In recent months, the buzz in the mining industry has centered around the failed deal between BHP Group Ltd. (BHP) and Anglo American PLC (NGLOY).
Meanwhile, another major mining company has continued to go about its business and avoid the limelight. That company is Rio Tinto PLC (RIO). Let’s take a closer look at what's happening under the surface with RIO.
Rio Tinto Mines Rich Veins
Why has Rio Tinto been so boring lately? It’s due to the fact that much of the hard work of accumulating high-quality metals reserves has already been done. The focus of the BHP-Anglo deal was copper (HGU24). But Rio doesn’t have to worry; its copper assets are growing rapidly (more on that in a moment).
In addition, Rio’s high-grade iron ore assets in Guinea can be sold directly into the growing low-carbon steelmaking industry. And its aluminum assets are set to see rising demand, thanks to the energy transition.
A greatly underappreciated aspect of Rio Tinto is its research and development spending. For example, in June, it announced a $142 million “microwave” in Western Australia. The facility will convert lower-grade iron ore from the Pilbara region into a higher-grade ore suitable for the next generation of steel mills, which use electric arc furnaces rather than metallurgical coal to turn iron into steel. This is key to the de-carbonization of the steel industry.
The mix of iron ore products is also changing as the world decarbonizes. Rio expects demand for direct reduced iron to double from 125 million metric tons last year to 250 million tons in 2035. The company will sell this higher-grade iron ore from its Simandou mine in Guinea.
Iron ore is far from Rio Tinto's only “iron in the fire.” Currently, its profit split is around 70% iron ore, 10% copper, and 10% aluminum, with the remaining coming from diamonds, borates and titanium. By 2026, this should shift to 60% iron ore, 20% copper, and 15% aluminum.
Rio's Copper Focus
Investors are underestimating the rate at which Rio Tinto is evolving.
I believe how it deploys its capital by segment provides a better guide to the company’s future fortunes and commodity footprint. On this basis, its $21 billion of copper assets are actually larger than its iron ore business.
A big chunk of that comes from Rio’s $15 billion investment into the giant Oyu Tolgoi copper mine in Mongolia, where production is just starting to ramp up. That mine gives Rio the potential to catch up to BHP in terms of production of copper – it could produce close to 900,000 tons by the end of the decade, a 50% increase from 2023.
Buy RIO Stock
The rising oversupply of iron ore globally explains why Rio Tinto’s stock trades so cheaply. It trades at just 4.5 times forward EBITDA (earnings before interest, taxes, depreciation and amortization), according to estimates from Goldman Sachs, compared with a sector average of 5.5 times.
The shares are also trading at a price/book multiple of 1.8 - below their five-year average, as well as the peer average. Given the company's clean balance sheet and high level of profitability, the shares should be trading at a premium multiple.
Rio Tinto's current dividend yield is nearly 6.5%, according to FactSet, putting it ahead of BHP’s 5.1% yield. Dividends have come down from the record highs of 2022, but the average yield should remain near 6% for the next several years. This is thanks to Rio Tinto generating $30 billion of cumulative excess cash by 2030. Special dividends are also possible.
While it's hard to get excited about iron ore, copper has more of a shiny, bright future. A key feature of all things related to the energy transition, demand for copper is expected to roughly double by 2040. And supply shocks are expected along the way - they happen every year.
If we look at the big picture, Rio has a large portfolio of long-lived assets with low operating costs, meaning it is one of few miners that can stay profitable throughout the commodity cycle. Another plus is that most of its revenue generation comes from operations located in the relatively safe havens of Australia and North America.
The company has a strong balance sheet, resilient free cash flow, strong operational momentum, attractive growth projects (especially in copper), and a nice dividend yield.
Rio Tinto’s increasing exposure to the red metal should add some color to its story. The stock - down 8.5% so far in 2024 - can be bought below $70.
