US Edition Rio Tinto
£33.02 -43½
Questor says BUY
Not all the assets being sold are ex-Alcan – but most are. However, Rio's strategic plan appears sound given today's market.
Rio intends to focus on Tier 1 assets. Such assets in the mining sector are among the largest and highest-quality producing mines of their respective commodities, characterised by economies of scale, expandable resource bases and attractive industry cost positions. This is all very sensible.
Aluminium demand is expected to rise over the next few years, but the business is really dependent on access to cheap power. That's because aluminium is produced by electrolysis. To illustrate this point, it is worth noting that just five of Rusal's aluminium smelters in East Siberia use 6pc of all the energy generated in Russia.
Therefore, as energy costs rise, the focus on Tier 1 assets lower down the cost curve is sound. However, investors need to remember that earnings for Rio over the next few years are going to be driven by the iron ore price.
The price has been holding up well recently, but it is likely to moderate over the next few years. A Bloomberg survey of analysts last month showed they expected prices could fall 29pc to an average $123 a metric ton in 2015 from a record $173 this year.
Last year, iron ore constituted 68pc of Rio's earnings, but just 40pc of revenues. By comparison, aluminium is estimated to constitute 6pc of earnings and 26pc of revenues. Prices are likely to remain elevated for some time, with cash generated from its business used to invest in its organic growth pipeline and buy other assets in other commodities.
The shares were originally tipped on May 4 last year at £33.79 and are down 1pc compared with a FTSE 100 down 2pc. Trading on an earnings multiple of just 5.7, falling to 5.5 next year, and yielding 2.4pc, the shares remain a buy.