Markets: Hanging on to Rio's compass

As the market homes in on BHP Billiton and Rio Tinto’s views on the commodities market's future, valuation targets for the mining behemoths are looking up.

Resources have been out of favour with the market for much of the past 12 months. Their contribution to the market cap of the ASX 200 has been whittled down to around 20 per cent, from as high as 30 per cent a year and a half ago.

This slide was initially brought about by falling commodity prices and has maintained momentum with fears China’s growth is slowing. BHP Billiton chief Andrew Mackenzie offered some context yesterday, reminding us that although China’s growth has slowed on a year-on-year percentage basis, absolute demand levels are increasing.

Rio Tinto reports after market close this afternoon and will hopefully provide more guidance on where they see commodity prices going than Mackenzie did yesterday.  BHP Billiton reports in just under two weeks’ time.

Under the ASX principles of continuous disclosure, there shouldn’t be any major surprises on the earnings front. But the interest will be in what management has to say about economic conditions and future plans to deal with any further downside to commodity prices.

Casting back to last year, Rio Tinto detailed they it intends to reduce costs by $US3 billion per annum from 2015. The progress towards this is difficult to measure, especially over the relative short time frame. Comments from management will be the best guide as to how Rio Tinto is progressing on this front.

The outlook for our major miners is buoyant, with both companies having undertaken cost cutting measures, and selling non-core assets in a bid to consolidate their portfolios. The end result of this, combined with an improvement in ordinary operations is maximising cash flow – equating to an improved earnings per share.

For Rio Tinto specifically, amid flat and possibly declining commodity prices, the key will be its ability to execute on its intentions to increase volume growth.  Its major iron ore project, Pilbara 360, is the focus of this. The market is expecting management to provide guidance on the timing of increased capacity at Pilbara 360.

There still remain potential downside risks for commodity prices and the larger miners are better placed to navigate this with their ability to increase volumes significantly over the longer term through expansion of existing projects.

On a valuation basis, analysts have the miners looking cheap compared with other areas of our market.

The analysts following Rio Tinto have the 12-month target price ranging from $67 through to $80. These will mostly likely be updated after Rio Tinto reports this afternoon. Meanwhile, Rio opened at $58.89 today.

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