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Mark Yu
Mark Yu
Articles (208)  | Author's Website |

Rio Tinto Gaining Traction

One of world’s biggest miners provided total returns that beat broader index performance

February 17, 2017 | About:

Rio Tinto (NYSE:RIO), the $104.8 billion miner, delivered its full-year results last week. It experienced a 3% deduction in its overall sales in 2016, down to $33.78 billion in 2016 compared to $34.83 billion in 2015. Despite the weak sales growth, the miner delivered an outstanding $4.62 billion in profits in 2016 compared to $866 million in losses the year prior.

As observed, Rio Tinto reported $536 million in gains in exchange and derivatives in 2016 compared to $3.28 billion in losses in 2015. As part of its guidance, Rio Tinto also expects to add $5 billion to its free cash flow by 2021.

“Today’s results show we have kept our commitment to maximize cash and productivity from our world-class assets, delivering $3.6 billion in shareholder returns while maintaining a robust balance sheet. At the same time, we strengthened the portfolio and advanced our high-value growth projects as we look to the future.

“We enter 2017 in good shape. Our team will deliver $5 billion of extra free cash flow over the next five years from our productivity program. Our value-over-volume approach, coupled with a robust balance sheet and world-class assets, places us in a strong position to deliver superior shareholder returns through the cycle.” – Rio Tinto CEO Jean-Sebastien Jacques

Rio Tinto Shares fell 0.2% compared to Standard & Poor's 500 index rose 0.07%.

Total returns

Rio Tinto greatly outperformed the broader S&P 500 index in the past year. Total returns for the mining giant were 88% compared to 27.8% for the latter according to Morningstar data. Meanwhile, Rio Tinto failed to notch a near percentage return, 0.08%, for the past five years compared to S&P 500’s 13.9%.

Valuations

Rio Tinto currently trades at a premium compared to its peers. According to Reuters data, the mining company had a trailing price-earnings (P/E) ratio of 17.5 times (industry value of 14.5), price-book (P/B) ratio of 2.04 times (industry value of 1.85) and price-sales (P/S) ratio of 2.5 times (industry value of 4.7).

Rio Tinto also had a 3.33% trailing dividend yield with a 5,426% payout ratio and 1% share buyback ratio, according to GuruFocus data.

Rio Tinto

Rio Tinto is a 144-year-old British-Australian multinational and one of the world's largest metals and mining corporations. Rio Tinto produces a diverse suite of minerals and metals that enables the world to grow and develop.

In 2016, Rio Tinto derived 42.6%, or $14.4 billion, of its sales from China, 14.8% from Other Asia, 14.1% from the U.S. and 10.9% from Japan.

In June 2016, Rio Tinto underwent a restructure in its business units and formed several product groups with which sales could be classified; these are Iron Ore, Aluminum, Copper & Diamonds and Energy & Minerals (1).

(Annual Report and Media Release*, Rio Tinto)

Iron Ore

As described in Rio Tinto’s previous annual filing, the company operates a world-class iron ore portfolio, supplying the global seaborne iron ore trade.

In 2016, Iron Ore sales grew by 5% and contributed 41% or $14.6 billion in total Rio Tinto sales when excluding other operations and intersegment transactions. The group also had a net earnings margin of 32% – highest among the several groups – for 2016 compared with 28% the year prior.

In review, Iron Ore sales dropped by 10% and 34% in fiscal years 2014 and 2015.

Aluminum

Rio Tinto is a global leader in the aluminium industry. Its business includes high-quality bauxite mines, large-scale alumina refineries and some of the world’s lowest-cost, most technologically advanced primary aluminum smelters.

In 2016, Aluminum sales dropped by 7% and contributed 27% or $9.5 billion in total Rio Tinto sales. The group also delivered net earnings margin of 10%.

In review, Aluminum sales fell by 3% and 17% in fiscal years 2014 and 2015.

Copper & Diamonds

Copper & Diamond sales fell by 19% in fiscal 2016. The segment contributed 13% or $4.5 billion to overall sales. The group delivered net loss of $18 million compared to $370 million in profits in 2015.

Energy & Minerals

This segment also carries Rio Tinto’s Iron Ore Group of Canada and its coal business. Sales in Energy & Minerals fell by 6% in fiscal 2016. The group contributed 19% or $6.73 billion in total Rio Tinto sales while having delivered a net earnings margin of 9% compared to 2% the year prior.

On average, Rio Tinto had sales growth or loss and profit margin averages of -11.2% and 8% in the past three years. The miner delivered $866 million loss in 2015 and $4.62 billion in profits in 2016 making profit growth incalculable for the period.

Cash, debt and book value

As of December, Rio Tinto had $8.2 billion in cash and cash equivalents and $17.5 billion in debt with a debt-equity ratio of 0.4 times compared to 0.54 times the year pror.

As per its full-year results announcement, Rio Tinto had a net debt of $9.6 billion and a gearing ratio of 17%. Gearing ratio is defined as net debt divided by the sum of net debt and total equity at each period end. In comparison, Rio Tinto had a net debt of $13.78 billion and gearing ratio of 24% in 2015.

Rio Tinto also had 4.7% of its $89.3 billion assets in goodwill and intangibles while having a book value of $45.73 billion compared to $44.13 billion in 2015.

Cash flow

(Annual Results-Media Release, Rio Tinto)

Rio Tinto experienced a 5.6% reduction in net cash generated from operations and was down to $8.47 billion for 2016. In review, Rio Tinto completed three bond purchase programs totaling $7.5 billion, which resulted in $493 million of the $1.3 billion in net interest paid for the period.

Capital expenditures were $3 billion leaving Rio Tinto with $5.45 billion in free cash flow compared to $4.7 billion the year earlier.

Rio Tinto allocated 47%, or $2.73 billion, of its free cash flow in dividends in 2016. On average, Rio Tinto allocated 79% of its free cash flow in both dividends and share buybacks in the past three years. The miner also had paid down $4.95 billion in borrowings net proceeds.

Conclusion

Despite the industry downturn experienced by the commodities sector, Rio Tinto carried on and maintained healthy free cash flow levels and payout ratios. In addition, the near sesquicentennial mining giant exhibited great discipline and improved its leveraged balance sheet rather than faltering.

Also, parts of Rio Tinto’s operations had exhibited less sales loss weakness in 2016 compared to the miner’s 2015 operations. Iron Ore sales, in particular, rebounded for Rio Tinto.

(Commodity Prices Presentation, Rio Tinto)

In December, both Credit Suisse and Citigroup upgraded Rio Tinto ADR shares to outperform and neutral.

The lowest target price among the 26 analysts who cover Rio Tinto was $14 per share while the highest was $59 per share.

(Rio Share Price, GuruFocus)

Brought by its losses in 2015, historical P/E multiples for Rio Tinto are out of whack. Using a five-year P/B multiple instead would indicate a value of $40 per share.

In summary, Rio Tinto would be a hold with a target price of $43 per share.

Notes

  1. Media Release: The main impacts are as follows: Iron Ore Company of Canada has moved from the Iron Ore Product Group to the Energy & Minerals Product Group; coal businesses have moved from the previous Copper & Coal Product Group to the Energy & Minerals Product Group; and diamonds businesses have moved from the previous Diamonds & Minerals Product Group to the Copper & Diamonds Product Group.

Disclosure: I do not have shares in any of the companies mentioned.

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About the author:

Mark Yu
A doctor in physical therapy (DPT) with a passion for finance. Value seeker. Long only. Global investing. Long-term investing.

Attempts to dissect company filings one company a day.

For quicker reading--jump ahead to an article's conclusion.

Visit Mark Yu's Website


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