The Australian mining titan, moving to tighten its hold on key assets, has enjoyed a 20% stock rise in a month, as analysts augur upside of 30% or more. To some, it looks like a better play than rival BHP Billiton.
For years, Oyu Tolgoi, the world’s largest copper-gold-silver mine development project in Mongolia has been a bone of contention between mining entrepreneur Robert Friedland and the giant global miner Rio Tinto Group.
The Mongolian project is 66% owned by Ivanhoe Mines (ticker: IVN), founded by Friedland. The storied entrepreneur brought Rio in as a partner six years ago to help mitigate his huge risks, only to see the Australian giant boost its stake to 49%. After years of bickering, Rio and Friedland hammered out a standstill agreement, freezing Rio’s interest at 49% of Ivanhoe. Last week, the agreement expired and Rio (RIO) quickly moved to increase its Ivanhoe stake to 51%, buying another 2% of the shares outstanding for $312 million. "It removes a cloud of uncertainty and is a huge plus for Rio Tinto," says David Lennox, mining-sector analyst at Fat Prophets in Sydney.
Control of Ivanhoe, and through it a tighter grip on key assets like Oyu Tolgoi, is helping Rio Tinto cement its position as one of the world’s biggest miners. Insatiable appetite for raw materials like iron ore, aluminum, copper, coal, gold and uranium from China, India and other emerging markets helped drive the stock before the crisis. Last year, concerns about a slowing economy in China, recession in Europe and anemic growth in the U.S. weighed on Rio Tinto stock. "The market was pricing in the expectation of lower commodity prices," notes David Radclyffe of Nomura Securities in Sydney. "Now that there is realization that China is successfully managing a softer landing, there is no reason why resources stocks like Rio should sell at deep discounts," says Fat Prophets’ Lennox. Rio stock is up a whopping 20% over the past four weeks, and analysts say it could have another 30% to 40% upside over the next 12 months.
That’s a far cry from heady days of 2008 when, in the aftermath of the Lehman Brothers collapse and the advent of the financial crisis, Rio Tinto found itself with $40 billion in debt following an ill-timed $39 billion takeover of Canadian aluminum giant Alcan and a slump in demand for its commodities. As Rio reeled, vultures circled around it. A bid from Chinalco of China to invest 19 billion Australian dollars (US$20.2 billion) in Rio collapsed after Australian regulators refused to rubber-stamp the deal, and the stock plunged further.
Yet Rio hunkered down and pulled off an audacious $15 billion rights issue. From over $40 billion in debt three years ago–most of it short-term–Rio has pared its debt to just under $8 billion. Indeed, it is now yielding so much money that Credit Suisse’s Paul McTaggart reckons it could be in a net cash position next year. "Rio remains our favorite mining stock because of its incredibly strong balance sheet," says Hugh Young of Aberdeen Asset Management in Singapore who sees the miner as a classic play on Asia’s growth story.
Macquarie Securities mining analyst Lee Bowers likes Rio Tinto because iron ore is his preferred commodity as Chinese crude-steel capacity recovers through 2012. Macquarie estimates that crude-steel production in China could top 730 million tons this year. Unlike its larger, more diversified counterpart BHP Billiton (BHP.Australia), Rio is a much more focused bet. "Rio is more heavily exposed to iron ore, which makes up 70% of its earnings," says Lennox. (For another iron-ore play, see "Shifting Strategy to Meet Shifted Demand.") "What’s driving Rio’s earnings and will continue to drive its earnings is not just higher commodity prices, but also higher production," he says. "If your bet is that China can continue to grow 7% for the next year or two, Rio will see higher prices and higher volumes, and that can’t be bad for the stock."
Credit Suisse’s McTaggart, has a Buy and 12-month price target of A$90 on Rio, more than 30% above the current level. The stock trades at just 8.4 times this year’s expected earnings, versus a historical norm of 9.6 times forward earnings. The company has bought back nearly $7 billion of its stock over the past year and might produce a positive dividend surprise when the company reports its annual earnings on Feb. 9, the Credit Suisse analyst says. Nomura’s Radclyffe also prefers Rio Tinto over BHP Billiton. He has an A$97 target price. Radclyffe believes that supply deficits in iron ore and copper will continue to 2014. That can only be good for stocks like Rio.