Rio Tinto (Price: 3516p | Target: 3765p | Rec: Buy) Approximately 86% of Rio Tinto’s 2H13E net earnings came from iron ore, versus only 50% and 36% for BHP Billiton and Anglo American respectively.

With the company continuing to ramp up iron ore production, the overwhelming investment view is thus predicated on the iron ore price outlook and in this regard we continue to believe the market is taking an overly conservative approach to forward iron ore pricing, and therefore to Rio Tinto’s potential earnings outlook.

Maintain Buy. * Post the FY13A results and company guidance for FY14E, we have made adjustments to our forward assumptions.

Our FY14E earnings are increased by 1%.

We have taken a more conservative view on the medium term production ramp up, resulting in an FY15E earnings reduction of 5%. * Rio Tinto’s earnings outlook remains starkly exposed to iron ore; the extent of this exposure is heavily dependent on forward price assumptions.

In this regard there is an astonishing divergence of analyst price forecasts, with a c.US$30/t average gap between the highest and lowest forward price forecasts.

The variance in this key assumption drives a c.30% spread in earnings estimates. * The single commodity exposure and the pricing uncertainty likely explains the relatively low earnings multiples that Rio Tinto trades on; currently a c.25% discount to its peers.

However, we note that the current share price is close to the valuation that we would derive using the lowest broker iron ore forecasts, suggesting the worst case is priced in and the shares offer considerable scope for a re-rating. * Incorporating the FY13E results and subsequent forward adjustments, our TP (based on an equally-weighted average of five metrics, namely NPV, dividend yield, one year PER, free cash flow yield and a sustainable PER) has increased to 3,765p per share.

We maintain a Buy recommendation.
To access the full note please click here Analyst: Hunter Hillcoat +44 (0)20 7597 5182
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