🕐19.08.14 - 10:27 Uhr

INVESTEC: RIO TINTO : SINGLE COMMODITY EXPOSURE, BUT TO HIGHEST MARGINS - HOLD



Rio Tinto (Price: 3406p | Target: 3552p | Rec: Hold) Rio Tinto’s single commodity exposure is often portrayed as a weakness, yet the exaggerated operating margins that its iron ore division enjoys affords it the capacity to withstand high price volatility.

Barring a collapse in iron ore prices, this provides it with a great deal more earnings surety than more diversified peers, which rely on commodity divisions with smaller operating margins and therefore greater earnings volatility.

Rio is capable of delivering a class-leading dividend yield, bolstered by buy-backs. * Iron ore EBITDA margins have been running at 60-70% this decade, twice that of the other commodity divisions.

As iron ore prices decrease, we expect EBITDA margins to fall to c.50%, in par with levels before the Supercycle, but the division is still expected to remain the most profitable, supporting Rio Tinto’s current growth strategy. * This enables the company to confidently predict “markedly increased cash returns” to shareholders.

In this regard, we assume a lift in the progressive dividend policy, with the pay-out ratio increasing 20% from recent levels of c.35% to a c.42%, which we believe can be maintained under even bearish commodity price assumptions.

With net debt now at targeted levels, we expect excess cash to be applied to buy-backs, potentially resulting in a 4% lift in EPS and DPS from FY17E onwards. * Our target price is based on an equally-weighted average of five metrics: NPV, dividend yield, 12-month PE, a 10% forward free cash flow yield and 13x sustainable EPS.

With the roll forward of our model post the 1H14A results and therefore the increased weighting towards higher-earning future periods, our TP has increased from 3,220p to 3,552p.

The iron ore price remains the key risk to the achievement of this TP.
To access the full note please click here Analyst: Hunter Hillcoat +44 (0)20 7597 5182
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