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Stock Analysis - Rio Tinto Plc ADR (RIO)

Initial Screening

Rio Tinto is a multinational mining corporation that was founded in 1873. Starting with a copper operation in Spain, the company has since climbed its way up to be the world’s second-largest mining company by Market Cap. With operations on six continents and a focus on North America and Australia, the company holds the spot as the biggest aluminum producer in the world.

Rio Tinto’s peer group and main competition consist of two other global leaders in mining, the Australian BHP Group (NYSE: BHP) and the Brazilian Vale (NYSE: VALE).

Though any financial figures quoted throughout this article will be referenced in USD, Rio Tinto is traded on multiple stock exchanges such as the New York Stock Exchange (NYSE: RIO, through an ADR), Australian Securities Exchange (ASX: RIO), and the London Stock Exchange (LSE: RIO) allowing for convenient access for investors and traders around the world.

Rio Tinto Infographic
 

Business Model

Rio Tinto’s assets can be segmented into 4 major commodities: Iron Ore, Aluminum, Copper, and Minerals. The strategic approach by the company varies depending on the commodity so the following paragraphs will look deeper into each asset.

Iron Ore is the commodity that generates the most revenue for Rio Tinto, and while a low longtime growth is expected, Rio Tinto has identified near-term priorities to improve productivity and automation and deliver value over volume.

Aluminum is Rio Tinto’s second-largest revenue generator. The company is the biggest aluminum supplier in the world, and its current strategy is to protect this global leadership while optimizing costs and capital intensity to forge success in a market with moderate long-term demand growth.

Copper & Gold contributes as the third-largest revenue stream. With a growing market that faces depletion in current mining sites, Rio Tinto is aiming to unlock growth through partnerships and exploration.

Minerals build the final revenue stream combining the remaining mined resources. In a high-growth market, Rio Tinto seeks to leverage Rio Tinto Ventures and partnerships to unlock and support a long-term value over volume strategy.

After looking into the different assets/commodities mined by Rio Tinto, let’s have a look at the revenue from a geographical and commodity point of view.

Rio Tinto Revenue by Commodity
 
Rio Tinto Operations
 

Both graphics can be found in the Rio Tinto Fact Book.

Dividend Growth and Sustainability

RIO’s current dividend yield as of 04/11/2021 is 5.84% which when benchmarked against its peers is quite noteworthy. Comparing the current yield to the 5-year average yield of 5.51%, it’s slightly higher than seen in the recent past. The following section will cover some history on and judge the sustainability of Rio Tinto’s dividend by examining the payout ratio as well as its growth to determine whether the mining giant makes a compelling case for dividend growth investors.

Dividend History & Growth

Rio Tinto introduced a semi-annual dividend in September 1990 with payouts typically in March and August. Since then, Rio Tinto has focused on rewarding its shareholders with mostly continuous dividend growth.

Nevertheless, it has to be said that there is always a possibility that the company will cut the dividend depending on the economic cycle and commodity prices considering the volatile history of the mining sector. This last happened in 2016 when Rio Tinto’s dividend was cut by 31%. In the years between the dividend cut and today, the company increased their dividend payouts by over 207% to not only surpass, but more than double the payout investors would’ve received in 2015 (before the dividend cut).

From a dividend growth investor's point of view, you will have to ask yourself whether the uncertainty of the company’s willingness to cut the dividend by so much in the past is worth the continued dividend growth when looking over an extended timeframe.

Payout Ratio

Over the past 10 years, Rio Tinto’s dividend payout ratio has hovered between 13.06% and 5425% (outliner in 2016), skewing the 5-year-average to 621%. A more accurate view can be obtained by looking at the average payout ratios between 2017 and today, which is 58.44%.

From a payout ratio standpoint alone, I think Rio Tinto is in a very good position at this moment. The ratio indicates that there is enough room to fuel future dividend growth while leaving enough revenue in the company to grow and weather fluctuations in demand and commodity prices.

Financial Snapshot

Using the Piotroski F-Score to get a first glance at Rio Tinto’s current financial health, we see it secures a 9 in the 0-9 ranking which can be read as a very healthy financial position. A note of caution here: operating in a very cyclical industry, at various points in time over the last 10 years Rio Tinto’s F-Score ranged between 2 and 9 so though it’s currently in good shape, one could deduce this health is rather volatile.

