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December 28, 2011 Dear Friend,
Our average "Overweight" investment
rating stock has 168% upside if it reaches our price target, our
average "Neutral" a 15% upside and our average "Underweight" a 19%
downside. We were concerned that several small cap stocks may
influence those averages, so we calculated for companies > $10
billion market caps that the Overweights have a 99% upside, Neutrals
an 8% upside and Underweights a 21% downside.
While we have upgraded Rio Tinto to Overweight from Neutral based on a 27% potential total return based on 25% if it meets our $60 per ADS upside plus a 2.4% dividend yield, we characterize it as a "bunt single" using U.S. baseball parlance or sort of a weaker Buy rating. Many cyclical shares are deeply depressed due to investor macro fears after the European banking crisis. An important influence in our upgrade is that Rio Tinto repaid $34 billion in net debt over the past three years. Further, we estimate the company will build $43 billion in net cash balances by 2020 even with larger cap ex budgets and progressive dividends. The company generates cash quite effectively, although a further 25% drop in commodity prices in a recession could dampen the degree of cash generation. Rio Tinto's earnings power fell with declines in various commodity prices from Spring 2011 peaks and with asset sales, and we cut our price target to $60 from $68 per ADS previously. We do not expect the company to sell discontinued aluminum assets for satisfactory cash proceeds, and estimate a $6 billion asset writedown and eventual spinoff to a "newco" we named "Shareholders' Aluminum" assets. CERTAINLY IT IS BETTER TO GIVE IT TO THE SHAREHOLDERS THAN THE CHINESE GOVT. or some other low ball buyer. Rio Tinto owns < 33% of its Guinea iron ore mines and railroads, and we do not understand the appeal of investing over $10 billion in such complex structures other than as a favor or courtesy to the Guinea and Chinese governments. Even with various commitments, Rio Tinto has discretionary cash flows and investors will look keenly to the returns it earns from diverse investments in Australia, Canada, Guinea, Mongolia, Latin America, etc. Faithfully,
John C. Tumazos, CFA
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Copyright © 2008 John Tumazos Very Independent Research,
LLC
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