Rio Tinto Metal prices offset soft start

Overall a reasonable 1Q21 operational result from Rio Tinto, with lower iron ore shipments and mined copper production as expected. Weather impacted RIO’s operations in 1Q21, in particular its flagship iron ore business in the Pilbara where travel restrictions also created a labour shortage. 

Lower volumes more than offset by upgrades to iron ore and aluminium prices. Covid remains a key challenge, dragging on Escondida’s output, slowing OTUG development, and adding costs and unique challenges across RIO globally. 

Maintain our Hold rating with an upgraded target price of A$118 (was A$114). Soggy 1Q21 for Pilbara as expected 1Q21 was a softer quarter vs 4Q20 in RIO’s core iron ore and copper businesses, but this was captured in our estimates. 

RIO posted 1Q21 Pilbara iron ore shipments of 64.6mt (RIO share) vs MorgE 64.6mt, down -12% QoQ with above-average rain during wet season impacting shipments. RIO also struggled with the impact of travel restrictions in WA which saw labour shortages across its iron ore system. Pilbara replacement projects remain on schedule. 

While activity is ramping up at Simandou (Guinea) with RIO receiving technical designs on infrastructure from Chinese design institutes. Work at the Simandou mine site is focused on cost cuts and opportunities to speed up timeline. Worth monitoring. Covid a larger challenge for copper Covid has been more of a challenge for RIO’s copper business. Group mined copper -9% QoQ to 121kt (vs MorgE 125kt). The biggest impact was on Escondida (RIO’s largest copper asset) in Chile, where throughput and recoveries suffered on the sustained loss of ~30% of its workforce from Covid. This contributed to less material stacked on the leach pads and 6% lower feed grade. 

Covid has hurt Oyu Tolgoi Underground development (OTUG) in Mongolia, with China’s tight border controls hampering concentrate shipments and the 2-week hard lockdown holding up development activities and travel. Some underground work continues but work on shafts 3 and 4 has been suspended for all of April and resumption is reliant on covid restrictions easing. This wont effect panel 0 (i.e. where mining starts at OTUG) but will impact panels 1 and 2. RIO is going to provide an update once it better understands the implications for ramp up. Higher mined grades in the OT open pit did help the group. Kennecott had a mixed performance as expected, with transition ore hurting recoveries but higher grades from the south wall offsetting. Price over volume 

While roughly inline with our estimates, the 1Q21 result appears below consensus. Although we do not expect meaningful consensus downgrades to result given the sustained strength in key metal prices. Accordingly we further upgrade our iron ore and aluminium forecasts (summarised later), leading to EPS increases (10-25%) for CY21-23. As a result our DCF valuation has increased to A$118 (from A$114). Remains strong but fundamentals peaking With the upgrade cycle still firmly intact, FCF yield 9%, and dividend yield 7%, we still see plenty of reasons to keep RIO in the portfolio. Particularly given the potential for sustained positive conditions supporting commodities. 

But with that said, it is also hard to not view these strong fundamentals as peaking. Particularly with iron ore, copper and aluminium prices all above levels we consider sustainable over the long-term. In the meantime on continuing strength we maintain our Hold rating. The key risk being metal demand drivers.

Company description Rio Tinto (RIO) is a global diversified mining company. The company’s flagship operating assets are its West Australian iron ore operations, located in the Pilbara region. RIO is highly competitive in iron ore, through economies of scale of its integrated operations and large number of active mines, which have supported the development of popular iron ore products. RIO is the world’s second largest seaborne iron ore producer after Brazil’s Vale SA. RIO’s next largest division is its geographically diversified aluminium division (including bauxite and alumina operations). RIO’s other key division is its copper business, which includes equity interests in sizeable mines such as Escondida and Oyu Tolgoi.

Changes to estimates Commodity prices We have further rolled forward our iron ore price assumptions as the spot market sustains near peak levels. We continue to believe that 1H21 will be a top for iron ore, with slowing China stimulus on a maturing economic recovery and uplift in Brazilian supply combine to take some heat out of the seaborne market. 

Meanwhile we have also delivered upgrades to our medium-term (2021-23) aluminium price assumptions. Moving to better accommodate a strong period of transitioning Chinese supply (environmental focus and energy/carbon mix shift) and expect covid recovery. Company assumptions We have not made any adjustments to our RIO forecasts post the 1Q21 result other than to incorporate the first quarter itself.