Over the last 5 years, earnings and revenue of Rio Tinto have been on a steady upwards trend, while total debt and Debt to Equity ratios have been on a steady decline signaling a good sign when analyzing the company's recent past.

Digging a little deeper into the debt metrics, Rio Tinto’s debt is well covered by their operating cash flows, and interest payments are covered considering a 63.3x coverage rate by EBIT.

Investment Case

In the following section, we will dive into the company's Moat as well as Bull and Bear cases to outline which headwind the company might face while providing insight into their strategy and growth opportunities.

Moat

Mining companies create their moat with protected investments. Long-term contracts for mining sites are usually negotiated with a fixed price per tonne and throughput which help to protect the companies against fluctuations in commodity prices for the term of the contract. Rio Tinto naturally leverages this strategy to create a moat by the size of their operations around the globe.

Additionally, Rio Tinto maintains a large Research and Development department to drive innovation for the Mine of the Future. Automation and optimization of mining methods have been one of the drivers of dramatically increasing the output of iron ore over the last decade.

The Bull Case

Over the last cycle, Rio Tinto has shown the ability to outperform and generate superior returns when compared against its peers. Basic Materials is a sector fueling industries around the world such as the technology market. Rio Tinto recently achieved battery-grade lithium production at one of its pilot plants leveraging waste materials from one of their old mines. Further development into this strategy could unlock the potential for Rio Tinto to become a supplier for the hot EV market.

Another driver for growth potential is the increasing demand for raw construction materials, whether it’s materials for booming cities around the world or infrastructure to lift the transition from conventional to renewable energies.

The Bear Case

Slowing economic growth rates around the world could impact the demand for basic materials and thus directly impact the commodity prices, which are driven by demand. The stock price is directly tied to the prices of precious metals and thus the stock could tank once the expansion hits its peak and we’re experiencing a correction or recession.

Another risk is the dependency on China. While Rio Tinto is operating on 6 continents and delivers resources around the world China is by far its biggest market and thus is heavily dependent on the constant growth of the Chinese economy. A slow down in demand could heavily influence the Balance Sheets of the company and darken the outlook for the years to come.

Furthermore, the company has caused a lot of environmental and cultural damage throughout its rich history. Any harm to the environment or heritage culture can be devastating and erode trust and thus impact future projects and opportunities.

Conclusion

For me, Rio Tinto is the best investment to add exposure to basic materials to my portfolio. Their portfolio and global presence combined with the long-term dividend growth makes a compelling investment case.

Basic Materials will be needed for decades to come to fuel the global economy and Rio Tinto has proven that it outperforms the competition even in times when the economy is fragile or commodity prices are facing a temporary weakness.

As always, I recommend potential investors browse through the documents found on Rio Tinto's investor relations page as a great start for your due diligence.

Thank you for making it through my stock analysis of Rio Tinto Group. Do you hold a position in Rio Tinto or are you invested in any other companies in the Basic Material sector? I invite you to share any feedback and experiences with the company or its peers!

Disclaimer

I hold a position in Rio Tinto Group (NYSE: RIO) and it is currently my core holding in the Basic Materials Sector of my dividend growth investing portfolio.

This article expresses personal opinions and observations of someone who is not licensed to provide financial advice.

I am not receiving compensation for writing this analysis and have no business relationship with any company whose stock is mentioned in this article other than the long positions I own. Furthermore, I cannot guarantee the accuracy of the financial metrics gathered from 3rd party services like Morningstar and Yahoo Finance.

Post Comments(1)

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MyFinancialShape May 4, 2021, 11:33 a.m.

Very good read, thx for sharing your very detailed analysis on Rio Tinto. I agree, it‘s probably the best mining company. I‘ve had Rio Tinto plus BHP Billinton in my portfolio, entered into the positions 2014. The commodity price crash 2016 clearly showed better resiliency and tougher management decisions in the case of Rio Tinto. They came out stronger, as did BHP. But Rio Tinto has an edge over its competitors. They cut their dividend a few years ago but rewarded us investors handsomely before and afterwards, after the reinstated their dividend. Again, thx for sharing and all the best. Cheers

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