Ground Breakers: Rio can close valuation gap to BHP with new iron ore beast, says Goldman Sachs

• Goldman Sachs says Rio’s new Rhodes Ridge JV could be the 80Mtpa cornerstone of plans to transform its iron ore business
• BHP recommendation cut from buy to neutral due to valuation downside
• Miners down to end the week

Number crunchers at Goldman Sachs say Rio Tinto’s (ASX:RIO) big new iron ore mine in the Pilbara, Rhodes Ridge, could help bridge its valuation gap to major rival BHP (ASX:BHP), which has been pummelled down by the investment bank to a neutral recommendation just five months after earning a buy rating.

GS Australian analysts Paul Young, Hugo Nicolaci and Caleb Heiner think Rio’s Rhodes Ridge JV with Wright Prospecting, owned by billionaire descendants of Lang Hancock’s business partner Peter Wright, could support a mine of a beastly 80Mtpa (equivalent to BHP’s new South Flank operation) with first production in 2028.

That is double the 40Mtpa being studied by Rio itself, which is eyeing first production by the end of the decade, with GS thinking it could support anywhere up to 120Mtpa with a resource consisting of 7Bt at 62% Fe with 600Mt at a high grade of around 64% Fe.

“RIO is studying a 40Mtpa operation with first production by the end of the decade, but we think the deposit can support a 40-120Mtpa iron ore mine, and model 80Mtpa, with first production possible in 2028,” they said in a note to clients yesterday.

“We think Rhodes Ridge will be part growth, part sustaining, pushing RIO’s Pilbara production up >10% and over the 2017 production target of 360Mtpa, offsetting depletion from existing operations such as the 100% owned Tom Price/Western Turner Syncline (WTS), Channar, Yandi and Brockman/Silvergrass mines/hubs, and JV mines West Angelas and Robe River.”

Rhodes Ridge has been fingered as the next major growth asset for Rio’s massive iron ore division, after the completion of the 43Mtpa Gudai-Darri and the proposed US$2 billion construction of the 25Mtpa Western Range JV with Baowu Steel.

Waiting in the wings also is its long troubled Simandou deposit in Guinea, the world’s largest undeveloped accumulation of high grade hematite.

‘Compelling turnaround pathway’

GS has a buy rating on Rio Tinto and $114.70 price target, expecting the development of Rhodes Ridge to halve a free cash flow gap to BHP by US$6-8/t by 2030, even with its equity share of production falling from a peak of 86% in 2027 to 77% after the ramp up of the half-owned JV.

It all hinges on execution though.

“Although Rhodes Ridge is long dated, we think RIO can define a compelling turnaround pathway for the Pilbara, which we think will
help close the 10-15% valuation gap vs. BHP over time, assuming RIO can execute,” Young, Nicolaci and Heiner said.

Meanwhile, GS has soured on BHP, with a recent run in its share price meaning the world’s biggest miner is now trading above its revised price target of $42.9 per share.

The investment bank says BHP is trading with 4% downside to the price target against 15% upside for its global miners.

It comes after BHP was granted the opportunity to open the books at OZ Minerals (ASX:OZL) after securing the support of its board with a $9.6 million, $28.25 per share bid last week.

Young, Nicolaci and Heiner think the OZ acquisition could bring forward work on a smelter expansion at the chronically underperforming Olympic Dam copper mine, realising US$0.8-1.5b of synergies with the inclusion of OZ’s Prominent Hill, Carrapteena and BHP’s possible 150,000tpa Oak Dam discovery.

In GS’ book the smelter expansion could cost US$2-3b at a rate of 1.4Mtpa, with its scoping work on the Oak Dam prospect turning up a 10-12Mtpa block cave with total capex of US$3-4b, NPV of US$4-5b and IRR of 20%.

The Carra and Prominent Hill tonnes could bridge a gap to the development of Oak Dam at the end of the decade, GS thinks.

But given Olympic Dam’s past challenges, it will involve convincing shareholders the bright outlook for copper in the energy transition justifies an investment bill that could hit US$5-7b.

Miners down to close week

Materials stocks have climbed with rising commodity prices this month, up 11.6% over the period.

But today has been a downer for the sector, off 1.08% led by big drops for a slew of lithium players.

Pilbara Minerals (ASX:PLS) fell 7.22% with Allkem (ASX:AKE) down 6.66%, IGO (ASX:IGO) falling 5.41% and MinRes (ASX:MIN) sagging 5.25%.

Major iron ore stocks were also in the red, with graphite miner Syrah (ASX:SYR), mid-tier lithium cos Liontown (ASX:LTR) and Core Lithium (ASX:CXO) and uranium miner Paladin (ASX:PDN) also among the losers.

Breaking the trend were Regis Resources (ASX:RRL) off the back of its AGM yesterday, as well as NRW Holdings (ASX:NWH), which announced its Action Drill and Blast business had secured $300 million of work over a seven-year contract with Talison Lithium at the Greenbushes lithium mine.