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Rio slipper drop

The two thunks hitting the floor last week were mining giant RIO dropping its slippers. And when the second drops, usually a third follows. Net result is the share price falls.

Management dropped the ball big time. Things have gone horribly wrong in a very short time frame, with huge cost blowouts at its developing giant Mongolian copper mine Oyu Tolgoi and production problems at its best in the world performing Pilbara iron ore mines.

These unthinkable circumstances are disguised for the moment by record high commodity prices, and another large shareholder capital return due in August.

Further down the track, however, things could change. My RIO price target of $120 is too optimistic. I think there may be doubts building around RIO’s profit in calendar 2020 expected at whopping $US12.5 billion – at least 37% ahead of current market consensus. Above $100 RIO is in sell territory. Because there will be profit reductions over coming months.

The likelihood is Oyu Tolgoi now another two years and $2.7 billion from production could end up being a huge $15 billion failure. The underground expansion of the mine is now expected to cost almost $US7 billion, compared to $US5.3 billion previously.

RIO, the mine operator and owner, through its 50.79 per cent of listed Turquoise Hill, is being pursued by US law firm in a class action over market disclosures over the Mongolian mine cost blowouts.   

Turquoise Hill shareholders are fearful of massive equity issue off the back of the cost blow outs. Turquoise Hill’s share price has dropped by more than half, compared to the same time last year. There has been some concern the delays were not disclosed sooner than October last year when Rio and Turquoise Hill indicated Oyu Tolgoi was running behind schedule. Rio only referred to a ‘‘revised ramp up schedule’’ in October, before providing much more detail about the size of the delays in February this year, and in the June production report.

So big sums are at stake in this game of legal chicken. 

‘‘We saw a challenging operational performance,’’ was the understatement from Rio’s chief executive Jean-Sebastien Jacques announcing Rio Tinto’s blighted June quarter production results.

The surprise and the second slipper to drop was the quantum of RIO’s mismanagement of its Australian iron ore legacy. Mining cost blow outs, related to grade control problems meant a promised new era of performance and productivity is in jeopardy. Consistently the world’s best operator in iron ore, RIO is in danger of ceding that crown to BHP and FMG.

And the once unthinkable is now a possibility, with BHP’s iron ore business having a similar, if not lower, unit costs than a Rio production platform that BHP has long coveted. In mid-June Rio downgraded guidance for annual iron ore production from a range of 333 million-343 million tonnes to 320mt-330mt. Tuesday’s production report put some flesh on the bones that, Rio’s key Brockman hub has delivered materially less ore than planned. This means RIO would be moving more overburden through the rest of 2019 and in 2020 ‘‘to improve mine performance and pit sequencing’’. And highlights the fact RIO had underinvested in infill drilling to further delineate the Brockman ore body.

Whether this failure of judgement or cost cutting is not clear. But it is regarded as a rookie error unbecoming of RIO management. Rio has always been regarded as the best in the business for its mining and technical expertise. So a mistake like this is humbling.

Cost blowouts in Mongolia and expected lower profits from iron ore suggest Rio shareholders might not get, medium term, the bonanza profit and share price ride we were expecting. And the real test will be how quickly RIO management fesses up with market sensitive information.

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