Rio Tinto Stock: At These Levels, It’s Hard Not To Be Bullish (NYSE:RIO)

La Cour Rio Tinto sign at their office in Montreal, QC, Canada.

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Thesis

Investors in Leading commodities miner Rio Tinto Group (NYSE:RIO) have suffered tremendously if they joined the party after its peak in May 2021. Accordingly, despite its seemingly attractive valuations, RIO has collapsed nearly 43% from its 2021 highs.

We believe the de-rating by the market is justified, as Rio Tinto’s operating model is inherently cyclical. Despite that, we believe Rio Tinto’s forward prospects remain relatively robust, as management seems confident in its long-term secular drivers. Coupled with its growing opportunities in copper, spurred by the world’s energy transition, we believe it would be unlikely for Rio Tinto’s profitability to fall back to pre-COVID lows.

As a result, we view the deep pullback as an opportunity to add exposure, despite the potential for falling dividend payouts, as Rio Tinto moves through the current recessionary cycle.

However, we believe the battering has been reflected in its stock price. Notwithstanding, Rio Tinto’s dividend yields could be cut further due to potential earnings compression through FY24. As a result, it could impact a critical valuation pillar for RIO. However, we believe the market had likely anticipated further cuts, as its valuation has fallen dramatically.

Moreover, we gleaned that RIO could find robust support at the current levels, helping to stem further downward momentum in the medium term. Therefore, we urge investors to leverage the recent weakness to start gaining exposure, riding along with RIO through the economic cycle.

RIO’s Valuations Have Been De-rated

RIO NTM EBITDA multiples valuation trend

RIO NTM EBITDA multiples valuation trend (Koyfin)

Through the chart above, we think it’s pretty clear that RIO has been battered, with the market de-rating it through its September lows. Consequently, its NTM EBITDA multiples have fallen to the two standard deviation zone under its 10Y mean. Hence, we deduce that the de-rating is highly significant.

Therefore, the critical question investors need to ask is whether Rio Tinto could maintain its profitability through the recession as macroeconomic headwinds worsen.

Rio’s Profitability Profile Is Expected To Remain Robust

Rio Tinto Gross margins % and Adjusted EBITDA margins % consensus estimates

Rio Tinto Gross margins % and Adjusted EBITDA margins % consensus estimates (S&P Cap IQ)

The consensus estimates (bullish) suggest that Rio Tinto’s profitability profile should remain robust through the cycle, even though it’s expected to moderate markedly from the highs in FY21.

Therefore, we believe investors must assess whether they are convinced with the company’s capability to execute through the worsening macro challenges as it steps up its CapEx investments.

In its H1 earnings call, some analysts were concerned about its investment cadence. But management highlighted that it sees robust long-term opportunities, despite near-term challenges. As a result, we believe it corroborates the company’s confidence in its growth opportunities as management articulated:

If we start adjusting our CapEx program because we think there is a recession in the next 6 months, we have lost it. We are in for the long haul here. In fact, if you really think about it, the best thing is to invest when you have a recession because that’s where you can buy services cheap. We are absolutely convinced that we have the right investment profile going forward. We do see positive markets for the future, we want to take advantage where we have those value-accretive growth options to actually bring them forward, and we just want to be consistent through the cycle. (Rio Tinto H1’22 earnings call)

Is RIO Stock A Buy, Sell, Or Hold?

Rio Tinto Adjusted EPS and Dividend per share consensus estimates

Rio Tinto Adjusted EPS and Dividend per share consensus estimates (S&P Cap IQ)

A critical risk to our thesis is attributed to the valuation impact of a potentially falling dividend payout through FY24 as Rio Tinto moves through the down cycle.

As a result, Rio Tinto’s FY23 Dividend yield is expected to fall to 12.2%, but still well above its 10Y mean of 6.22%. Therefore, we postulate that the market had already anticipated these headwinds.

RIO price chart (monthly)

RIO price chart (monthly) (TradingView)

Furthermore, we gleaned that RIO has fallen back to its long-term 200-month moving average (MA) support level.

Investors should note that the 200-month MA has supported the long-term uptrend of RIO over the last ten years, including the decline in 2016. Therefore, we believe it should proffer robust buying momentum at the current levels to help stanch further downside pressure.

Notwithstanding, investors should remain cautious about further downside volatility to force holders to capitulate like the collapse seen in 2016 and 2020.

We have yet to glean such a capitulation move in RIO yet. Accordingly, we urge investors considering adding exposure to layer in over time, keeping some ammo for such potential forced selling to add more aggressively.

We rate RIO as a Buy.

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