Rio reiterated their Pilbara guidance of 330Mt in 2016 and 350Mt in 2017 with their 2015 results. This ramp-up is being driven by approved brownfields expansions and the two-stage development of Silvergrass. An update of our bottom-up mine by mine Pilbara model shows that not only can Rio achieve guidance, but they exit 2017 at a run rate of 360Mtpa, while maintaining their premium Pilbara blend product. Furthermore, Rio retains the optionality of developing the world-class Koodaideri deposit, which would utilize spare infrastructure capacity created by the automaton of the rail system. Buy on valuation (A$57.5/sh), FCF (9% yield), and sector leading growth and cost out.
March Q likely to be seasonally weak
Port data for January and February suggests that Rio has been shipping at a rate of around 300Mtpa, well below the 345Mtpa run-rate achieved in the Dec Q. This was likely caused by the usual seasonal rains and high swells, so shipping rates should rebound in March. We assume 81Mt of shipments in the March Q, a 6% decline QoQ. However we expect this to be caught up in subsequent quarters and expect Rio to ship 333Mt in 2016. Driving down costs and boosting FCF We think that filling the 360 infrastructure, together with the automation of the rail and mining fleet, will reduce Rio’s C1 costs from US$13.8/wmt in 2H15 to US$12/wmt by the end of 2017 (at constant currency and no inflation). The iron ore price would need to fall by around US$5/dmt to offset the benefits of expanding to 360, which is unlikely, as this is just 1% of global supply.
I have already noted that February volumes out of Port Hedland were weak to the tune of 3-5mt (that’s BHP and FMG). So together the three Pilbara majors are down on a annualised shipments basis of roughly 100mt in the first two months of the year.
That is not only going to reverse but will have to made up for over subsequent months.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
