Key Morningstar Metrics for Rio Tinto (ASX:RIO)

Data from Morningstar Direct as of 22 February 2024

What we think of Rio Tinto’s Shares

Like BHP, Rio Tinto has ridden the commodity supercycle since the early 2000s. Its asset portfolio is concentrated on iron ore. Copper and aluminum are moderate contributors along with the minerals business, with all coal sold by 2018. Aluminum should constitute a substantially larger share, given the USD 44 billion that Rio Tinto paid for Alcan in 2007, but the acquisition was near the top of the market. Rio Tinto and BHP have the lowest operating costs of the iron ore players. Despite iron ore being the bulk of company earnings, expectations for long-term excess returns are weighed down by the value-destructive overinvestment during the China boom, which diluted returns. After adding back the not-inconsiderable writedowns, we expect adjusted midcycle returns slightly above Rio's cost of capital. 

Rio Tinto Share Price (ASX: RIO)

Source: Morningstar Direct. Data as of 22 February 2024

Rio Tinto Economic Moat Rating

As a commodity producer, Rio is a price taker and needs low-cost mines with long lives and a low installed capital base to support the longer-term excess returns needed to justify an economic moat. We forecast midcycle returns on invested capital, or ROIC, slightly above its WACC driven by its moaty iron ore business which accounts for more than half of midcycle EBIT. Our forecasts are based on an assumed iron ore price of USD 60 per metric ton (which we note is materially less than the average price of around USD 100 per metric ton over the past decade), aluminum price of about USD 0.80 per pound and copper price of USD 3.10 per pound. Our midcycle assumed prices are based on our estimates of the marginal costs of production. As we think Rio’s midcycle ROIC isn’t sufficiently above its WACC to justify assigning a narrow moat, we don’t assign a moat to Rio.

In calculating ROIC, we have added back to invested capital around USD 8.3 billion in asset and goodwill writedowns taken over the past decade on the basis that these amounts relate to assets developed or acquired in the ordinary course of business and so should be included when calculating ROIC. Some of the more material amounts include USD 2.7 billion in relation to its copper business, USD 2 billion in relation to aluminum and USD 1.4 billion in relation to diamonds. However, we have not added back USD 21.1 billion in relation to aluminum assets purchased in 2007 nor USD 3.3 billion in relation to coal assets purchased in 2011 on the basis that management was subsequently replaced (in 2013) and that Rio has shown much improved investment discipline since then, as evidenced by relatively small writedowns subsequent. If we did also add back these USD 24.4 billion in aluminum and coal writedowns, Rio’s midcycle ROIC would be modestly below its WACC of 9%. Alternatively, if we instead chose not to add back any writedowns, Rio’s midcycle ROIC in 2027 would be around 11.5% compared with its WACC of 9%.

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Rio Tinto Risk and Uncertainty

Our Morningstar Uncertainty Rating for Rio Tinto is Medium. Rio Tinto has an outsize exposure to iron ore mining and demand is heavily reliant on China’s continued outsize investment in infrastructure and fixed assets. Rio Tinto has low operating costs and a strong balance sheet, with capital allocation significantly improved following a period of overinvestment through the China commodities boom. However, Rio still faces the cyclicality of commodity prices, operating leverage, high capital intensity and the risk of poor capital allocation.

Rio Tinto’s environmental, social, and governance, or ESG, risks are relatively small, relating to carbon emissions, water resource dependency, land disturbance, labor strikes and disputes, and community relations. Emissions can carry carbon-related costs, though we think demand for steel is relatively price inelastic and any carbon price is likely to be passed on to steel consumers. There is also potential for Rio’s higher-grade iron ore to attract a premium for lower emissions incurred in the steelmaking process due to lower fuel use (usually coal).

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Rio Tinto Bulls Say

Rio Tinto Bears Say