RIO
Some interesting observations from the RIO slide deck, released overnight.
Capex
Firstly, doubling capex, including a sizeable chunk for decarbonatization.
Cashflow
Secondly, note that 2018 and 2020 free cash flows are ~$8-9bn. The reason that’s relevant is because the iron ore price, over that period, was ~$80-$120tn, similar to now. Assuming this doubling of capex, free cash flow moving forwards will drop quite noticeably, plausibly below the 2016 levels.
Should iron ore move towards a level that we think is sustainable, a number closer to $70tn, RIO will likely be free cash flow negative. Generally speaking, we don’t think the implied free cash flow yield is the same number that marginal investors are currently incorporating.
Production
Copper
Production has been underwhelming, here copper, but it’s the same with iron ore production, which has been downgraded multiple times relative to ambition.
And when we speak about Quality, normally we are short-cutting to the financials, and mixing the terms “fundamentals”. RIO’s fundamentals are very high quality, but the operational aspects have been subpar at best. The background commodity environment has been very strong, and as such provides a cover for RIO’s poor performance here, but, it is interesting to note.
Makes a stronger case to ratchet down executive compensation, if not something that should clearly show up in a lower sustainable multiple to apply.
Iron ore
There’s doesn’t seem to be much mention of Simandou, and little by way of way of further expansion plans.
Grades seem broadly stable over the forecast horizon, with some minor downgrading relative to history. Initially, there was a moderate flurry overnight, as RIO originally put out a higher number for the proportion of lower grades relative to total, however they re-released the presso pack with a more modest figure.
Conclusion
Capex to go up, free cash flow to go down, little to no production growth expected, likely low returns on much of that free cash flow (as decarbonisation is great for the world, but the producer captures little of the economic benefit, in exactly the same way as a polluter who overproduces, because they don’t bear the full cost of their activities, called a negative externality). Grades to decline slightly.
Against that backdrop, falling iron ore prices matter quite a bit.
We’ve got no RIO in our portfolios, and whilst the yield is attractive at first blush, and RIO is (despite possibly its best efforts) a high quality company, we see better opportunities elsewhere.
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