5 Reasons Rio Tinto Looks Attractive

NEW YORK (TheStreet) - We feature Rio Tinto (RIO) as a value pick on favorable market conditions due to strong demand from China and other emerging Asian economies. Industry analysts recommend the stock on estimated strong potential upside over the next few months.

5. Company Description and Investments

Rio Tinto is an Australian diversified mining giant engaged in the exploration, development, production and processing of minerals with product groups aluminum, copper, diamonds and minerals, energy, and iron ore. Its major businesses are open pit and underground mines, mills, refineries and smelters, and a number of research and service facilities. The company has a market capitalization of $117.97 billion and institutional ownership of 4%.

Rio holds 48.5% stake in Ivanhoe Mines ( IVN) with a total investment of more than $4 billion since Oct. 2006. The company recently exercised its subscription right to acquire an additional 27.9 million common shares of Ivanhoe for $536 million. In December 2010, Rio completed 100% of the divestment of its equity holdings in Cloud Peak Energy ( CLD). In January 2011, it accomplished the divestment of 61% of Alcan Engineered Products with maintaining ownership of Alcan Cable.

In April 2011, Rio acquired a majority interest in Riversdale Mining gaining control of a significant Tier-1 coking coal project. In June 2011, Tata Steel, India's largest steel company, sold its entire 26.27% stake in Riversdale Mining to Rio for $1.13 billion after receiving 100% appreciation on its four-year old investment. Rio now owns 99.76% of the Africa-based coal producer, with coking coal being a key raw material for the production of steel.

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Recently, Rio expressed interest to sell its 57.7% stake in South Africa's Palabora copper mine, which accounted for 8% of Rio's mined copper production in the first half of 2011, stating operating the mine no longer suits its investment strategy. In addition, South African miners face uncertain power supplies, rising labor and energy costs and a strong rand that squeezes profits. Palabora has mine life until early 2016, but Rio has initiated studies to expand it to 2030.

Rio has entered into a $1.5 billion joint venture agreement with China's Aluminum Corporation of China (Chinalco) ( ACH) for the Simandou iron ore project. The project is on track to make its first shipment by mid-2015. The joint venture for the Simandou mine aims at an initial production of 70 million metric tons per year, with estimates for potential future output reaching up to 170 million tons.

With the acquisition of Riversdale Mining, the company has new options for growth in thermal and coking coal in Mozambique. The first production from Benga coking and thermal coal mine is expected by the end of 2011. Also, the proposed expansion of Pilbara iron ore to 283 million metric tons per annum is on track and will be completed by the end of 2013.

4. Production Highlights

For the first half of 2011, Rio reported iron ore production of $90.7 million metric tons, an increase of 4% from the year-ago period. With a current operating capacity of 225 million tons per annum, the Pilbara mines produced 110 million tons, up 3% from the same period prior year. For full year, Rio expects to produce in excess of 240 million tons (100% basis) from its global operations in Australia and Canada.

Bauxite and aluminum production for the first half of 2011 increased 5% and 1% to 16.8 million tons and 1.9 million tons, respectively. Rio estimates full-year bauxite, alumina and aluminum production at 35.8 million tons, 9.2 million tons and 3.9 million tons, respectively.

Mined molybdenum production for the first half of 2011 increased 32% to 79,000 tons, with the metal's prices soaring 11% during the period. Mined and refined copper production stood at 273,400 and 185,100 tons, respectively. Mined and refined gold production was 346,000 and 204,000 ounces, respectively. For 2011, Rio forecasts mined and refined copper production at 539,000 and 350,000 tons, respectively.

3. Financial Highlights

Rio recorded net earnings of $7.59 billion for the first half 2011, an increase of 29.8% from the year-ago period. Underlying earnings surged 35% to $7.78 billion, or 399.3 cents per share. Consolidated sales revenue for the period increased to $29.06 billion from $24.54 billion in the first half of 2010, consequent to higher prices for its products. Cash flow was 31% higher at $12.9 billion.

