Rio Tinto (RIO), which takes its name from an ancient mine in Andalusia, began life in the 1870s and is now ramping up spending to make it to the 2070s. That means building new mines. Investors have shied away from major capital investments in the past, maybe because Rio has managed to throw away so much of their cash. But it has turned a corner and is now spending wisely.
These growth plans, as well as a fall in iron prices, mean a leaner time for investor payouts after a bonanza few years. The interim dividend was cut by a third this year, and analysts see a downward slope for cash returns until 2026. Free cash flow is expected to fall until the same year, as per analyst consensus. The good news is the company is starting from an extremely high base: dividend payouts last year totalled almost £10bn.
The question for long-term investors is the degree to which Rio pivots away from iron ore as its key earnings driver. It is uncertain how long China will maintain its hunger for the steel ingredient, having driven demand for the past 20 years. Investment bank Bernstein forecasts that iron ore demand will rise 0.8 per cent a year to 2030 and then contract 0.9 per cent annually for the following decade.
A shift to electric arc furnaces that could run off hydrogen rather than coal will also alter the industry, as they require less but higher-grade iron ore and can use scrap as a feedstock. China is unlikely to make a snap decision to shut down its dozens of new steel foundries that cost billions of dollars to build. But new steelmaking capacity elsewhere is likely to use the next generation of technology.
The iron ore market is directly linked to Rio’s dividend because of the way it has been driving operational performance. In the first half of this year, iron ore contributed cash profits of $9.8bn (£7.9bn), 82 per cent of the overall group figure. This was a greater proportion than usual – it was 70 per cent in for 2022.
More of the same
While structural changes are slowly emerging, Rio is working on a major new iron ore project, Simandou in Guinea.
Currently, iron ore production is dominated by Australia and Brazil. Simandou would be a major new source of iron ore globally, and Rio has an effective share of 25 per cent in four of its 'blocks'. But production is still years away, given the need to build a 600km rail line to a port as well as the mine infrastructure and the mine itself.
The industry excels at this type of project – the Pilbara in Western Australia is about as far from other infrastructure as anywhere on earth – but this is still a big undertaking.
More advanced are Rio's copper development options. The shift underground at Oyu Tolgoi is on track after years of cost overruns and delays and the company has committed $500mn to build a new underground operation at the Kennecott mine in Utah. Another underground project in Arizona, named Resolution, is also in the works as a joint venture with BHP (BHP).
“Rio Tinto, with Kennecott underground and potentially Resolution following, has impressive copper growth options,” said RBC Capital Markets analyst Tyler Broda in July. “We see the equity story, especially with Oyu Tolgoi helping to offset the profitability impact from the expected fall in iron ore, as increasingly compelling.”
Oyu Tolgoi will be free cash flow-positive from 2025, as per RBC’s forecast.
Of course, Simandou will require significant spending once it is moving. This will put more pressure on the dividend. Ideally, Rio's copper expenditure will have turned into a rise in output by then and, if the assumptions about the market falling into deficit late in the decade are correct, another payout bonanza should ensue. Hold now to benefit then.
