Rio Tinto: Even With Current Downward Momentum, Price Outlook Is Favorable
Geoff Considine, Ph.D | Aug 23, 2021 14:08
This article was written exclusively for Investing.com
Rio Tinto (NYSE:RIO) is the world’s second largest metals and mining company (BHP is the largest). Headquartered in London, the company has operations around the globe.
The company’s products include iron ore, aluminum, gold, diamonds, titanium, and uranium. While mining and processing these materials tends to be energy intensive, the firm is proactively developing and implementing procedures that will Investing.com
Even considering the small number of analysts covering the stock, the uniformly bullish price targets are notable. Trefis.com, an analytics company that calculates fair value for stocks using fundamental models and discounted cash flow (DCF), estimates the current fair value of RIO to be $100.25.
Market-Implied Outlook for RIO/h2
I have analyzed put and call options at a range of strike prices, all expiring on Jan. 21, 2022, to generate the market-implied outlook for the next 5 months (between now and the expiration date). I chose this expiration date to provide an outlook through the end of 2021 and because January options tend to be liquid.
The standard presentation of the market-implied outlook is a probability distribution of price return, with probability on the vertical axis and return on the horizontal axis.
Source: author’s calculations using options quotes from eTrade
The market-implied outlook for the next five months is highly symmetric, with similar probabilities of positive and negative returns of the same magnitude. The maximum probability corresponds to a price return of +1.9%. The annualized volatility derived from this distribution is 33%, which is moderate for an individual stock.
I was quite surprised that the forward estimate of volatility was not higher, given the large recent drop in RIO. RIO’s volatility over the past month scales to an annualized 46% (calculated using daily closing prices). The trailing 6-month annualized volatility is 35%. Options prices suggest that the recent month’s higher volatility is an anomaly. This is a positive sign because falling volatility indicates that the market’s confidence in RIO is firming up.
To make it easier to directly compare the probabilities of positive and negative returns, I look at a version of the market-implied outlook for which the negative return side of the distribution is rotated about the vertical axis (see below).
The negative return side of the distribution is rotated about the vertical axis (Source: author’s calculations using options quotes from eTrade)
The options market assesses almost identical probabilities of positive and negative returns (the red dashed line and the solid blue line lie almost on top of one another). In theory, a neutral outlook from the options market would correspond to a somewhat elevated probability of negative vs. positive returns because risk-averse investors tend to pay more than fair value for put options which protect against losses.
A symmetric market-implied outlook, as we see here, is therefore a somewhat bullish indicator from the options market. The slightly higher probability of negative returns vs. positive for smaller-magnitude changes (from 0% to 12% in the chart above) is small enough that I don’t see it as meaningful.
Summary
Evaluating RIO, a huge metals miner and producer, depends on outlooks for metals prices, global trade and economic recovery from COVID. The analyst coverage, while limited, is bullish and the expected price appreciation for the stock over the next twelve months is about 40%.
The market-implied outlook is also moderately bullish and the expected (annualized) volatility derived from the options market is 33%, not terribly high for an individual stock. The P/E is low compared to historical levels and the dividend yield is above 9%. Income investors should remember, however, that dividends from ADRs tend to be less persistent and predictable because many foreign companies are less committed to steady dividend appreciation than U.S. firms and, of course, dividends paid by ADRs are impacted by fluctuations in currency exchange rates.
If we assume that the expected price appreciation for RIO is half what the analysts predict, a 20% expected return for a stock with annualized volatility outlook of 33% is still attractive. And, of course, there is also the substantial dividend income.
While RIO has some downward momentum going, both the equity analysts and the options market indicate a favorable view for Rio Tinto. My overall rating for RIO is bullish.
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