MARKETS SPECTATOR: Ripping into Rio

As far as research notes go, Citigroup analysts Clarke Wilkins and Heath Jansen are pulling no punches. In the wake of Rio Tinto chief executive Sam Walsh’s commitment at last week’s AGM to “deliver our iron ore expansion plans in the Pilbara,” Wilkins and Jansen are scathing in their assessment of Walsh’s plans.

“What is the purpose of mining companies?” the two Citi analysts rhetorically ask. “Is it to provide commodities to customers so that they are plentifully supplied at all times, or is it to create value for shareholders?”

Rio Tinto should delay its planned 360 million tonne iron ore mining expansion, Wilkins and Jansen says. The company should return its cash to shareholders to close the 19 per cent gap between Rio’s share price and what Citi says the stock is worth. Wilkins and Jansen estimate Rio’s net present value is $71 a share. The stock at 1155 AEST was down 99.5 cents, or 1.7 per cent, to $57.455, a 19 per cent discount to Citi’s valuation.

Rio’s strategy of buying and building mines has resulted in the company’s share price dropping 1 per cent over 12 months to May 10, 11 per cent over two years and 36 per cent over five years, according to Citi.

“After a period of write downs and misallocation of capital, the market is unlikely to give them the benefit of the doubt to continue to build more mines,” Wilkins and Jansen say. “Potential buyers of the stock are going to take a wait and see approach. Those who own the stock can only wait or add, although with capital flows continuing out of the sector, adding looks less likely.”

If Rio Tinto continues with the 360 iron ore project, Citi - which has a “buy” rating on the stock – says the company’s share price may suffer for as long as five years.

“If the company proceeds to try and dig itself out of this situation then the risk is the share price could be down for the next one, two and five years,” Wilkins and Jansen say.