Rio Tinto (RIO-US
$67.25): “Iron Ore Plus More”
By: Sam Shibilski, AIM
Student at Marquette University
Disclosure:
The AIM Equity Fund currently holds this position. This article was written by
myself, and it expresses my own opinions. I am not receiving compensation for
it and I have no business relationship with any company whose stock is
mentioned in this article.
Summary
- Rio Tinto (NYSE:RIO-US) is a longstanding Australian metal mining company which specializes on the finding, mining, and processing of metal and mineral resources. Its primary revenue segments are Iron Ore Mining (57.29%), Non-Ferrous Metal Ore Mining (21.15%), Alumina and Aluminum Products Manufacturing (17.37), Diamond Mining (1.36%), and Other (2.83%). Its primary customer bases are Mainland China (49.7%), US (14.2), and Japan (8.9).
- China has reduced steel production in an effect to lower their carbon production. However, they are supplementing their production with an increased steel imports.
- China and Australia trade disputes have continued from 2020 into 2021 and although Australian iron ore has not been tariffed the threat continues to exist however small.
- Rio Tinto enters the battery minerals market at a material scale through their new mine in Jadar, Serbia with expected operations opening in 2026.
Key Points:
China plays a significant factor in the global steel market in addition to their relationship with RIO, making up over 50% of the global steel usage in 2019 and historically 60% of the iron has come from Australia (World Steel). Since May 2020, China have banned and tariffed Australian products because of China’s accusation that Australia has been hostile in relation to Covid-19 questioning and foreign investment. These bans have been far reaching, however Australian global exports have continued to rise through this pressure and most notably left out of the bans is Australia’s coveted iron ore (Bloomberg). Due to China’s dependency on Australian iron, it is not in their best interest to place tariffs on it. However, China is more willing to purchases non-Australian iron such as Brazilian iron from Vale. This transition from Australian to Brazilian ore, however possible on paper would take a tremendous Chinese supply chain shift to move away from the ocean liner that is Australian ore, again 60% of China’s total imported iron ore.
Simultaneously, China has intentions of achieving state carbon neutrality by 2060. One of the initiatives has been to begin a shift away from carbon-based steel production. As such the EAF (electronic arc furnaces) industry, an alternative to carbon steel production, is expected to increase from its 15% Chinese market cap in the coming decades. Additionally in a more immediate response, China has increased its imports of pre-made steel, thus the carbon expensive process of smelting iron ore into steel originates and is attributed to the producing country and not China. This increase in Chinese steel imports will decrease its need for iron ore, however the global demand will remain constant with other producers increasing iron ore exports to China. This will also be a lengthy shift because China currently produces about 50% of the world’s steel. Furthermore, RIO needs to extend their relations with other top steel producing countries such as India, Japan, US, and Russia early in order to remain a leader in the iron ore industry.
It is not just China that is pushing better carbon based ESG, but the world. RIO’s Board sees this as a driver for their major revenue streams – iron ore, copper, and aluminum – and has expedited their entry into the battery minerals business. With the funding of $2.4 billion being approved in late July a mine in Jadar, Serbia is set to begin building in 2022, with live operations in 2026. This expansion is RIO’s first material move into this business; a core battery mineral, lithium, demand is expected to grow at a CAGR of 25% to 35% over the next decade. Through Jadar’s scale it is expected to be able to power over a million electric vehicles (EV) per year. This expansion will provide new customers not just for RIO’s lithium but also for their longstanding products through the need for iron, copper, and aluminum in wind turbines, EV, solar cells, and transmission lines.
What has the stock done lately?
Since mid-May 2021, when the stock peaked, RIO has seen a steady decline from $94.65 to $67.25. This near 29% decrease in value is directly correlated with the decline of iron ore price. As seen in the ore monthly prices from FRED iron has decreased 24.37% since June and it is suspected to have fallen more intra-month May data was available.
Past Year Performance
Over the past year RIO has seen a 11.90% increase in stock price, however two common benchmarks iShares MSCI ACWI ex-US and iShares Global Materials have outperformed RIO posting gains of 25.15% and 26.83% respectively. When looking at RIO and its iron ore peers, they are trading at historically low PE values; RIO currently at 5.79 with a 5Yr average of 11.3 and Vale currently at 4.39 with a 5Yr average of 11.9 (excluding 2019 for Vale). Additionally, RIO has committed a $9.1 billion dividend payout from and EBITDA of $12.8 billion.
My Takeaway
Rio Tinto alongside other iron miners are trading at
a PE discount because their stock price fall has been overshot and exaggerated
with respect to the recent decreases in iron ore prices. China has influenced
the iron ore price as they have decreased, they production of steel in line
with their ESG and recent increases in regulation. The overall steel demand
looks to stabilize as China increases their steel imports. As for China and
Australia relations, although China has tried to clamp down on many of their
imports from Australia iron ore has not and likely will not be touched unless
either nation acts very directly and aggressively against the other because
both countries heavily depend on their iron relationship. Furthermore, with
RIO’s investment into a new business segment, battery minerals, they are
providing diversity to their business model, creating new customers for their
entire business, and are showing their ability to move with the times.
Furthermore, Jadar is just opening the door into the battery minerals market, a
market they wish to further explore in the years to come with the continued
boom of the EV market.