Rio recognized capital expenditure of $5.1 billion for the first half of 2011, compared to $1.8 billion in the same period prior year, indicating investment ramp-up at world-class Tier-1 growth assets. In addition, the company's $7 billion share buyback program is expected to be completed by the first quarter of 2012. Interim dividend for the first half 2011 was 54 cents per share compared with 45 cents per share in same half last year.

With major price increases in all of Rio's product commodities, underlying earnings were higher by $4,997 million as compared to first half 2010. Prices for copper, molybdenum, gold and aluminum escalated 31%, 13%, 26% and 20% during the first half of 2011, respectively.

With a total approved capital cost of $91 million, the company completed the project of de-bottlenecking Dampier port in order to expand the Pilbara capacity by 5 million metric tons to 225 million metric tons per annum. The project was completed by the end of 2011 first quarter.

Looking ahead, the company remains bullish on long-term demand growth for its commodity portfolio, and expects consumption to double in the next 15 to 20 years. Also, given the supply limitations, Rio is confident in commodity pricing trends. Moreover, Rio expects higher average prices for commodities in the second half of the year and in 2012, primarily supported by China's strong demand.

2. Rio's Industry Estimates

Rio Tinto estimates global iron ore demand will exceed 800 million tons in the next eight years to meet demand growth projections in steel making. The company's chief executive believes that emerging markets China and India represent close to 75% of global iron ore demand, with China garnering a hefty 90%. With expansions under way at other miners in the world, Rio has raised its iron ore production capacity in Western Australia to 333 million tons a year from about 225 million tons currently. Similar expansion plans are under way at competitors AngloAmerican, BHP Billiton ( BHP) and Vale ( VALE).

Global demand for refined copper is projected to increase by more than 40% to 27 million metric tons by 2020 as countries like India and China continue to urbanize and industrialize, and the massive Mongolian gold and copper Oyu Tolgoi project, owned by Ivanhoe Mines, is strategically positioned to capitalize on that demand as it grows to become a top-five global copper producer, Rio Tinto's Mongolia country director says. The Oyu Tolgoi project is expected to begin commercial production in the first half of 2013 and is likely to produce 450,000 tons of copper and 330,000 troy ounces of gold annually.

Similarly, the company foresees aluminum demand surging in Southeast Asia, driven by engineered aluminum and other domestic aluminum products. With most of the countries in the world seeking to expand their gold reserves to diversify away from U.S. dollar holdings, demand for gold is likely to crest further. Strong investment and jewelry demand would also support gold prices.

With crude oil prices poised for further spikes, coal demand is likely to soar, driven by consumption for steel making and electricity generation. Analysts say coal production is likely to lag demand in the next few years.

1. Analyst Estimates

Fairfax Research recommends a buy rating on the stock, saying Rio's operations are less prone to currency swings. The research firm believes that income sensitivities for Rio are almost half that of other miners due to its highly diversified transnational operations. Fairfax pegs Rio's five-year CAGR earnings per share at 18.2%, ahead of BHP Billiton (17%) and AngloAmerican (17%).

Analysts at JP Morgan have an overweight rating on the stock in a research report. The report highlights that the Rio Tinto/Mitsubishi Development deal with Australian coal miner Coal & Allied would ramp up the minorities in a key part of Rio's business from wherein there would be significant growth in the upcoming years. As per the deal, both miners would acquire the balance shares of Coal & Allied at a complete valuation of $11 billion.

We recommend the stock to be a value pick for investors based on factors like a strong first-half performance, investments in world-class mining sites and companies that own high-growth properties. Also, Rio's diversified businesses provide a stable platform for future growth. Additionally, maximizing shareholders value through dividend distribution is one of the key policies of the company.

All four analysts polled by Bloomberg recommend a buy on the stock. Data from Bloomberg has analysts forecasting the stock gaining 69.3% to $101.17 in the upcoming 12 months.

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