Rio Upgraded to Outperform - Analyst Blog

We upgrade our recommendation on Rio Tinto (RTP) from Neutral to outperform based on the slight improvement in the economy and the new quarterly pricing system. The new system has increased commodity prices by more than 50% on an average leading to an encouraging interim result during the fiscal 2010.

The quarterly iron ore price is based on a three-month average of price indices for the period ending one month before the onset of the new quarter.

The market has also picked up, which has reported a slight growth in the overall demand for iron-ore. Rapid industrialization and urbanization in China, the largest importer of iron-ore, will further help in strengthening the demand for Rio’s products in the future.

China is expected to grow by 9% in 2010 and Chinese steel consumption is expected to increase 6.7% to 579 million tons in 2010. China is expected to remain the largest consumer of metals in the years to come. Hence, the medium-term outlook for metal commodities remains encouraging.

Management expects global demand for Rio’s key products such as iron ore, copper, and aluminum to double by 2022, primarily driven by China, India, and other emerging economies. Rio’s investment in various growth projects will enable it to capitalize on long-term demand.

A total of $3 billion has been approved for investments in the entire fiscal year 2010 for the expansion of multiple projects. Recently, Rio along with Ivanhoe started developing the Oyu Tolgoi project and signed a MoU with Chinalco for the development and operation of the Simandou iron ore project in Guinea for a total investment of $563 million.

We are also optimistic on Rio’s decision to reduce debt through the divestiture of its loss-making unit, Alcan Inc. acquired in 2007. Since 2008, Rio generated more than $10.0 billion through divestitures and in 2010; a total of $3.6 has so far been generated. More divestments are expected to take place in the near term.

The much-awaited joint venture with BHP Billiton Ltd. (BHP) to produce iron ore in Australia will definitely push up the bottom-line as it is expected to generate cost synergies of $10 billion. However, the stock’s short term rating remains at Hold, equivalent to a Zacks #3 Rank.