Morningstar stock analyst are raising their fair value estimate for Rio Tinto (RIO) to £19 per share from £15.40 as a result of slightly higher 2016 iron ore and metallurgical coal price forecasts, based on higher-than-expected prices realised so far this year.
Our long-term iron ore price forecast remains $35 per tonne by 2020, acknowledging the rapid industry cost cuts and a larger forecast drop-off in China's steel demand. A further decline to $30 per tonne mid-cycle by 2025 factors in rising substitution from scrap as China's stock of steel matures. In the same vein, our metallurgical coal forecast is USD 80 per tonne to 2020 before a further decline to USD 75 per tonne by 2025 as substitution from scrap takes hold.
Profitable Throughout the Commodity Cycle
Rio Tinto is one of the world's biggest miners, along with BHP Billiton, Brazil's Vale, and U.K.-based Anglo American. Above-average assets relative to peers and a solid operating record make Rio Tinto one of the few miners that are profitable throughout the commodity cycle.
Geographic and product diversification, however, provide only modest benefit. Most revenue comes from the relatively safe havens of Australia, North America, and Europe, though the company has operations spanning six continents.
Rio Tinto has a large portfolio of long-lived assets with low operating costs. Operations include aluminium, coal, copper, diamonds, gold, iron ore, industrial minerals, and uranium. This competitive resource base sets Rio Tinto apart from most peers.
A more recent focus on debt and cost reduction sees much new investment relegated to the back burner. After an elevated period of investment through the resources boom, capital allocation is much more measured. As a commodity producer, Rio Tinto is a price taker, not a price maker. The lack of pricing power is aggravated by the volatile and cyclical nature of commodity prices. We don't ascribe an economic moat to Rio Tinto, given the bloated invested capital base doesn't permit returns in excess of the cost of capital. The firm's assets are large, however, and despite being overcapitalised, generally have low operating costs.