MELBOURNE AUSTRALIA 2 February 2007 – We wonder if the management of Rio Tinto (ASX: RIO) have sent a big ‘Thank you’ card to the Chinese government and industry. Yesterday Rio reported a 25% increase in their full year profit for 2006 of just under $10 billion, compared with a measly $7 billion the year previously.
So which way will Rio – and for that matter BHP Billiton (ASX: BHP) – go from here? Will the market take the view that the peak has been reached last year with commodity prices, and that the only way is down for future profits? Or will they look on the bright and say that this commodities boom still has plenty of upside and that these levels of profit can continue for many years to come?
Well, Ord Minnett certainly believe there is still some value left in Rio, to the extent that they have recommended that clients switch from BHP into Rio, citing reasons the ‘Preferred Portfolios’ research report states Rio “Offers slightly better relative value than BHP at current prices with a more ‘defensive’ earnings stream amongst the leading diversified miners.” On the other hand they say that BHP is still “a core portfolio holding but Rio currently offers better relative value.”
Nick Hatch, analyst at Investec Securities (LON: INVP) in London told Bloomberg News “The big challenge for Rio will be to maintain earnings growth when commodity prices are coming down and cost pressures remain.”
Analyst Simon Toyne from Numis Securities (SEA: NUM) in London said, “The lack of further capital management disappointed some people. This will feed the perception that Rio will be involved in sizeable merger activity.”
Merger activity involving Rio Tinto eh?! Although there was some perhaps over the top speculation about Rio and even BHP becoming potential targets for private equity buyers, the more likely scenario is for Rio to be the predator rather than the hunted.
According to Bloomberg, estimations on average copper prices are expected to fall by around 10% this year compared to last year. They report that “Miners may gain less from copper prices this year, according to UBS AG and Barclay’s Capital’s estimates. UBS expects copper prices to average [USD]$3 a pound in 2007, and Barclay’s estimates an average of $6,025 a metric ton ([USD]$2.73 a pound). Cash copper prices averaged $6,740 a ton last year.”
Discussing the overall prospect for commodities prices this year, ANZ Bank (ASX: ANZ) analyst Andrew Harrington said “We see aluminium as one of the better performers in base metals this year, which should help Rio.” He went on to say, “But we are much less positive on copper, which is more important to the company.”
Whereas UBS analysts in the UK maintain their buy rating on Rio, believing that “The 30 percent increase in the ordinary dividend should be seen as a rebasing and is a positive step. We believe Rio can afford to increase again in 2008.”
But Fat Prophets analyst Gavin Wendt isn’t so sure, he told Reuters “Shareholders have been getting used to buybacks. But how long this can go on is a question companies such as Rio are asking themselves.”
In early trade this morning, Rio Tinto shares were down by as much as 1.6% following the release of the earnings report overnight.
The outlook for copper prices is one of the issues that may continue to weigh on the stock if copper demand and prices fall. Bloomberg News reports that “Copper prices fell to the lowest in more than a week after inventories of the metal used for making pipes and wires climbed.”
Antil Vij, analyst at Escorts Securities Ltd in New Delhi said, “I expect copper prices will decline in the short term because it’s a supply-demand market, and inventories are rising.”
Although the near term attitude towards copper is looking decidedly bearish, chances are that in the medium to longer term, the continued demand from the whole of south-east Asia will keep copper prices much higher than they were three or four years ago.