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Investment Overview for Rio Tinto (NYSE:RIO)
WHAT HAS CHANGED?
Iron ore and coal prices have fallen sharply over the course of the last year, due to oversupplied markets and weak demand. The fall in coal prices has prompted Rio Tinto to review its coal mining operations and selectively divest its mines. In contrast, despite the fall in iron ore prices, the company has continued to ramp up its iron ore output.
- Divestment of coal mines
- Rio Tinto completed the sale of its interests in the Bengalla Coal Joint Venture in 2016. This asset sale follows sales of the company's interests in the Clermont mine, located in Queensland, Australia, and Rio Tinto Coal Mozambique, which represented the majority of the company's coal mining interests in Mozambique, during the course of 2014.
- Rising iron ore production
- Despite the sharp fall in iron ore prices, Rio Tinto has continued to ramp up its iron ore production. The company completed the expansion of infrastructure to support production rates of 360 million tons per annum (Mt/a) in 2015 at its Pilbara iron ore mining operations, located in Western Australia. The Pilbara operations achieved production rates of 330 Mt/a during the course of 2015. The company intends to further ramp up production at its Pilbara operations, following the infrastructure expansion at the site. Rio Tinto is among the lowest cost iron ore miners in the world, and its operations are profitable at current price levels.
Below are key drivers of Rio Tinto's value that present opportunities for upside or downside to the current Trefis price estimate for Rio Tinto:
Iron Ore Shipments
- Iron Ore Shipments: We expect Rio Tinto's iron ore shipments to rise rapidly till 2017, due to the completion of the expansion of the company's infrastructure at its Pilbara operations to support production rates of 360 Mt/a in 2015, and the company's plans to ramp up production from the site. However, market conditions for iron ore are currently characterized by weak demand conditions and an oversupply situation. If demand does not recover sufficiently over the forecast period, Rio Tinto may be forced to reduce its planned iron ore shipments. In this scenario, if shipments grow at a weaker rate than expected and Rio Tinto's iron ore shipments reach 375 million tons by the end of our forecast period as opposed to around 400 million tons in the base case, it would represent a downside of around 5% to our price estimate.
Average realized prices of Iron Ore
- Average realized prices of iron ore: Market conditions for iron ore are currently characterized by weak demand conditions and an oversupply situation. This has resulted in plummeting iron ore prices over the last year or so. We expect iron ore prices to fall in 2016 as well, before recovering gradually over the rest of the forecast period. However, if prices recover earlier and more robustly than expected, driving up Rio's realized iron ore prices to $55 per ton by the end of the forecast period, as opposed to $49 in the base case, it would represent an upside of around 11% to our price estimate.
Rio Tinto Group is a diversified mining and resources group, headquartered in London and Melbourne. The company has operations across six continents, but these are mainly concentrated in Australia and Canada. The company has a number of subsidiaries, each focusing on one of the different product types in the company's portfolio. The company has a principal focus on mining of primary ore for metals. It also owns a number of high-capacity smelting facilities for aluminum and refining facilities for copper & gold.
The company's Iron Ore division is the most valuable division for the following reasons:
The iron ore segment accounts for around 40% of the company's revenues and nearly 60% of its EBITDA. Though these numbers may decline over the next four years, the division will still contribute a majority of the company's profits. The company has long-term contracts with iron and steel manufacturers worldwide, securing the interests of its mining operations.
Weakness in demand for iron ore
Iron ore is used as a raw material in the manufacture of steel. Thus, the demand for steel indirectly influences the demand for iron ore. China is the world's largest consumer of steel and iron ore. It accounts for the purchase of nearly two-thirds of the seaborne iron ore supply. Chinese demand for steel is expected to decline by 4% and 3% in 2016 and 2017 respectively, following on from a 5.4% decline in 2014. Weakness in demand for steel will translate into weakness in demand for iron ore, which will put pressure on prices.
Oversupply of iron ore
Weakness in demand for iron ore and an increase in production by iron ore majors has resulted in an oversupply situation. Though the seaborne iron ore surplus has narrowed to around 33 million tons in 2016 as a result of supply cuts by high-cost iron ore producers, a ramp up in production from the big low-cost producers is expected to boost the surplus to 100 million tons by 2018. With the oversupply situation expected to prevail in the near term, the growth in iron ore prices will remain muted.
Weak global demand for copper
China is the largest consumer of copper in the world, accounting for nearly 40% of the total world consumption of copper. China's GDP growth is expected to slow to 6.3% and 6% in 2016 and 2017 respectively from 6.9% in 2014. Slower economic growth in China has led to a moderation in demand for copper. Further, the proposed structural transformation of the Chinese economy from an investment and export led growth model to a consumption led growth model, may negatively impact Chinese demand for copper in the long run. Weak Chinese demand for copper will put pressure on copper prices.
Weakness in demand for coal
China is the world's largest consumer of both metallurgical and thermal coal. Weak demand for both kinds of coal from China, combined with an oversupply situation due to an expansion in production by major mining companies, translated into plummeting coal prices in 2014 and 2015. Measures taken by the Chinese government to curb domestic production raised the demand for imported coal in China, boosting coal prices in 2016. However, the ratification of the Paris Climate Agreement by major coal consumers such as the U.S. and China is set to weigh on the long term demand for coal.
Aluminum as a replacement for other materials and metals
- Aluminum is lightweight and its use in cars can help reduce weight and thus emissions.
- Aluminum is durable and requires lower maintenance (corrosion resistant) compared to other metals and is hence finding its applications in the construction industry.
- The unique characteristics of aluminum, such as malleability and ductility, help in the fabrication, storage, and distribution of retail products. It is thus being widely used in the packaging industry as well.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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