Rio Tinto: Reasons To Buy

Nordroden

Investment Thesis

Buying Rio Tinto For The Wrong Reasons

It is reasonable to opportunity that nan world reliance connected metals for manufacture and infrastructure will almost surely turn complete nan adjacent 20 years. Developing nations proceed to beforehand their economies, and pinch that, an expanding request for metals to build houses, roads, bridges, trains, and more. As consumers successful developed countries go wealthier, they besides go much limited connected metals, particularly those basal to support nan maturation of electrical vehicles and smart grid infrastructure, specified arsenic copper and lithium. Driven by concerns complete Lithium supplies, Ford signed a memorandum of knowing to spot it go a "foundational partner" successful Rio Tinto's (NYSE:RIO) Rincon lithium project. Human advancement is driving request for superior and secondary metals successful developed and emerging markets. Last I covered Rio Tinto was measurement backmost successful 2021.

A emergence successful request for metals surely doesn't wounded RIO stock, but it shouldn't beryllium nan only facet guiding your determination connected whether aliases not to put successful nan manufacture aliases nan company. In nan 10 years betwixt 2011 and 2022, world alloy accumulation (the superior extremity marketplace of RIO's business) grew by 33%, yet RIO's Iron Ore income remained flat; $29.9 cardinal successful 2011 compared to $30.1 cardinal successful 2022.

Global request for robust ore is 1 of galore factors influencing RIO's gross and profitability, specified arsenic governmental and economical factors, from proviso levels to competition, tariffs, inventories, commodity value speculations, and demand. Because of this, if you determine to acquisition RIO connected nan presumption that metals prices aliases nan company's profits will emergence owed to higher demand, you whitethorn extremity up emotion fto down arsenic a result.

The correct logic to bargain RIO

RIO is 1 of nan lowest-cost producers of metals successful nan world. Revenue and margins mightiness fluctuate, but seldom will nan institution find itself successful a business wherever accumulation becomes unprofitable, for example, owed to value fluctuations. Higher-cost producers are nan first to unopen down operations arsenic prices spell down, restoring nan supply-demand equilibrium earlier RIO's accumulation measurement is impacted. This buffer offers a separator of information that translates to lucrative, risk-adjusted returns for semipermanent shareholders. Second, RIO's shareholder-friendly superior allocation strategy is unparalleled. The institution returned $78 cardinal to shareholders successful dividends successful nan past decade. Our bargain standing rests connected these elements alternatively than request estimates aliases commodity prices.

Revenue drivers

Slowing building successful China dimmed request outlook for robust ore successful 2022, but manufacture pundits are optimistic for 2023 prospects. Iron ore is nan superior input for alloy and constitutes half of RIO's income successful 2022 and two-thirds of EBITDA. The metallic forms nan backbone of RIO, generating a return connected assets of 68% successful 2022, much than immoderate different metal. Last year, RIO invested $2.9 cardinal successful expanding existing robust ore fields and $3.1 cardinal successful processing nan Gudai-Darri mine, which opened successful June 2022. Free Cash Flow from Iron Ore declined 27% successful 2022 arsenic commodity prices fell from nan unsustainable 2021 levels. Nearly 80% of RIO's robust ore accumulation is shipped to Chinese alloy mills.

Smaller "energy modulation metals" mines, specified arsenic copper and lithium, are progressively being acquired by much salient mining corporations. In 2022, BHP Group (BHP) bought OZ Minerals for $6.6 billion, while RIO accrued its liking successful nan TRQ copper excavation to 66% for $3.3 cardinal and bought nan Rincon Lithium task for $900 million. I expect much deals to come. Management assured shareholders it would beryllium disciplined successful its plus purchases. However, its copper business is importantly little ascendant than its rivals. In 2022, for instance, BHP mined 1,573,000 metric tonnes of copper, whereas RIO output stood astatine 521,000 metric tonnes of nan metal, up from 493,500 metric tonnes successful 2021 but down from erstwhile years. Notwithstanding management's show of ambivalence toward mergers and acquisitions, it is clear that RIO needs to diversify its merchandise portfolio.

Lower copper prices and softer by-product minerals, chiefly golden ore successful nan Oyu Tolgoi mine, led to a 14% year-over-year autumn successful copper conception gross successful 2022, from $7.8 cardinal to $6.7 billion. Copper is often recovered pinch varying concentrations of different minerals, including gold, silver, zinc, and lead, and successful varying degrees crossed a mine. RIO's copper mines generated a antagonistic Free Cash Flow because of nan company's ongoing capacity description expenditures, arsenic guidance continues its efforts to grow copper accumulation capacity successful its existing mines.

Inflationary pressures proceed to person a meaningful effect connected RIO's margins. Despite higher mean trading prices of Aluminium successful 2022, nan EBITDA separator declined to 29%, down from 38% successful 2021. The accumulation declined from 7,544,000 tonnes to 7,894,000 tonnes successful 2021 owed to operational challenges successful nan Kitimat, and Boyne smelters didn't thief either. Still, fixed nan impermanent quality of these challenges, accumulation should emergence successful 2023. Aluminum income could transcend $15 cardinal this twelvemonth if prices stay steady.

Dividend and Capital Allocation Policy:

RIO maintains a dividend payout argumentation ratio of 40% - 60%. The dividend will up and down pinch commodity cycles, alienating galore income investors, particularly unit investors seeking unchangeable dividends. However, looking astatine nan company's capacity complete nan past 10 years, full returns person been exemplary, outperforming smaller mining companies represented successful nan XME, REMX and PICK mining ETFs, and different larger peers, including BHP, Glencore (OTCPK:GLNCY), Anglo American (OTCQX:NGLOY) and Vale (VALE) arsenic shown successful nan chart below.

Data by YCharts

While group who don't understand nan business are disappointed successful nan company's caller determination to trim nan dividend by half, those who are loyal shareholders understand nan business's quality and its cyclicality. In nan agelong term, I expect RIO to repetition nan bonzer returns it delivered successful nan past decade.

Summary

Although galore opportunity that RIO's ticker is simply a proxy of robust ore prices, dissimilar nan metal, RIO pays dividends, and a batch of it acknowledgment to its shareholder-friendly argumentation of distributing astir each excess profits supra CapEx needs to shareholders.

High barriers to introduction are caused by nan precocious superior costs basal to commencement mining operations, nan complexity of applicable regulations, and nan knowledge and acquisition required to navigate done various geopolitical situations astir nan world.

There is simply a costs disadvantage for smaller miners. When compared to mining ETFs that see smaller mining companies, RIO is simply a much charismatic investment, and successful this peculiar case, diversification isn't needfully an advantage.

Bashar is simply a contributing writer astatine Seeking Alpha, focusing connected Long/Short finance ideas, pinch a geographic attraction successful North America. Before that, Bashar worked astatine an Investment Fund successful nan United Kingdom. He has a Master's grade successful Finance from nan Queen Mary University of London and a Bachelor's grade successful Economics from Middlesex University.