At its recent investor seminar, Rio Tinto (RIO) warned of an uncertain and volatile short-term outlook, nothing new there, though with an expected fourth-quarter pick-up in Chinese fixed-asset investment.
Longer term, Rio remains bullish on global commodity consumption with China remaining the key driver until at least the mid-2020s. The company expects an additional 2 billion humans to urbanise globally by 2030. All commodities will benefit, though the rate of growth will slow, particularly for iron ore and coking coal, these being early-cycle beneficiaries in developing economies.
We broadly agree with Rio's view of the world and expect the scenario to support a gradual pull-back in commodity prices to levels nonetheless above long-term historical averages. With iron ore for example, our forecast long-term delivered China price in 2013 real terms is $90 per tonne, 50% below first-quarter 2011 highs of $180 per tonne, but ahead of the 10-year average of $80 per tonne. Compare that with prices near $20 per tonne just 10 years ago! For copper, our long-term price forecast is $2.50 per pound, 43% below first-quarter 2011 $4.35 per pound highs, but in line with the 10-year average and well ahead of sub-$1.00 per pound levels just a decade ago. Bear in mind also those 10-year averages are capturing an unprecedented commodities boom.
After listening to Rio Tinto's world views, we have made no changes to our fair value estimate for the company. We believe Rio remains materially undervalued. The company says it is balancing value-accretive investment with returns to shareholders. We don't think this necessarily translates to higher dividends. Cut-backs in expenditure and operating costs should allow the dividend to be sustained, in line with the progressive dividend policy, despite falling commodity prices. The payout ratio can rise materially from 2011's sub-20% position simply by 2012 earnings declining.
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