Delivering Superior Returns
Rio Tinto (NYSE:RIO) managed to deliver superior returns to its shareholders last year, despite the global challenges caused by COVID-19 worldwide. Strong demand in iron ore and recovery of the copper and aluminum prices in H2 ‘20, fueled the strong financial performance.
China was the growth engine and outweighed the weaker results in all other regions. The positive commodity price momentum has continued this year and with less restrictions in Europe and America, we expect the prices to remain elevated.
The strong financial performance allowed the company to raise its dividend payments by +26% last year and reduce its debt.
Industry leading returns of 27% ensures strong results as long as the commodity prices remain at current levels.
Source: Annual report
Chart source: Annual Results presentation
What could possibly go wrong?
One more thing occurred in ‘20, RIO blew up the 46,000-year-old Juukan Gorge rock shelters in its hunt for profits. The company’s reputation got severely damaged by this incidence. It also caused the former CEO Jean-Sebastien Jacques to step down and hand over the leadership position to Jakob Stausholm. Rio Tinto urgently needs to repair its reputation to mitigate the impact of this incidence through increased focus on ESG (Environmental, Social, and Governance).
Why relevant? The mining industry is a very susceptible sector for political risk. The mining industry in Australia represent a significant portion of its GDP and the public and political opinions impacts Rio Tinto’s operations long-term. Bad corporate behavior could trigger changes in the government policy. This could lead to expropriations, license cancelations and contract “reviews”. Bad corporate behavior is simply bad for business.
Expanded Focus for the Business
The four areas of focus for the company now includes the following:
Chart source: Annual Results presentation
ESG credentials are becoming an integral part of the business, leading the company to define its investor purpose as follows.
”Deliver superior returns to our shareholders while safeguarding the environment and meeting our obligations to the wider society.
ESG priorities includes Safety, Communities & heritage, Inclusion & diversity and climate.
Source: Annual report
What it means in practice
The company is now taking a very different approach in its ways of working. Action is taken to better manage the partnerships & cultural heritage and new leadership team members have been appointed to better reflect the new priorities, to name a few.
Safety continued to be a top priority. The important KPI All Injury Frequency Rate (AIFR) improved in Q1 this year to 0.35 vs 0.40 last year. Strong support was given to the employees, contractors and communities to maintain tight COVID-19 controls.
These initiatives will continue to secure continuity and minimize the disruptions in the operations.
Communities & heritage are prioritized and the company has reviewed over 1300 sites to avoid any new expansion into a culturally sensitive area. This has resulted in removal of 54 million dry tonnes of iron ore from the reserve. Internal development initiatives are launched to increase awareness for community and heritage issues.
New programs are also launched to accelerate the career development of indigenous Australians in the business.
These initiatives will mitigate the risk repeating the Juukan Gorge incident and help the company to secure more exploration contracts.
Note: Improvement actions
Diversity & Inclusion initiatives include more women in leadership roles and more equal board representation. RIO recently appointed Isabelle Deschamps as it Chief Legal Officer & External Affairs person. She has a background in AkzoNobel where she was a driving force behind the Diversity and Inclusion program.
The D&I initiatives will likely make it easier for the company to hire the best possible talents to its operations in the future.
Climate change is being addressed by new partnerships and corporate goals. New innovative solutions are introduced to reduce waste and meet demand for emerging commodities like lithium. The company is working towards disclosures consistent with the evolving CA100+ benchmark.
The sustainability initiatives are likely to improve the profitability of the operations as it prolongs the lifespan of the assets and realize more value from the extracted materials. Inclusion of the CA100+ Benchmark also helps to secure future financing.
Source: First quarter production results
What it means for the future?
RIO’s focus has clearly expanded from solving productivity challenges to now also include ESG considerations.
ESG focus is not only the right thing to do, but will most likely also increase the profitability and sales over the long-term. Profitability by focusing on maximizing asset values, longevity of mines and recycling resources. Increase sales by better connect the corporate approach that appeals to local governments and the wider society.
Overall, RIO is positioning itself for further growth and creating new durable competitive advantages in the mining industry through the ESG initiatives.
Is now a good time to invest?
Rio Tinto is trading at 14x its price to earnings ratio. The earnings are also expected to rise in the future (tailwinds from COVID recovery).
This is also supported by an attractive 5.4% dividend yield where shareholders get paid to be long-term investors.
The stock is currently trading at $86 and our recommendation is to buy the stock at this level and hold until it crosses $120 USD, which gives it a PE multiplier of 20x earnings from current levels.
