Rio Tinto: The Ultimate Commodity Leader for Commodity Expansion

‚ Rio Tinto provides ideal variety. The materials sector makes up only 2.8 percent of the S&P 500 index, and the metals and mining subsector makes up only 0.3 percent. ‚ In 2021, the company generated $25 billion in cash flow, compared to $6 billion for

Salesforce, which is worth 1.5 times Rio. Technology accounts for 27% of the market in the United States.

‚ Rio Tinto is a market leader in iron ore and aluminum, with a top-tier copper growth profile. In the energy revolution, copper could become the "new oil."

‚ Metals are extremely important in the global energy shift. Industrial metals provide one of the most significant development prospects in the future decade, with demand anticipated to put a strain on available supplies. ‚ Rio Tinto provides growth, income (10%+), and diversification for all investors. Rio offers an incredibly asymmetric risk/reward opportunity, with the stock trading just above a strong 10-year support foundation.

rio TinTo (nYSe:rio) mainTainS a favorable riSk/reward raTinG baSed on iTS unique porTfolio diversification benefits, leverage to secular growth patterns, and unusually asymmetric risk/reward profile. Rio has top-tier copper growth potential, industry-leading aluminum profitability, and probably the best iron ore holdings in the world. A nearby technical support base that has evolved over the past 13 years, a discounted valuation, a 10% dividend yield, and a structurally bullish supply and demand balance for industrial metals over the next decade all support the downside.

Rio Tinto has a very asymmetric risk/reward profile, with a fundamental upside potential of 104 percent to 161 percent and a present dividend yield of 10% or more. Over the next decade, the global infrastructure and energy transition boom will almost certainly underpin solid industrial metals markets.

While a tenfold increase in copper's price and it becoming the "new oil" are both plausible scenarios, it's crucial to consider the source. Goldman Sachs is a sell-side investment firm that specializes in helping companies, notably mines, raise finance.

However, looking ahead a decade, the following comments describe the most likely directional trend for copper, and industrial metals in general. The materials business, particularly the mining and metals industry, appears to be approaching exciting times.

Diversification

Rio Tinto is a global leader in iron ore and aluminum production, with one of the best copper growth profiles among its peers. As a result, Rio Tinto's investment rationale is dependent on global supply and demand for these important industrial commodities, as well as the company's competitive positioning. The exceptional portfolio diversification that Rio Tinto offers to most of today's investors is an underappreciated feature of the Rio Tinto investment thesis. The increasing dominance of index funds in today's markets is well-known. Furthermore, the vast majority of active portfolio managers now underperform their index, according to the investment community. As a result, many active managers use a technique known as "shadow indexing" to ensure that their performance does not stray greatly from their benchmarks.

With the S&P 500 index serving as the barometer of "the stock market" for most professionals and many people's favorite investment vehicle, it's critical to know what "the market" has to offer. Using the holdings of the SPDR S&P 500 Trust ETF, the following table breaks down the sector weightings in the S&P 500 index (SPY). The table 1, published by State Street, shows how the bulk of today's investors have sector exposure in their portfolios.

The materials sector weighting in the U.S. stock market is highlighted in yellow (Rio Tinto is in the materials sector but is not in the S&P 500). With only 2.82 percent of the market, it's safe to say that most investors aren't familiar with the materials sector.

If the secular growth trends in the next decade match the first quotes, index investment is expected to underperform by a significant amount. The period following the 2000 tech boom provides a look into the prospect of long-term negative index performance. It took until 2013 for the S&P 500 to surpass its 2000 high.

When we look at the materials sector more closely, the exposure to the metals and mining business (Rio Tinto's subsector) is even more concerning from a diversification standpoint. The table below, prepared by State Street, lists all of the firms in the materials sector of the S&P 500 index.

The two businesses in the metals and mining subsector, as well as their total weighting in the S&P 500, are highlighted in yellow. Index investors, as

Table 1. Source: State Street.

Rio Tinto is a global leader in iron ore and aluminum production, with one of the best copper growth profiles among its peers.

well as many investors in portfolios that benchmark to the S&P 500 and similar indices have a 0.3 percent stake in what could be one of the most promising growth possibilities in the next decade.

Furthermore, Freeport-McMoRan (FCX) and Newmont (NEM), two similar businesses, effectively offer exposure to copper and gold. As a result, Rio Tinto provides investors with near-perfect diversification by giving meaningful exposure to iron ore, aluminium, copper, gold, and lithium, among other commodities.

In conclusion, by adding Rio Tinto to their portfolio, the majority of today's investors can attain a more efficient portfolio (the same or better-projected return with lower risk). Rio Tinto is a great way to diversify your portfolio.

The New Oil Is Copper

Returning to the Weisenthal statements from earlier, Rio Tinto has a world-class copper portfolio with peer-leading growth potential. Rio offered to buy the entire shares of Turquoise Hill Resources (TRQ) that it did not already own in the first quarter, demonstrating its growth potential.

