Oyu Tolgoi Weighs

Rio Tinto recently released its June-quarter production report and also provided a significant update on the Oyu Tolgoi copper-gold project in Mongolia.


The key focus of the production report was on Rio Tinto’s Pilbara iron ore division, where shipments were affected by recovery works following Topical Cyclone Veronica. The company also said it was behind on waste stripping. This has led to a downgrade in 2019 output of 14Mt and a rise of about US$1/t in unit costs to US$14–15/t, and is likely a factor in the soft achieved price of US$78.50/t, which was 6% below our estimate. At this stage it appears the company may not be able to achieve production rates of 350–360Mtpa, while maintaining Pilbara blend product specifications, until the Koodaideri project is online in 2H21.


The Oyu Tolgoi development has been hampered by stability risks, leading Rio Tinto to redesign the underground mine. This has caused a capital expenditure overrun of US$1.2–1.9bn, taking the budget from the original US$5.3bn to US$6.5–7.2bn, with a delay in first production of 16–30 months versus 2016 guidance, to between May 2022 and June 2023, depending on final design.


The final design of the first panel of mining, known as ‘Panel 0’, will continue into early 2020. This could affect the outcome of the grade profile and unit costs. We have lowered our valuation of Rio Tinto’s share of the asset from US$5.4bn to US$4.7bn, or around 3.5% of the group’s total valuation.


Heading into the August result, we don’t expect capital management. Rio Tinto has used a 50% dividend payout ratio at the interim result for the past three years. We note the current strength of iron ore markets and Rio Tinto’s unstretched valuation metrics, although we can’t see any near-term catalysts to rerate the stock significantly. We maintain our Hold recommendation and have trimmed our target price to $106.00 from $109.00 due to changes to our earnings forecasts.

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