Steady as she goes

Last week, Rio Tinto (NYSE:RTP) announced a solid September quarter production report in our view. Once again the focus was on the company's two key commodity earners, iron ore and copper, which currently generate 75 percent of revenue. Iron ore production was the second-best ever, whilst the copper business performed soundly. Going forward, the acquisition of Alcan will help Rio diversify their earnings base away from the current reliance on these two commodities.

"We believe Rio's September quarter report was a solid one at a time of great cost and infrastructure pressures."

From a technical perspective, buoyant investor support has been a key feature of Rio over the past two months. As evident on the daily chart, following a correction between July and August, prices have rallied strongly to achieve a new all time high of $375.79, extending the longer-term upward trend.

After rallying by as much as 69 percent in just two months, the upward trend of any stock would be at risk of pausing for consolidation and Rio is no exception. However, we believe that any such pause will be relatively short-lived with support located at $325.56 limiting initial downside risks, ahead of additional support at $290.28.

Following the production update, reaction was mixed. However, we believe the report was solid, with particularly good performances from the two key commodity earners, iron ore and copper. In our opinion, the overall negative market reaction to the production result was unjustified.

There were in fact numerous highlights. Near-record iron ore production and shipments were achieved during the quarter, and Australian production was 11 percent ahead of 2006 for the first nine months of the year. This is despite two derailments which impacted output during the most recent quarter.

Elsewhere, on the iron ore front, Yandicoogina's capacity of 52 million tons per annum was reached during the third quarter, making it the largest single iron ore mine in Australia. Meanwhile, the Hope Downs development of a 22 million ton per annum mine and related infrastructure is nearing completion.

There was also good news on the metals front. Production of refined copper was 30 percent above the same quarter last year when the Kennecott Utah Copper smelter was shut down for scheduled maintenance. In addition, higher gold grades at Grasberg contributed to a 35 percent increase in Rio Tinto's share of mined gold production compared with the same period last year.

But there are operational challenges. Margins in the Pilbara region of Western Australia remain under pressure due to continuing increases in contractor and other mining input costs.

Meanwhile, the infrastructure challenges of congested ports and railways in Queensland and New South Wales continued to impact hard coking and thermal coal production on Australia's east coast.

However, an investment program by owners and operators of coal ports on the eastern seaboard of Australia is expected to increase capacity from the second half of 2008.

Now looking at aluminium, following the successful $38 billion bid for Alcan, Rio will take the role as the world's biggest aluminum producer. Aluminum will account for more than 30 percent of the enlarged group's 2008 earnings, up from only 9 percent in 2006. The acquisition could add as much as 7 percent to Rio's total earnings next year.

We believe the outlook for aluminium is extremely rosy, with the potential for it to significantly outperform other metals. This is of course critical to Rio and goes a long way towards explaining its generous knock-out bid for Alcan.

Rio was criticized by some in the market for overpaying, but at the time we strongly disagreed and still maintain our view. China, the world's largest consumer and producer of aluminium, is set to become a net importer of the commodity over coming years, as its demand exceeds production.

Aluminium trails base metals such as copper, lead and tin this year, as the metal price has declined by around 9 percent, but we believe it will outperform these commodities over the next few years.

The company's pre-tax expenditure on exploration and evaluation also remained robust through the first nine months of 2007, nearly doubling to $348 million versus $175 million last year.

And from a valuation perspective, Rio remains on a very modest price to earnings multiple of 13 times 2008 consensus earnings estimates. This compares favorably in our view to growth stories in the industrial sector which are on price multiples twice this level.

Back to the charts, and given the resilience of the broader upward trend, we believe the outlook for Rio remains outstanding. In the coming months, we expect to see prices continue above $375.79 to new all time highs.

Accordingly, Rio Tinto will remain firmly held within the Fat Prophets Portfolio.

*Disclosure: Interests associated with Fat Prophets declare an interest in Rio Tinto*