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Stock Analysis & Ideas

Rio Tinto: Has Downside Potential Despite Solid Results

I am neutral on Rio Tinto (RIO) as its high-quality assets, tremendous track record, stellar balance sheet, prudent investments in long-term growth projects, and fair valuation multiples are offset by a negative forward outlook, weak Wall Street analyst sentiment, and downside implied in its average price target.

Rio Tinto is a leading global miner, extracting minerals such as diamonds, iron ore, copper, bauxite, industrial minerals, and uranium. With headquarters in Melbourne, Australia, and London, UK, RIO has a global presence with world-class assets in a diverse array of regions.

With over 49,000 full-time employees and operations located in 35 different countries, RIO is considered the second-largest materials and mining company in the world.

Strengths

Thanks to its immense scale, Rio Tinto is able to develop and implement cutting-edge technology and mining methods in its operations, while it also enjoys economies of scale. It also is able to leverage its strong balance sheet and global business network to pursue the most promising mining ventures and make accretive acquisitions as it sees fit.

Recent Results

Rio Tinto reported record results in Fiscal Year 2021. It generated nearly $63.5 billion in revenue, over $25 billion in net cash from operations, and nearly $17.7 billion in free cash flow. These numbers represented 42%, 60%, and 88% year-over-year increases, respectively.

As a result, it was able to increase EBITDA by 58% to over $37.7 billion, after-tax profit by 116% to $21.1 billion, and earnings per share by 72% to $13.21. Underlying return on capital employed soared from 27% in 2020 to 44% in 2021.

The dividend per share increased by 71% to $7.93, and the special dividend per share soared by 166% to $2.47, for a total dividend per share growth of 87% to $10.40.

Despite these hefty dividend payouts, net cash improved from -$664 million at year-end 2020 to $1.6 billion at year-end 2021.

Valuation Metrics

RIO stock looks like it is trading near fair value at the moment, as its forward enterprise-value-to-EBITDA ratio is 4.6 times compared to its historical average of 5.2 times, and its forward price-to-free-cash-flow ratio is 11.4 times compared to its historical average of 11.1 times. 

That said, EBITDA is expected to decline by 23.5% in 2022 and decline by 16.6% in 2023. Also, normalized EPS is expected to decline by 21.3% and 12.7% in 2022 and 2023, respectively.

Wall Street’s Take

According to Wall Street analysts, RIO earns a Hold analyst consensus rating based on one Buy, two Holds, and one Sell rating in the past three months. Additionally, the average Rio Tinto price target of $70.00 puts the downside potential at -15.9%.

Summary and Conclusions

Rio Tinto boasts an impressive track record of allocating shareholder capital prudently and owns a world-class portfolio of assets. It is currently enjoying soaring profitability, and its balance sheet is also in fantastic shape with zero net debt. On top of that, the stock price looks fairly priced when compared to historical valuation averages.

On the other hand, EBITDA and earnings are expected to face steep declines in the coming years, Wall Street analysts are neutral on the stock here, and the average price target implies downside potential over the next twelve months.

As a result, investors might want to steer clear of the stock for now.

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