Turquoise Hill Resources is currently owned by Rio Tinto to the tune of just over 50%. Rio will hold 66 percent of the Oyu Tolgoi mine if the bid is accepted, with the Mongolian government owning the remaining portion.

With the start of the underground expansion, Oyu Tolgoi is now a tier-1 resource that is entering its most valuable phase of development. The underground mine will bring Oyu Tolgoi to its planned output capacity, as it contains far greater grades of copper and gold than the open-pit mine. Oyu Tolgoi is expected to produce 1 billion pounds of copper per year at peak stable production through 2041, with the potential to prolong the mine's existence for decades. If copper prices remain in the $4 to $6 range, Rio Tinto's cash flow potential at this level of production may vary from $2 billion to $3.6 billion per year, according to my calculations. This range represents a copper price movement of between -7 and +40 percent from today's pricing. This, in my opinion, is a conservative estimate of copper's future potential over the next decade.

A more positive scenario could emerge as a result of the energy transition, which has resulted in a structurally tight supply situation. If this happens, cash flows would jump from $2 billion to $3.6 billion per year at $4 to $6 copper, according to my calculations. Please note that my cash flow forecast includes Rio Tinto's 66 percent ownership of the Oyu Tolgoi mine and 330,000 ounces of gold production per year. For $2.7 billion, Rio is effectively acquiring 330 million pounds of anticipated and established copper production and 110,000 ounces of annual gold production. This appears to be a fantastic capital allocation decision. A new mine of this size would necessitate a far higher level of capital investment, a significantly longer time frame, and the extreme dangers that all new mine developments entail.

PORTFOLIO OF COPPER

Rio Tinto has built a formidable copper portfolio that includes world-class assets. Rio Tinto, for example, owns a 30% stake in the world's largest copper mine, Escondida in Chile. Rio Tinto owns a 55 percent stake in the Resolution Copper mine in Arizona, which, if fully operational, could supply 25% of the U.S.' annual copper consumption for the next forty years.

Rio will hold 66 percent of the Oyu Tolgoi mine, which is expected to become the world's fourth-largest copper mine, as previously stated. Finally, the firm owns the Kennecott copper mine in Utah, which has been producing since 1906 and is the world's deepest open pit mine. This mine has been renovated to ensure that it can continue to produce for at least another decade.

The price range for Rio Tinto shares is $36 to $89, with $36 to $62 being the most likely scenario several years hence. Please keep in mind that these per-share valuations solely apply to Rio's copper holdings. With Rio Tinto's stock nearing $74 per share and copper accounting for only 12% of the company's current revenue, the copper analysis shows that Rio Tinto's stock has significant upside potential.

Copper is a worldwide commodity with a fluctuating market price. Production disruptions in the mining industry are common owing to a variety of natural and recurring events, such as equipment problems, labor strikes, and natural catastrophes.

FORECAST FOR COPPER

In the short term, the global economic downturn, which coincides with new production coming online and production recoveries from the COVID delays, appears to be causing copper supply to exceed demand. Copper inventories, on the other hand, are around 16-year lows.

With copper's growing relevance in the energy transition (see "Global Growth Opportunity" in my previous research), industry and government actors would be wise to restock inventory of a mission vital commodity as soon as possible. As a result, the price of copper is anticipated to be well-supported near current levels, with the caveat that downside volatility could emerge if the world enters a recession. Regardless, the outlook for copper over the next decade appears to be very positive.

Copper is a worldwide commodity with a fluctuating market price. Production disruptions in the mining industry are common owing to a variety of natural and recurring events, such as equipment problems, labor strikes, and natural catastrophes. As a result, if manufacturing is disrupted, a "little excess" can turn into a material deficit. Copper inventories are reaching 16-year lows, exacerbating the lack of tolerance for a mistake.

While copper is theoretically stretched to the upside in comparison anticipated COVID price decline in the first half of 2020, it has been consolidating sideways for nearly a year. As a result, copper is not technically overextended when measured over a one-year period. Nonetheless, investors should be aware that the $3.50 to $3.90 range could be tested. If this happens, copper stocks will likely see significant downward volatility, providing an attractive entry point for investors eager to accumulate shares.

The possibility of a near-term copper correction, as well as the resulting volatility in copper equities, emphasizes a key pillar of Rio Tinto's investment case: diversity. While a copper bellwether like Freeport McMoRan would certainly see a significant selloff in a near-term copper correction, Rio Tinto's shares should see far less volatility because copper accounts for only 12% of the company's current operations. Rio Tinto's copper case revolves around its long-term growth goals, which are well linked with the possibility of supply shortages by the middle of the decade.

