Learn To Love What Wall Street Hates

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One of my favorite places to hunt for dividend stocks is among the companies Wall Street is avoiding—and chiefly among these, at the moment, are materials stocks. Wall Street is fearful a deep recession will hurt demand for materials, especially industrial metals, so it keeps selling off these companies’ stocks.

Meanwhile, Wall Street is also totally ignoring reports of potentially massive shortages of industrial metals, recession or not. The news—as with so much financial news lately—comes out of the U.K.

That creates a nice opportunity for us…

 

 

Russian Metal Ban

We’re all familiar by now with the fact that Russian energy exports have been put on a blacklist, resulting in higher oil and natural gas prices.

But now, the London Metal Exchange (LME)—the world’s largest market in standarized forward contracts, futures contracts, and options on base metals—is facing pressure from many traders to stop accepting Russian metal. The fear is that LME warehouses will become a stockpile for unwanted material, distorting global prices for commodities like aluminum and copper.

The LME plays a critical role in the daily functioning of the global industrial metals market, supplying metals when there is a shortage or taking metals into its warehouses when there is an oversupply.

The Financial Times reports that metals consumers are now saying to the LME: “Your contract is not fit for us at the moment, we are self-sanctioning Russian material, we don’t want to dip into the LME warrant pool and pull out a warrant for Russian material.”

If the LME continues to accept unwanted Russian material into its warehouses while many of its users shun it, there could be an oversupply of unwanted base metals. The effect would be that LME prices would reflect the glut of cheap, unwanted Russian metal it holds and not the everyday price charged in real-life deals that happen directly between producers and consumers.

Many private deals already include a premium on the price for transactions that do not include metal supplied from Russia. For example, Chile’s Codelco—the world’s top copper producer—is selling its metal for $235 per ton above the LME benchmark three-month contract.

If this mismatch continues, it will undermine the LME’s role as a marketplace that sets a fair and accurate global market price for industrial metals.

In addition to the LME, the Biden administration is also considering whether to target Russian aluminum through a U.S. ban, raising tariffs, or putting sanctions on Rusal, the largest Russian producer of aluminum.

Any U.S. sanction on Russian exports of aluminum (used in aircraft, weapons, vehicles, cans, etc.) would have far-reaching implications for global metals trading and also be inflationary.

 

Aluminum’s Time to Shine?

If there is no ban, but “self-sanctioning” becomes more widespread in 2023, we could see prices for Russian metals fall and the LME warehouse stockpiles keep rising, as it is the market of last resort.

However, aluminum is a different story than copper or nickel, which is already banned by the LME.

Russia contributes around 8% of global aluminum supply, and also exports lots of its precursor materials, bauxite and alumina. In the past, Russia had supplied up to three-quarters of LME aluminum warehouse stocks, so a full ban on its metals would certainly cut the metal available on the exchange.

Of course, the LME is hoping the White House acts, taking the decision out of its hands. But whichever entity takes action first, it will be good news for one company whose CEO recently said Russian aluminum should be banned.

 

Rio Tinto

That company is Rio Tinto Group (RIO), which is the only major mining company in the world that has a significant aluminum division. In fact, aluminum was its second-highest earner in terms of underlying cash profits in the first half of 2022, only behind iron ore and ahead of copper. A ban on Russian aluminum would boost Rio Tinto even further, thanks to its major aluminum operations in Canada. (The company bought Canada’s aluminum giant Alcan back in 2007.)

Of course, there is a lot more to Rio Tinto than aluminum. I like the fact that the company is also investing with a focus on the longer-term. On October 11, Rio Tinto announced that it will modernize its Sorel-Tracy site in Quebec to bolster the supply of minerals controlled by China, while reducing emissions at the site by introducing a new smeltering technology.

The company will start producing titanium metal and quadruple its scandium oxide output to 12 tons annually at the site. These materials are essential to aerospace, medical products, and fuel cells. Currently, China produces three-quarters of finished titanium products and 61% of scandium globally.

In addition, Rio Tinto has bid to take full ownership of Canadian miner Turquoise Hill (TRQ) for $3.3 billion, which would give it greater control over the vast Oyu Tolgoi copper mine in Mongolia. Turquoise Hill holds 66% of the Oyu Tolgoi project, one of the world’s largest known copper and gold deposits, located in the Gobi desert. The Mongolian government owns the remaining stake.

And don’t forget that Rio Tinto has a large portfolio of long-lived assets with low operating costs, meaning it is one of few miners that will remain profitable through the commodity cycle. Plus, most of its revenues come from operations located in the relatively safe havens of Australia and North America.

Rio Tinto’s balance sheet is sound, and I expect the company to run a relatively conservative balance sheet for the foreseeable future. I love the management’s focus over recent years on returning excess cash to its shareholders. In July, Rio Tinto management said it would pay a semi-annual dividend of $4.3 billion ($2.67 per ADR), or 50% of underlying earnings. That was the second-highest half-year payout on record, in line with the company’s dividend policy.

I believe Rio Tinto’s capital discipline will continue, the balance sheet will remain sound, and distributions to shareholders will remain generous (although the current 12.65% yield will drop), even if metals prices like iron ore weaken.

That makes Rio Tinto a buy anywhere in the $50s.


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