Why Axiom Capital's Gordon Johnson Started Rio Tinto At Neutral

Axiom Capital's Gordon Johnson initiated coverage of Rio Tinto plc (ADR) RIO with a Neutral rating and a price target of $26, saying that the company was likely to be impacted by deflating commodity prices, despite its position of a lowest-cost producer. Helped by a weaker Australian dollar, Rio Tinto had done "a stellar job" in reducing costs – from $18.7/mt in 2H14 to $16.2/mt in 1H15 – and had guided to additional cost savings. The company maintained its crown as "the world's lowest-cost producer," which did position it better than its peers against a deflationary environment. Johnson added that Rio Tinto did have core exposure to iron ore, or IO, "where spot prices are at levels not seen since the Global Fin. Crisis ("GFC")." Rio Tinto's Iron Ore segment accounted for 64 percent of total 1H15 EBITDA, versus 83 percent in 1H14, indicating that "the heart of its operations lies in iron ore." The company had four reportable segments and more than a dozen individual commodities mined for market, making it "a true conglomerate." However, despite "impressive idiosyncratic diversity," the company's "exposure to iron ore + our outlook on prices suggests risk to its ‘15/'16 EPS," Johnson said. In the report Axiom Capital added, "With our supply/demand ests. + YTD steel output in China down ~3% y/y + near-record Chinese steel inventory + YTD exports up 27% y/y (from an already record ‘14), we see structural demand for IO deteriorating. Despite these data, RIO continues to believe China's steel demand will peak at >1Bmt in 2030 – we, however, see demand having already peaked."