Huntleys' Stock of the Week

Recommendations: Buy

RIO's current stock prices

BHP and RIO Head to Head

Investment Rating:

RIO is a diversified global resource leader with a portfolio of world class assets in aluminium, coal, copper, diamonds, gold, iron ore, industrial minerals and uranium. A top three miner behind BHP and sometimes Vale. Operations span six continents but sovereign risk is low with most assets in Australia, the US, Europe and Canada. The balance sheet is weakened by Alcan. Continued robust operating cash flows or up to US$15bn of planned disposals are needed to bring debt under control. RIO is generally a well managed resource exposure but given debt, may not be suitable for conservative investors in the current climate. Management's rejection of BHP's mega merger was a mistake. A proposed US$19.5bn strategic partnership with Chinalco is a hotly debated near term fix but detracts longer term.

Event:

• The current state of play sees RIO with a market capitalisation of US$47bn, around one third of BHP's US$137bn. This is a far cry from May last year when market cap was over US$147bn, equivalent to three quarter's BHP. Then everything was going along swimmingly. It's amazing what a decline in product prices can do to a lower margin business with debt. RIO had over US$40bn net debt at end December with Alcan on the ropes due to global aluminium oversupply. That combination equates to leverage, both to the upside and down. Unfortunately for RIO it's currently getting downside to the point of seeking the devil as a bed fellow. Chinalco is a major competitor and customer. We see little long term upside in such a union, either for RIO or any number of other resource industry players, BHP included.

Impact:

• We retain our Buy recommendations on both BHP and RIO. RIO is relatively cheaper based on our commodity and currency forecasts. Although this is just one scenario. Downside to these estimates would leave RIO overwhelmingly more exposed than BHP. Note the "High" business and share price risk ratings for RIO, unchanged from our last report, versus "Medium" for BHP. Conservative and longer term investors should favour BHP. We have made modest downgrades to valuations and near term earnings forecasts for both companies based on the JFY09 thermal and coking coal settlements. Thermal came in around US$70/tonne versus our US$80/tonne forecast. Coking coal was US$129/tonne versus our US$150/tonne forecast. These are 44% and 57% falls respectively from JFY08. We await the iron ore settlement with interest - with any luck our forecast 50% decline may prove overly negative.

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