Rio Tinto Shares (ASX: RIO) Performing Well Despite Bribery Overhang

This article was originally published at MF & Co. Asset Management.
Rio Tinto Group is one of the largest and a leading mining corporation dual-listed in Australia and London stock exchange. Operating key projects in Australia and North America, Rio shares delivers a variety of commodities to the world, including iron ore, bauxite, copper and minerals.

Attention has been drawn to a bribery investigation that Rio Tinto has been involved in that has been splashed across the news. Swiss prosecutors have been investigating whether Rio Tinto offered a bribe to an ex-Mongolian minister who was linked to Oyu Tolgoi copper. If such corruption ends up taking place, RIO may suffer 66% stake loss in Oyu Tolgoi.

About Rio Tinto Shares (ASX: RIO)

Rio Tinto Limited (ASX RIO), together with Rio Tinto PLC (LSE RIO) is the Rio Tinto Group, operating as a dual-listed company. The company’s revenue is largely dominated by iron ore and aluminium, occupying 50% and 27% of revenue respectively in FY2017. As the second largest miner, Rio Tinto shares current market capitalisation is $31.63 billion.

Among its peers is BHP Billiton Ltd (ASX BHP) that stands out with almost triple the market capitalisation compared to RIO at $95.19 billion. Similar to RIO, iron ore and copper are the primary divisions contributing to 38% and 28% of group EBIT in FY2017. Another Iron ore competitor is Fortescue Metals Group (ASX: FMG) which has a market capitalisation of $13.86 billion.

Restructuring the Portfolio: RIO Expects More on Copper

With operating cash flow of US$13.9 billion globally, RIO has a diversified asset portfolio, with 44% of assets from China and 17% from North America in FY2017. The iron ore business has free cash flow of US$7.26 billion, followed by the aluminium business with US$1.4 billion free cash flow.

In such a mature industry, Rio Tinto has implemented disciplined capital expenditure which targets commodity development across new markets especially those accelerated by mine depletion. Getting rid of its last coal mine gave RIO development capex for Oyu Tolgoi copper and lithium in the Jadar project.

RIO’s additional $US2.5 billion debt repayments have reinforced the company’s positive balance sheet performance and return to shareholders. The company has safeguarded profit margin by achieving low-cost plan with heightened barriers to entry to newcomers in the industry.

RIO’s inconsistent action toward coal support ignited concern among investors recently with two filed resolutions from shareholders urging RIO to disclose detailed membership funding to its coal lobby group – Minerals Council of Australia (MCA). The company inquiry centred on unequal treatments to shareholders with restricted Australian votes amplifying the transparency concern bundled with refusal to the UK to allow shareholder votes.

The nature of mining means that Rio Tinto shares massive fixed cost and high operating leverage could mean cost reduction measures are inefficient when faced with lower commodity prices.

RIO’s Emerging Market: The Future Is Uncertain

Demand for electric vehicles (EVs) will rebalance the copper market after several years of oversupply in the near future. The company is well placed to take advantage of the supply deficient market. Accompanied by EVs innovation, energy storage technology has triggered RIO Tinto shares immediate focus on lithium – the feedstock for lithium batteries.

The supply of iron ore and aluminium has been underpinned by China as the largest shipping partner. Attention to high-quality iron offers long-term options to navigate China with flattened iron demand the big focus under environmental reform.

Integrated aluminium production is set to give rise to potential customer partnerships via the delivery of value-adding products in the automotive industry. A weaker US dollar also symbolises solid growth in commodity exports.

RIO’s ownership of Oyu Tolgoi has been threatened by the escalation of the publicised Swiss bribery investigation, along with the criminal proceedings against a former Mongolian officer. A seized account was used to transfer US$10 million to the officer participating in investment negotiation for Oyu Tolgoi in 2009. Another legal proceeding against RIO’s former CEO pointed to misleading and deceptive conduct in the 2011 annual report, commenced by ASIC.

Driven by price, profit in the mining industry is hard to determine largely due to volatile commodity prices. Furthermore, the tariff dispute between the US and China creating more uncertainty around their revenue lines.

Financial Performance Assisted by Capital Programme

ASX RIO shares PE ratio is at 12.7 much lower than BHP Billiton (ASX: BHP), at 20.24. The industry average is 28.5. The undervalued ASX RIO share price has also rallied thanks to the company’s US$2.5 billion share buyback plan. RIO shares can be expected to see a boost in price as an additional US$1.9 billion share buy-back will be completed by the end of 2018.

BHP leads in EPS growth of 162.56%, followed by Fortescue Metals Group (ASX: FMG) of 112.39%. RIO’s EPS grew at 91.08%; even though this is a bit lower than its compettitors, it is nothing to be sneezed at.

RIO shares is ahead on price to book ratio (2.43) with the figure slightly higher than that of BHP (2.31) and FMG (1.36).

PE Ratio EPS Profit Margin ROE Price to Book
RIO 12.7 91.08% 22.11% 20.86% 2.43
BHP 20.24 162.56% 12.38% 11.49% 2.31
FMG 6.33 112.39% 24.78% 23.11% 1.36

Solid Growth Prospects For RIO Tinto Shares Despite Bribery Worries

 The copper market is expected to ramp up under renewable resources innovation in the near future. Holding diversified assets in major regions, the ASX RIO shares is ideally placed to navigate the emerging markets and deliver solid profit growth.

Although the ownership issue may arise in the bribery investigation, the group has been advancing Oyu Tolgoi’s US$5 billion underground expansion on track amid the probe.

To target the environment-reformed Chinese market, Rio’s high-grade Iron ore and value-added aluminium products can secure long-term contracts for the company.

This article on Rio Tinto is written by Henry Fung, Managing Director at MF & Co. Asset Management, a boutique investment firm based in Sydney, Australia. For MF & Co.’s full website and further articles follow the link: MF & Co.

For an understanding of why Copper is so important in the future: click here

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