Aluminum

Due to the desire for "light weighting" to reduce energy consumption across the global economy, the aluminium industry is likewise undergoing a structurally optimistic transformation. The most significant and positive structural shift, however, is coming from China. As can be seen in the slide below from my last analysis, China has halted aluminum capacity expansion, which has been flat since 2017. This seismic change is transforming the global aluminum market into a more economically stable supply dynamic, which will likely support higher prices in the medium to long term.

One of the most carbon-intensive metals to manufacture is aluminum. Given China's carbon target obligations and global trade tensions, the structural supply limitation is very likely to persist.

Rio Tinto is one of the world's most efficient aluminum industries in terms of carbon footprint. Rio Tinto has a competitive cost advantage as carbon prices rise and carbon becomes more of a cost. Coal is used to power 60% of the global aluminum industry. Aluminum prices will be pushed up as the cost of these coal operations continues to rise. As a result, Rio Tinto should see much better profit margins.

PROFITABILITY OF ALUMINUM

Rio Tinto is, in fact, the industry leader in terms of profitability. Alcoa (A.A.) is a bellwether in the aluminum industry, similar to Freeport McMoRan in the copper industry, and serves as a good comparable firm for Rio Tinto's aluminum business. Furthermore, the aluminum businesses of Alcoa and Rio Tinto are nearly the same size in terms of sales.

Rio Tinto's aluminum division generated 159 percent of Alcoa's EBITDA in 2021 and nearly twice as much in 2020, on roughly equal sales. Rio Tinto's aluminum business, in comparison to Alcoa and the industry as a whole, clearly warrants a significant premium in terms of valuation.

When discounting the cash flows of each firm, Rio Tinto's aluminum division has a lower discount rate than Alcoa's, which enhances the value premium resulting from Rio's considerably superior profitability.

Ore of Iron

Rio Tinto's copper and aluminum divisions are minor in comparison to its iron ore industry. The price of iron ore has risen in recent years, resulting in phenomenal cash flow for Rio Tinto. Using EBITDA as a cash flow proxy, the iron ore industry earned roughly $28 billion in 2021 alone.

Rio Tinto is currently valued at $124 billion, or 4.5 times its iron ore EBITDA and 3.2 times its total EBITDA for 2021. The market anticipates iron ore prices to trend toward the mid-$80 per tonne level in the next years, which explains the incredibly low valuation. In 2021, the average price will be around $147, while in 2020, it will be around $103. appears to be a reasonable baseline assumption. Prior to the recent price rise, this price projection represented the upper end of the iron ore trading range between 2016 and 2020. For iron ore, this is expected to be a strong support zone. As a result, Rio Tinto's iron ore results from 2018 to 2020 provide a high-confidence projection of long-term iron ore earnings.

Range of Potential Returns

Rio Tinto, on the other hand, is currently trading around the $74 level. Much, if not all, of Rio Tinto's present valuation is accounted for by the $74 to $90 valuation projection for the iron industry. When looking out several years, the range of projections for the copper and aluminum businesses was $53, $79, and $106.

It's important to remember that Rio Tinto pays a sizable dividend. At today's pricing, the base dividend for 2021 corresponds to a 10%+ yield. This is a sizable profit in and of itself. Rio has most certainly reached the limit of its payout capabilities for the time being, given the size of the dividend payment. Rio should continue to be a top income producer regardless of the shortterm payout policy.

Lithium

Before moving on to a technical analysis and closing remarks, it's worth noting that Rio Tinto is seeking significant growth prospects in the lithium mining industry. As the automotive sector cranks up E.V. production, lithium costs are soaring. Lithium prices, for example, increased by 576 percent in Q1 2022 compared to Q1

2021, according to Sociedad Quimica y Minera de Chile S.A. (SQM).

The energy shift and tight supply conditions have put a strain on global commodity production capacity, and lithium is an ideal example. In a commodity bull market, it also highlights the very real prospects for other metals. Rio Tinto is developing two big projects, each capable of producing around 50,000 tonnes of battery-grade lithium per year. One project is moving forward, while another is on hold while the Serbian government evaluates it. In the end, lithium is a fantastic development potential, and Rio Tinto's actions indicate that it aims to be a major player in the industry. Rio Tinto has excellent growth opportunities as the energy shift takes shape.

Technicals

The technical backdrop for Rio Tinto is one of extraordinarily strong longterm support with minimal evident resistance. A theoretically asymmetric risk/reward opportunity exists due to the lack of technical overextension, minimal observable resistance, and strong support nearby.

Summary

Rio Tinto has a very asymmetric risk/ reward profile, with a fundamental upside potential of 104 percent to 161 percent and a present dividend yield of 10% or more.

Over the next decade, the global infrastructure and energy transition boom will almost certainly underpin solid industrial metals markets. Rio Tinto is a best-in-class blue chip on the verge of a historic boom cycle, providing ideal diversification for all portfolios.