iron ore production stands at more than 250 million tons. Look below to see how increase in production will affect the company’s value.
But, falling iron ore prices coupled will soaring production costs due to the increase in labor and other raw material costs will keep the EBITDA margins in check. The company it trying to combat the same by investing in developing basic resources for carrying out the mining operations.
While we expect the near-term weakness to persist, we believe the company is well-positioned once the current slowdown in the global commodity market passes. Its plans to expand its iron ore and copper businesses in emerging markets including India should be beneficial in the long term. Rio is also undergoing structural changes including aluminum capacity cuts and the divestiture of its diamond business. However, rising taxes could add to the list of worries for the company.