Rio Tinto iron ore exposure a hit with Citi analysts

Wednesday, 13 Jul 2011

Rio Tinto has already outperformed the UK 350 mining sector over the year to date but Citi reckons it can continue to motor ahead thanks to a continuing tight iron ore market. The company remains the broker’s most favored UK metals and mining stock.

Citi analysts led by Mr Heath Jansen point out that with iron ore set to contribute 60% of earnings over the next five years, the strength of that market will be critical in deciding the future of Rio Tinto’s share price.

While the consensus view is that there is a surplus looming for iron ore supply, Citi believes this may not occur for some time.

The market has long been fixated on the looming market surplus as a result of a wave of project developments entering the market over the next four years.

Certainly the list of upcoming iron ore projects is impressive, with most of the new supply over the short to medium term likely to come from Australia and Brazil, the two expected to provide two-thirds of forecast supply growth in the next five years.

The global iron ore production project pipeline suggests over 1500 million tonnes per year of capacity yet Citi’s current supply demand model suggests only a small 50 million tonne surplus will develop by 2014.

The broker’s highly conservative stance on surpluses going forward reflects its view of a tightening iron ore market caused by a growing list of problems and setbacks that threaten to undermine near term supply.

For instance, in late June Brazilian mining giant Vale significantly downgraded its 2015 production target to 469 million tonne from 522 million tonne.

Citi has been sceptical of Vale’s production targets for some time and the broker’s own forecast for 2015 output by miner is actually 370 million tonne, which is 100 million tonne less than Vale’s new target.

The broker added that “We see the risk of further reductions in Vale’s production target as likely.”

Ongoing problems, including cost blowouts and delays, with development of the 45 million tonnes per annum Oakajee Port Project and associated iron ore mines in Western Australia, presents another potentially significant drag on supply going forward.

Citi said that Rio Tinto continues to be the cheapest mining company amongst the large cap diversified miners including Xtrata and BHP Billiton, trading on a 2011 prospective multiple of 8 versus around 10 for the rivals, mainly because of its heavy exposure to iron ore and the market’s view of a surplus for the commodity.

As a result, the analysts believe, Rio Tinto’s share price is already factoring in a considerable fall in the iron ore price.

(sourced from ProaActiveInvestors)