Rio Tinto Stock Overvalued After 70% Rise?

Rio Tinto stock (NYSE: RIO) has seen a formidable rise of over 70% since late March (vs. over 55% for the S&P 500) to its current level of more than $60. This is after falling to a low of close to $35 in late March, as a rapid increase in the number of Covid-19 cases outside China spooked investors, and resulted in heightened fears of an imminent global economic downturn. The stock is currently about 15% above its February 2020 high. Are the gains warranted or are investors too exuberant? We believe that the stock has risen and recovered slightly more than its potential, and it could drop marginally to settle around $60 in the near term. Our conclusion is based on our detailed comparison of Rio Tinto’s stock performance during the current crisis with that during the 2008 recession in our dashboard analysis – Rio Tinto Stock’s Recovery Has Gone Far.

How Did Rio Tinto Stock Fare During 2008 Slowdown?

We see RIO’s stock declined from levels of around $90 in October 2007 (the pre-crisis peak) to little over $20 in March 2009 (as the markets bottomed out) – implying that the stock lost almost 75% of its value from its approximate pre-crisis peak. This marked a drop that was higher than the broader S&P, which fell over 50%.

However, RIO’s stock recovered strongly post the 2008 crisis to over $55 in early 2010 – rising more than 140% between March 2009 and January 2010, as against the S&P which bounced back by about 50% over the same period.

During the current crisis, RIO’s stock lost one-third of its value between 19th February and 23rd March 2020, and has already recovered more than 70% since then. The S&P in comparison fell by about 35% and rebounded by over 55%.

Where Is The Stock Headed?

The outbreak and global spread of coronavirus led to lockdown in various cities across the globe, which affected industrial and economic activity. Lower demand from construction players and shedding of capacity by major steel companies, mainly in China, has led to a drop in global iron ore prices. Additionally, the lockdown has affected the global supply chain for companies like Rio Tinto which have operations spread across geographies, leading to a decline in production and shipments. A drop in copper and aluminum prices is also hitting a diversified miner like RIO. This was evident from the recently released H1 2020 results, where Rio Tinto’s revenues declined by 7% to $19.4 billion while net earnings were down by 20%. Though iron ore production was up, it could not translate into higher revenues due to a  drop in price realization.

The rally across industries over recent weeks can primarily be attributed to the Fed stimulus which largely calmed investor concerns about the near-term survival of companies. As the global lock downs are lifted gradually, iron ore demand is expected to rise with supply constraints easing. This is likely to lead to an uptick in shipments toward the end of 2020. Global iron ore price has also increased since April, from $80/ton to over $100/ton currently. Though the stock has increased significantly over the last 5 months, the recent surge in Covid positive cases in a number of states in the US could prove to be an impediment for RIO. If the rise in cases warrant a re-imposition of lockdowns, then the stock could see a sharp drop to as low as $50. In the absence of another lockdown, the stock could remain close to its current level with only a slight downside, with Trefis estimating Rio Tinto’s valuation to be $60 per share.

In contrast here’s how Vale’s stock could look post Covid-19. Interestingly, RIO’s peer Cleveland-Cliffs’ stock plunged despite revenues being stable.

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