Questor share tip: Rio Tinto shares jump on production record

Rio Tinto
£33.31 +86.5p
Questor says BUY

RIO Tinto [LON:RIO], the largest iron-ore miner in the world, broke its production record during the first half sending shares 3pc higher yesterday. Questor believes the shares are a good long term bet as iron ore prices stabilise on resilient Chinese growth figures.

The mining group is now digging more iron out of the ground than ever before. This is handy, because the $106bn (£61.8bn) mining giant generates 89pc of its earnings from steel-making material, 7pc from copper and 4pc from diamonds and other minerals. Iron-ore production hit a record 139m tonnes in the first six months ended June, a 10pc increase on the same stage last year.

This is only the beginning of a multi-year expansion of mines in the Pilbara area of Western Australia. Rio said back in May that improvements here and elsewhere had increased the iron-ore production to 290m tonnes a year, which was two months ahead of schedule, with a target of 330m tonnes a year production rate by 2015.

Delivering its first-half production update yesterday, the company added that the rail infrastructure required to accelerate shipments further was now in place and the port is expected to be completed in the first half of 2015.

Rio is also in a very strong position because of its cost base. The Pilbara produces iron ore at a cost of about $50 per tonne, so it makes sense for the company to be increasing output now that prices are stabilising at around $100 per tonne, up from$89 in mid-June.

China is still crucial to the Rio Tinto investment case. The country imports more iron ore than any other, to feed its hungry steel mills. Steel is essential for the massive infrastructure projects and urban developments that are currently taking place across the country.

Fears of a slowdown in China hit commodity prices last year. The latest updates from the Middle-Kingdom are more promising for miners, as growth picked up in the second quarter and Chinese daily steel output hit a new record in June.

Rio Tinto has taken this opportunity to pile pressure on Chinese domestic iron ore producers who suffer from some of the highest production costs in the country - well above the price of imported ore from Australia and Brazil.

Elsewhere, copper output jumped 23pc year-on-year to 323,000 tonnes in the first half, prompting Rio to lift its full-year guidance from 570,000 to 585,000 tonnes.

In other operations, bauxite and aluminium production was broadly in line with last year at 20.2mt tonnes and 1.67m tonnes respectively.

Hard coking coal output increased 9pc to 3.9m tonnes, while semi-soft and thermal coal rose 2pc to 13.5m tonnes. Titanium dioxide feedstock meanwhile dropped 14pc to 762,000 tonnes.

Rio has achieved an impressive turnaround. Only a year ago the then chief executive Tom Albanese announced he would step down following a record $14bn writedown on the value of the company’s mining assets, largely linked to the takeover of aluminium miner Alcan. However, shares in Rio are still 7pc below the level they were before the writedowns were announced.

Questor recommended buying Rio shares at £28.06 on July 17, and since then they have risen 21pc. That rating was reiterated in February (Buy, £34.97) as new chief executive Sam Walsh hit production targets.

The shares trade on 11 times forecast earnings, falling to nine times next year, and are expected to pay a 209 cent (122p) full-year dividend that would provide a yield of 3.8pc. If production targets continue to be hit and iron-ore prices remain resilient, there is no reason to think the profits won’t rise further, sending the shares higher. The investment case is still largely a commodity bet on China, but with the added benefit of a decent dividend to boot. Buy.