Until recently, the golden rule of mining was: those who have the gold make the rules. It now appears if you’re a company involved with gold, you won’t even make the podium.
And it’s not just gold either. In 2013, many investors shunned commodity dependent miners altogether. Even some of the biggest Australian companies felt the wrath of negative investor sentiment. BHP Billiton Limited (ASX: BHP), Rio Tinto Limited (ASX: RIO) and Newcrest Mining Limited (ASX: NCM) were anything but impressive.
However, it could be that in 2014 these shares will outperform, and if the S&P/ASX200 (ASX: XJO) (^AXJO) ever reaches 6,000 points, the miners will need to rise in value. For Rio’s share price to make the leap back to its pre-GFC levels of over $100, a number of things will need to happen.
Firstly, the price of iron ore and the continued ramp-up in production needs to be sustained because it accounts for over 90% of earnings. The iron ore division, with Pilbara production forecast to reach 360 million tonnes by 2018, has the weight of the whole company resting on its shoulders. However, it can only do so much.
The company’s Aluminium business will have to become much more efficient. This has been a priority of CEO Sam Walsh recently, but it’s not going to be easy. In the 2013 full-year report, the company had revenues from the aluminium business (which includes bauxite, alumina and aluminium) of $12.46 billion but produced an EBITDA result of $1.89 billion – representing a 38% increase on the 2012 year. However, the division has thin profit margins and has amassed the greatest write-downs of any division since it bought the Canadian aluminium business, Alcan, in 2008. However it is safe to say the majority of its write-downs are now behind it and its major markets (including North America, Europe and the Pacific) are now rebounding post-GFC.
The copper division is the second highest contributor to earnings and the sixth biggest producer of the commodity in the world. Recently, the price of copper has come under pressure and management acknowledged “volatility in the near term” but said the long-term fundamentals remain positive. In 2013 the copper division suffered write-downs, a setback in production thanks to a wall slide at Bingham Canyon Mine, and low prices, but the business continued to become more efficient, with $US350 million in cost reductions. However for Rio’s share price to grow sustainably, the division will need resilient commodity prices and continued demand from markets such as China.
Lastly, in the energy division earnings have been slipping on the back of poor prices for both coal and uranium. Coal prices are likely to stay low for a while, whereas upside potential exists for uranium. A turnaround here would be small on the balance sheet but would go a long way in reviving investors’ appetite for miners’ exposed to the energy sector.
If Rio reaches $100 per share (currently $63.70) in 2014 I’ll be very surprised. However, I believe there could be upside potential for bullish resource investors looking to play this turnaround story in 2014 and beyond. There will always be uncertainty in commodiy stocks and although each of Rio’s businesses will need to fire on all available cylinders to return to levels prior to the GFC, as long as iron ore prices and copper remain strong and the write-downs stop, 2014 could be a good year for the commodities powerhouse.