Rio Tinto, recognized as the world’s second-largest mining company, is on the verge of expansion with its recent $6.7 billion purchase of Arcadium Lithium. This strategic acquisition positions Rio Tinto in a market projected to grow at a compound annual rate of 10% through 2040. However, analysts express uncertainty regarding future lithium prices, raising questions about whether this move represents a strategic investment or a potential miscalculation that could adversely affect its share value.

Headquartered in London and Melbourne, Rio Tinto primarily generates revenue from iron ore extraction in northwest Australia. Last year, iron ore constituted 60% of the company’s $54 billion in sales, driving significant free cash flow and allowing for robust dividend distributions. The company’s vast portfolio also includes other metals such as copper, aluminium, and lithium.

This year, attention has largely focused on Rio’s competitors, BHP and Anglo American, yet Rio Tinto has been steadily enhancing its copper assets and bolstering its high-grade iron ore production for low-carbon steel manufacturers. An update released on Wednesday highlighted that its iron mines produced 84.1 million metric tons in the third quarter, reflecting a 1% year-on-year increase and a 6% rise from the previous quarter.

Aside from iron, Rio Tinto is expanding its footprint in metals that facilitate the transition to clean energy. Recently, the company revealed it would take over Arcadium Lithium for $6.7 billion, a move that includes a 90% premium on Arcadium’s share price prior to acquisition discussions, and a 39% premium just before the official offer announcement.

Although the acquisition price is significant, strengthening its position in lithium aligns with Rio Tinto’s strategy to serve the battery production market. This move builds upon its existing lithium involvement through the Jadar project in Serbia, which has faced delays due to social and political pressures. Moreover, Rio acquired the Rincon lithium project in Argentina for $825 million in 2022.

The timing of the Arcadium acquisition seems tactical, as lithium prices have struggled since 2022 due to a decline in battery demand caused by delays in energy transition efforts and slower-than-anticipated electric vehicle adoption. Rio’s counter-cyclical approach indicates lessons learned from its earlier $38 billion acquisition of Canadian aluminium company Alcan, made during a market peak in 2007.

The integration process is expected to be seamless since Arcadium operates in regions where Rio Tinto already has a presence. The acquisition is projected to yield an annual production of 75,000 tons of lithium carbonate equivalent, with expectations for this output to more than double by 2028.

A major attraction for investors in Rio Tinto shares is the historically high dividend yield, averaging 7.5% over the past five years. Current dividends have receded from the record highs of 2022, yet a forward yield of 6% remains appealing compared to the FTSE 100 average of 3.6%. It’s important to note that Rio’s share price has decreased nearly 10% this year, influenced by lower iron ore prices.

Previously rated as a hold, Rio Tinto shares have produced just under 7% returns over the past year, outperforming BHP Group, which has shown minimal positive traction. As is common with the mining sector, investing in Rio carries risks, particularly from environmental and social angles. Nevertheless, it presents an increasingly diverse portfolio with substantial asset returns and generous cash payments. While investment in lithium represents a long-term strategy amid an evolving energy landscape, the company’s robust dividend offers some reassurance for patient investors.

Recommendation: Buy
Rationale: A diverse mining entity with significant long-term growth potential.

BlackRock Energy and Resources Income Trust
The BlackRock Energy and Resources Income Trust presents a diversified investment avenue in global mining strategies, and despite its relatively steep net asset value, it could provide good value opportunities.

As of late August, Rio Tinto was the trust’s largest holding, making up 4.4% of its total assets, followed by Anglo American at 4% and New York-listed Teck Resources at 3.6%. The trust allocates around 20% of its portfolio to diversified miners with various metal assets, emphasizing copper mining at 6.5%.

Since its strategic shift in focus towards supporting the renewable energy transition in mid-2020, approximately 29% of the trust’s investments now support this transition, mirroring its exposure to traditional energy sectors.

Following the new strategy, fund managers Tom Holl and Mark Hume have achieved commendable returns related to the themes they invest in, with a total return of 145% since the strategy’s implementation, in contrast to the MSCI World Energy index’s 111% and the S&P Global Clean Energy index’s 7%. Over the same timeframe, the FTSE All Share accumulated a total return of 46%.

The fund trades at a 9% discount to its net asset value, showing a positive trend compared to the average 12-month discount of 10.8% among similar trusts focused on commodities and natural resources. Although the fund’s performance has seen fluctuations in the past year due to commodity market volatility, its historical returns suggest the new investment strategy is showing promise.

Recommendation: Buy
Rationale: Comprehensive access to mining and energy firms at a favorable discount.

[email protected]