Rio Tinto s early Christmas present

There are plenty of reasons to be negative but over the past few weeks we have found even more reasons to be positive. Today’s Rio Tinto announcement reaffirms our conviction going into 2013. Perhaps we have too much hope, but successful investments are built on solid convictions. The tired sounding Rio Tinto only a few months ago is today a lot more upbeat. It sees Chinese GDP growth moving back above 8% next year. This is in contrast to many economic forecasters who continue to pull back their numbers to the low 7% range – some bears are now in the 5-6% camp.

It’s unclear who is right but Rio puts forward a good convincing argument for optimism. Rio’s iron ore assets are in perhaps the most attractive geography in the world, producing at around US$24.50 per tonne. Even if the iron ore price does come back to US$80 there is a very large buffer margin and production is expected to rise to around 290 million tonnes per annum in 2013. Simandou in Guinea will come on by mid 2015 – a timeframe perhaps quicker than some had expected.

Just for the record – the Chinese housing market has no collapsed, the banking system is healthy, and inflation is now well below the PBOC’s target range. New house prices are actually rising in albeit at a very modest rate in around half of the 70 Chinese cities measured. Some markets are doing better than others, not everybody is benefiting but that’s a reality for China which encompasses 4 vast municipalities, 22 provinces and 5 autonomous regions. A successful political transition has been put in place in the past few weeks

Rio is looking out through to 2030 where it sees one billion tonnes of steel being consumed by China. This hasn’t changed, in fact the timeline has been pushed out this year, but it has been reaffirmed today. Rio is a business that not only has huge production upside over the next few years but is very well placed in the long term as these forecasts materialise.

Bottom line: We think the market could get an earnings surprise next year and the tone of conservatism around capital expenditure is there to reaffirm institutional investors that the board is mindful of over spending. A good clean balance sheet, world class assets, the best geography in the world given Chinese consumption growth – what more could investors want? While BHP is today expected to echo similar long term optimism, the focus on management succession will dominate. For Rio Tinto, it’s a matter of heads down and pleasing the market when earnings are reported over the next few months.

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