- Iron Ore constitutes 75% of the Trefis price estimate for Rio Tinto's stock.
- Aluminum constitutes 10% of the Trefis price estimate for Rio Tinto's stock.
- Copper constitutes 9% of the Trefis price estimate for Rio Tinto's stock.
WHAT HAS CHANGED?
- Impact of Coronavirus
- Rio Tinto's stock dropped about 40% since the outbreak of coronavirus to $36 in March 2020. The global spread of coronavirus led to lockdown in various cities across the globe, which affected industrial and economic activity. The iron ore demand from industry players affects global iron ore price levels, in turn, impacting the company’s price realization for its products. Lower demand from construction players and shedding of capacity by major steel companies, mainly in China, led to a drop in global iron ore prices. Rio Tinto's stock has since recovered back to its pre-coronavirus level of $60 at the end of August 2020. This was mainly due to the Fed's stimulus package and the gradual lifting of lockdowns, which has also led to recovery in the iron ore prices which are closer to $167/ton. With such a sharp rise in iron ore prices and successful rollout of vaccines, RIO stock price has increased to $75 per share on 25th March 2021. We expect continued strength in iron ore prices, higher revenue and earnings over the coming quarters wil drive strong growth in the stock in the near term
- Increased regulatory curtailments in China supporting iron ore prices
- China has been fighting alarming levels of pollution and undergoing a structural change by cutting down its steel output. The Chinese regulatory authorities have cut down the output of substandard steel products and the Chinese steel producers are demanding iron ore with Fe content greater than 60% as it produces more steel per ounce of iron ore and emits less coke into the environment. Rio has access to high-grade iron ore at low cost which has remained beneficial for the company throughout 2017 and 2018.
POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE
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:
Average realized prices of Iron Ore
- Average realized prices of iron ore: The structural change initiated in China has largely impacted global iron ore prices by widening the price gap between high-grade ore and low-grade ores. Producers of higher-grade ores are able to charge a substantial amount of premium for their products and the expected to continue to do so in the near future. In the long term, if Chinese demand grows faster than anticipated, driving up Rio's realized iron ore prices to $90 per ton by the end of the forecast period, as opposed to $84 in the base case, it would represent an upside of around 3% 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.
SOURCES OF VALUE
The company's Iron Ore division is the most valuable division for the following reasons:
The iron ore segment accounts for around 57% of the company's revenues and nearly 76% of its EBITDA. These numbers may decline only marginally over the next few 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.
Potential impact of the U.S. government's infrastructure plan
The U.S. government has planned a ten year $1.5 trillion overhaul of domestic infrastructure, with a particular focus on transportation infrastructure. The implementation of this infrastructure plan, once it has been passed by Congress, is expected to sharply boost U.S. demand for copper and iron ore, which should translate into improved pricing environments for these commodities.
Sustainability of Chinese iron ore demand
Chinese economic growth has been declining over the past few years. The Chinese government instituted a fiscal stimulus targeting the infrastructure sector in 2016, in order to revive growth. Though the fiscal stimulus has boosted the demand outlook for iron ore, demand growth in China has occurred at a lower rate than expected, as indicated by the rising stockpiles of iron ore. This has raised questions about the sustainability of Chinese iron ore demand.
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.