Stock in Focus: Rio Tinto: A mispriced mining giant?

Investing in mining companies is often marked by uncertainty, with market conditions prone to macroeconomic fluctuations and company earnings subject to the ebb and flow of the commodity markets. While some investors steer clear of such volatility, others are attracted to the potential of the lucrative gains that can be achieved by identifying the right metals at the right times through the commodity cycle.

Copper is widely thought to stand out as such a metal in these current times. The metal is poised to see a significant demand growth in the upcoming years as we transition towards a greener future. Its price demonstrated remarkable resilience throughout 2023, contrasting sharply with the downturn experienced by most other base metals and platinum group metals.

Rio Tinto’s strategic pivot

One mining major that is seeking to benefit from this emerging trend is Rio Tinto. With a keen eye on the horizon, Rio Tinto is now ramping up its copper production just as the global push for sustainability gains momentum. As the world embraces greener technologies and infrastructure, copper consumption is set to grow by 24% over the next decade according to Wood Mackenzie’s base case forecast.

Rio Tinto's targeted focus on expanding its copper assets is a calculated move that could continue to deliver substantial rewards for investors, who can expect to see anywhere from 40-60% of underlying earnings returned via dividends through the commodity cycle.

Financial resilience amidst a challenging backdrop

Looking at the company's 2023 annual report released this week, it's evident that even amid tougher market conditions, the company continues to yield significant free cash flows. Total free cash flows stood at $7.7 billion for the year, allowing it to pay out a hefty 6.64% dividend yield. Despite this, the shares fell by 2% on the day of the announcement.

It’s also worth remembering that the $7.7 billion free cash flow figure still lags behind the five-year average of $10.6 billion annually. Despite weaker iron ore and aluminium markets, Rio’s return on capital employed still remained at 20%. With the company expanding its copper output from the Oyu Tolgoi mine in Mongolia, slated to achieve an annual copper production of 500,000 tonnes in the near future, earnings and free cash flows could yet see further growth.

Near-term copper production growth

The company’s production guidance for 2024 has confirmed a continued rise in its copper output, from 620k tonnes in 2023 to 660-720k tonnes of mined copper in 2024 and 175k tonnes to 230-260k tonnes of refined copper. Rio Tinto is placing itself at the forefront of an evolving industry landscape and in a good position to capitalise on it.

However, investors should always remain mindful of the cyclical nature of the mining industry, which can subject Rio Tinto's earnings to volatility. Regulatory challenges, geopolitical uncertainties, and environmental concerns all post potential risks.

For example, Rio has encountered a number of issues in getting its large iron ore development in Guinea, the Simandou iron ore project, on track. The Simandou project is known to contain vast iron ore reserves, estimated to be one of the largest untapped high grade iron ore deposits globally. But Rio Tinto has suffered from a complicated ownership structure, legal disputes, construction difficulties and political changes in Guinea.

Investors interested in gaining some copper exposure could equally look to Rio's larger rival BHP, as well as smaller players listed on the London markets like Atalaya Mining, Taseko Mines, and Central Asia Metals.