Rio Tinto Rebound Went Too Far?

Rio Tinto stock (NYSE: RIO) has seen an impressive rise of close to 70% since the March lows of this year, as it increased from $36 to $61 off its recent bottom, compared to the S&P 500 which saw a 45% rise since its recent low. The stock was able to outperform the broader market due to a rise in global iron ore prices following the US government’s announcement of a string of measures along with stimulus packages announced in other economies to keep businesses afloat, in addition to the gradual lifting of lockdowns. But are the gains warranted or are investors getting ahead of themselves? With RIO’s stock 15% above the level at which it was at the end of 2017, we believe that the stock has increased beyond its near term potential and could see a drop of around 10% from its current level. Our dashboard What Factors Drove 15% Change In Rio Tinto Stock Between 2017 And Now? provides the key numbers behind our thinking.

RIO’s stock price rise between 2017-2019 is justified by the 7.9% increase in Rio Tinto’s revenues, from $40.5 billion in 2017 to $43.7 billion in 2019, mainly due to a rise in iron ore prices and higher shipments. But this was offset by a 27% decline in profitability, with net income margins dropping from 21.8% in 2017 to 16% in 2019. Though margins were unusually high at 33.8% in 2018 due to a significant gain from the sale of assets, they dropped in 2019 (to below 2017 levels) because of a high impairment charge related to RIO’s copper and aluminum assets. On a per share basis, earnings dropped from $4.92 in 2017 to $4.25 in 2019.

Despite lower EPS, the P/E multiple increased from 11x in 2017 to 14x in 2019 as the stock price continued to rise during this period. This divergence was also because the market expected higher growth in the future with iron ore prices increasing significantly in 2019. However, the multiple decreased in 2020 following the outbreak of coronavirus, but has since then shot up again as iron ore prices rose following various stimulus measures announced. The multiple currently stands at a little over 14x.

What’s The Trigger For A Downside?

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 recently. Additionally, the lockdowns also adversely impacted the global supply chain for companies like Rio Tinto which have operations spread across geographies, leading to a decline in production and shipments. Along with iron ore, a drop in copper and aluminum prices is also expected to hit a diversified miner like RIO. This was reflected to a certain extent in the Q1 2020 production report of the company. Though iron ore and bauxite production went up y-o-y, the production across all its major segments saw a drop ranging from 4% to 16% sequentially (Q1 2020 vs. Q4 2019).

Q1 2020 saw only a partial impact of the current crisis, with the actual gravity of the situation likely to be reflected in the half yearly numbers, which are expected to report a sharp decline in revenues and earnings year-on-year. Though the stock has increased significantly over the last 4 months after the Fed’s announcement and with global economies opening up, the recent surge in Covid positive cases in a number of states in the US could prove to be an impediment for RIO. If the rise in cases warrant a re-imposition of lockdowns, then the stock could see a sharp drop to as low as $50. However, even in the absence of another lockdown, with the gravity of the crisis on RIO expected to be known in the H1 results soon, EPS is likely to drop significantly in 2020 and considering the volatility of global commodity prices, we think that RIO’s stock is overvalued at the moment. Trefis has a fair price estimate of $55 for Rio Tinto’s stock, which reflects a potential downside of about 10%.

In contrast here’s how Vale’s stock could look post Covid-19. Interestingly, RIO’s peer Cleveland-Cliffs’ stock plunged despite revenues being stable.

See all Trefis Price Estimates and Download Trefis Data here

What’s behind Trefis? See How It’s Powering New Collaboration and What-Ifs For CFOs and Finance Teams | Product, R&D, and Marketing Teams