How to generate a RIO “buy”

Big iron is again outperforming on the stockmarket today even as its business dissolves. Let’s take a look at how this magnificent fiction is achieved. Deutsche has just cut its iron ore prices to $51 for 2015 and $60 for next year and today recommended RIO as a buy (not picking on it especially):

After incorporating the commodity and currency revisions our Rio earnings have decreased by 15% in 2015 and 9% in 2016. The largest impacts were the drop in the Fe price. Despite the downgrade to earnings, we still have Rio generating around US$690m of free cash flow in 2015 prior to the US$2b buyback. We think cost decline is keeping good pace with price decline. In the Pilbara, we think Rio can drop C1 unit costs to around US$14/t in 2016. Our Rio valuation has decreased by c. 5% to A$78.35/sh. Despite the downgrades we still forecast a free cash flow yield (post capex, pre dividends and debt payments) of 6% in 2015 increasing to 9% in 2016. Expect more impressive cost out with the interim results in August and some project approvals. With a strong balance sheet we are now confident Rio can buy back stock and approve growth (South of Embley bauxite, Silvergrass, Hunter Valley, OT underground when approved) for years to come, even at lower iron ore prices.

So then, the elements of the RIO “buy” are:

  • ignoring profit falls in favour of
  • free cash flow and yield while assuming that prices will rebound shortly and
  • that slow and steady cost out can keep pace with the tearaway iron ore price crash, as well as
  • assuming that further investment in already massively oversupplied sectors will generate earnings growth (as opposed to further price collapses).

That’s about as glass half-full an analysis that I have ever read but, hey, it works, at least until it runs into the brick wall of zero profits, deflating assets and writeoffs.


  1. David – H&H
    the only thing thats holding up BHP is that existing shareholders will get 1 share of SOUTH32 for every share they own in BHP.

    However BHP profits were down 50% in the half year to Dec 31.
    From 1 Jan to 31 Mar –
    IRON ORE is down 30% and going down further
    Coking coal – down over 25%
    Thermal coal – down over 25%
    Copper down over 20%
    Manganese down over 35%
    Oil down over 50%

    How the F^%* is BHP not down below their low of $26.50 i

    • Hey Joe!! South32 will likely trade at about $2 a share on the ASX, putting its market capitalisation at about $10.6 billion.
      Investors have been expecting the new company will trade at about $3 a share, and other valuations of the spin-off are about $US15 billion.
      Deutsche values South32 at about $2.68, and says it’s possible that BHP’s valuation would drop by more than the share price of South32 when the spin-off is completed.

      • The day SOUTH 32 is listed is the day when there will be a huge selloff in SOUTH32. ALL of their raw materials other than oil,ironore, copper and Potash ( BHP) are well down by over 20-30% in the Jan Qtr and the forecast for them to keep dropping in the final qtr with the US$ strength set to continue for at least next 12 months or more

  2. ps – I forgot ALUMINUM, ALUMINA AND ZINC and LEAD are all significantly down this quarter as well.
    Sure the Aus $ is down too but BHP profit is going down much much faster –

  3. Amazing, share price is effectively what it was in June14, however, its iron ore margins then were around $85/t, its margins now are >$20/t, with Australian IO making <90% of Rio’s EBITDA. Margin has gone – share price will inevitably follow.

    But not today by the look of it… it (iron ore) may have to drop another $10/t before the market begins to shake itself out. Heck, AGO is still producing and it must be losing money hand over fist… with every tonne they ship.

    This baby is going far lower than I ever envisaged, EVER…

  4. I would think it’s a buy because of the outstanding quality of its staff. Only explanation.

    • [email protected]

      if kevin hurt you MB he didn’t mean to OK?

  5. Guys it is all going to be good, according to the WA govt who have allowed BCI to defer royalties.?????. WTF WW
    Deferral of 50% of BC Iron’s NJV royalties for the December 2014 to September 2015 quarters, subject to the FOB received price being less than A$90 per dmt in the quarter
    Repayable in seven equal instalments from the 31 March 2016 to 30 September 2017 period
    Defers $8-12 million in royalties by 1-2 years

    • maybe thats why BHP and RIO idiocy spreads keep increasing. They are lining up for Royalty Relief too?
      What a Royal PITA :}

    • [email protected]

      They’re all lining up WW, they’d be mad not to..

      Oh and skip the repayment fiction coz they’ll be gone bust.

      Onyer Colin

      • Mate, I’ll tell you what is interesting, many of these small IO companies are headed up by accountant and lawyer types, who have no idea of accountability to shareholders.
        Many have web sites and on the main page is a tab, “Sustainability” and the topics covered are generally that Quolls and Bilbys etc wont be harmed in the mining operation.
        What they need under this tab is the equation of when the company is cash flow positive or if it is running on empty, simplified down to the sale price of their good, IO.
        For BCI the value should be close to 61 USD per dmt and the current IO price which is about 51 usd/dmt, so that all can tell, quickly, that their operations are not sustainable.
        Bullshit over.
        Then shareholders may have some confidence in the mob running these companies.
        I am comfortably satisfied that BCI is not sustainable. WW

  6. Can anyone direct me to a How to Guide on how to short stocks? Have an online brokerage account and would like to get in on this!

  7. Banks aren’t going to win the eventual rights issue ticket if they are bearish on the names…