Rio Tinto share price: 2 potential risks facing the miner

Rio Tinto share price ↑

Australia’s big three miners and their investors have been some of the chief benefactors from rising iron ore prices over the last 18-months.

For one, their share prices are up. Rio Tinto has gained about 25% in the last year and returned billions worth of dividends to its shareholders. The miner’s 2020 dividend totalled $9.0 billion – or 557 US cents per share, representing a 72% payout ratio.

On the ASX (the company is dual-listed), the Rio Tinto share price (ticker: RIO) was up 1.17% to $113 per share by 11:38AM on Tuesday, 6 April.

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The company's operational performance was also solid in 2020. Net cash, free cash flow, and net earnings were all up. Some analysts aren’t convinced that the good times can last though.

Risk 1

One key question is for how long can iron ore prices remain elevated. For now prices are at multi-year highs: CME's front-month iron ore futures contract last traded at US$163.89 per tonne.

But as we move further out, expectations – as least as they are relayed in futures markets – are more subdued. That is essentially UBS’s point, with the investment bank noting that:

‘We see evidence to suggest iron ore is now approaching an inflection point & prices are at risk of falling sharply during 2021/22.’

This view is based on a few things: Brazilian iron ore supply improving (it has been dour since early 2019) and Chinese pollution regulation impacting steel production and therefore iron ore demand. Plus, the investment bank notes that in recent times Chinese port inventories are up.

Should iron ore prices ‘fall sharply’, some of the metrics that have made Rio and Co potentially attractive to investors could and likely would be impacted. UBS estimates that RIO's free-cash-flow yield would fall to 7% were iron ore prices to trade around US$90 per tonne.

UBS currently has a Neutral rating and $104 price target on Rio Tinto.

‘In our opinion, the risk/ reward is balanced with the stock supported by high cash returns near-term, but in our opinion this is not sustainable,’ the investment bank said.

Risk 2

The investment bank has also sees risk from another front: Oyu Tolgoi.

Located in the South Gobi region of Mongolia, Oyu Tologoi touts one of the largest copper and gold deposits in the world.

Rio has been developing the underground portion of this mine for years, at significant cost. In May 2016 the initial capital cost was earmarked at $5.3 billion. In December 2020 an additional $1.45 billion was approved to go towards the development of this mine.

Mined copper at the open pit portion of Oyu Tologoi increased 2% in 2020. The real prize however is the underground portion of the mine, with Rio Tinto noting that between 2028 to 2036 it expects to produce, on average, 480,000 tonnes of copper per annum.

But will Rio meet its targets?

UBS points out that Rio Tinto is yet to receive the required government approvals, power agreements, or finalise funding arrangements with Turquoise Hill Resources.

‘We see a risk that RIO will delay the undercut decision which results in further delays/ capex increases vs guidance.’

In January, RIO itself said that 'the government of Mongolia advised Rio Tinto that they were dissatisfied with the results of the definitive estimate and the funding implications for the share of economic benefits between the shareholders of Oyu Tolgoi.’

Not the most positive update in the world.