Rio Tinto's competitive positioning and investment risks analysis

Rio Tinto

Moderate Buy

Rio Tinto faces a competitive market, but has concluded some important deals, including a very large one in Guinea, and a mergers and acquisitions campaign that gives it a strong asset base. The company has a strong commitment towards sustainable development, including in the environmental, social and corporate governance fields. This can be an advantage when discussing new deals with foreign governments.

However, there are several elements that also need to be taken into consideration when making the final decision and that moderate the buy action. The company is active in a difficult external environment, where political and legal risks can always play a negative impact on an investment. The financial figures and the stock performance are positive and sustainable, but there is concern about a growing financial leverage in the future and a fluctuating stock price (although, this would be a good moment to buy, since the price has decreased over the last weeks).

Firm Analysis

As the company's website mentions, Rio Tinto is a "leading global mining and metals company" (About Rio Tinto). As such, the main area of activity for the company is related to mineral resources, primarily identifying new resources and providing the financial and human resources to exploit these resources. Beyond this, the company aims to make this process a sustainable one and there are separate commitments on their website in things ranging from approach to environmental protection to safety and health and communities. The company claims that sustainable development is fully integrated into all company activities and strategies.

The company plays a close attention to corporate governance and has laid down ground rules when it comes to the criteria of selection of the members of the board, as well as shareholding policies for both executive and non-executive directors. According to Rio Tinto's website, the company has also imposed rules according to which employees and directors need to seek clearance from the company before any share dealing takes place.

Financing

The company's financing has fluctuated, largely influenced by the investments that Rio Tinto chose to make. In the last years (2012 and 2013), the leverage has been mostly positive, but the estimates for the next period of time reflect a growing negative leverage, as the chart below emphasizes.

Risk and Performance

There are two types of primary risks that the company should be concerned about, due to the nature of their business: political risk and legal risks. A lot of Rio Tinto's exploitations are in developing countries, where the political risk is translated through repeated changes in government, potential military coups and a volatile political situation. This could, in turn, mean that the new governments in power will deny Rio Tinto rights to exploit that would have been given by the previous governments. The result would be that the investments that Rio Tinto had made in developing the infrastructure for the exploitation, as well as the costs related to identifying deposits of minerals, would be lost.

The legal risk is, in fact, a diverse form of political risk. The new authorities (but also the existing ones) could promote legislation that would affect the company's business. This new legislation could include, for example, new regulations regarding environmental protection, with new norms that would cost Rio Tinto more. Other implications of legal risks could include special conditions regarding the exploitation: investing a certain amount of money, employing a certain number of individuals, beyond the actual needs for the exploitation etc.

To a lower degree, the company is also subject to economic, market and credit risk, depending on the financial resources it needs to access in order to consolidate its investments, but also to the evolution of the mineral resource global market, particularly the price of commodities on the different stock exchanges around the world.

Investment

The company's strategy appears focused on large exploitation deals, particularly in developing countries. A good example in this sense is the Simandou deal, worth $21 billion, in Guinea (Kehoe, 2014). This is an iron ore project that has been stalled for some time and that the company aims to rekindle with new investments. As this project shows, Rio Tinto prefers an overarching approach: in this case, this would be the largest infrastructure project in Africa and would include the mine, a 650 kilometers railway line and a multi-purpose port (Kehoe, 2014).

The company has also been very active, throughout its history, in mergers and acquisitions, partially growing because of this active M&A approach. As early as 1929-1930, the company has acquired and subsequently merged several smaller companies with interests in copper mines in Rhodesia (Harvey, 1981). The Rio Tinto mines in Spain were sold so that the company could focus on exploration during the second half of the 20th century (Rio Tinto Review, 2006).

In 1962, Rio Tinto merged with Consolidated Zinc, an Australian company, something that would profit both entities. Although the two entities initially operated as separate companies, a full merger was established in 1995, even if the two entities continued to trade as separate companies on the stock exchange. Other important acquisitions and mergers were used as instruments of growth, including the acquisition of the aluminum company Alcan for $38.1 billion, in 2007.

Sustainability and long-term viability

The company is strongly involved in building and implementing a sustainable strategy, on all three levels: environment, social and governance.

In terms of the social level, there are two primary aspects of interest: the company's employees and the interaction of the company with the communities. In terms of the employees, the company promotes an integrated human resources management strategy, with instruments such as a three-year learning roadmap and integration with local learning schemes. The company is also committed to diversity and inclusion.

The company also pledges community development and support, including through measures such as indigenous employment, encouraging women employment, looking out for cultural heritage and approaching resettlement and compensation as a long-term strategy, with the company continuing to work with the locals years after the resettlement.

Environmentally, the company's efforts range from air, water and land to biodiversity, energy and climate change and waste. Rio Tinto works with different stakeholders and relevant organizations in order to properly understand and implement best practices in each of these situations. As previously discussed, the company is also closely focused on corporate governance.

Valuation

The company has not only solid financial figures, but also interesting business and market perspectives, as it has recently completed a large deal in Guinea and there are many more opportunities that the developing world offers in terms of mineral exploitation. The decision to buy, sell or hold should thus take into consideration not only the limited stock and financial perspective, but opportunities from the future that the company can benefit from and that are reflected in some of the projections.