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Daily Letter | 1

19 January 2007

Rio Tinto plc


Damien Hackett 44.20.7050.6641
RIO : LSE : £25.51 HOLD ↓ damien.hackett@canaccordadams.com
Target: £26.00 ↓ Nicholas Pickens 44.20.7050.6646
nicholas.pickens@canaccordadams.com

COMPANY STATISTICS:
Recommendation: Hold
Metals and Mining -- Senior Diversifieds
12-month target price:
Price:
£26.00
£25.51
TARGET PRICE REDUCED
52-week Range: £23.52-£33.22 Event
Market Capitalization (Million): £26,081
Rio Tinto will announce preliminary financial results for the full year to
EARNINGS SUMMARY: December 2006 on 1 February 2007. We expect attributable profit
FYE Dec 2006E 2007E 2008E
excluding exceptional items of US$7,832 million (US$5.78/share), a
Sales $USM 25,963 27,366 25,154
EBITDA $USM 13,556 14,005 11,707 downward change of 3% following the release of a quarterly operations
Net profit adj. $USM 7,832 7,723 6,275 review earlier this week. We have also revised our commodity price
Free cash (1) $US/sh 5.27 6.68 5.92 forecast assumptions going forward resulting in a downgrade to our
EPS $US/sh 5.78 5.70 4.63
Dividend $US/sh 0.90 0.95 1.00 profit estimates for 2007 from US$6.05/share to US$5.70/share.
EV / EBITDA x 5.0 4.9 5.4
PER x 8.1 9.0 11.1
Action
Free cash yield % 11.2 13.0 11.5 We have downgraded our rating to HOLD from Buy, with a target price
Yield after capex % 6.8 9.2 7.8 of £26.00/share (previously £36.00). We believe investors should hold
Dividend yield % 1.9 1.8 1.9
EBITDA margin % 52.2 51.2 46.5 this stock over the near term to benefit from what we see as likely
EBIT margin % 45.4 44.3 39.0 substantial capital returns.
Gearing (2) % 1.7 -22.3 -39.7
ROE (3) % 46.4 35.1 22.6 Rationale
ROIC (4) % 33.8 29.9 23.5 In our view, Rio Tinto may have reached a peak in earnings in 2006
Price to book x 3.4 2.8 2.3
against our revised commodity price assumptions, and we believe the
1. Operating cash flow before investment and financing.
2. Net debt over total capital. momentum in earnings growth seen in preceding years is unlikely to be
3. Adjusted earnings pre exceptionals and goodwill over shareholder equity. maintained. The stock is currently trading at 9 times earnings for
4. Adjusted net income over PP & E plus working capital.
2007E while EV is priced at 4.9 times EBITDA, well below the historical
SHARE PRICE PERFORMANCE: trading range for this company based on consensus estimates of 12-
3400 month forward earnings, Figure 7. Consequently, we believe the current
3200 share price is likely to be supported by PE expansion into a period of
3000
weaker earnings - we note that the stock is priced at 15 times earnings
2800
in 2009E, indicating to us that there is room for PE expansion for the
2600
next two years back to historical mid-cycle levels.
2400

2200
Investment risks
2000
Jan-06 Mar-06 May-06 Jul-06 Sep-06 Nov-06 Jan-07
There are risks associated with metal prices not matching our forecasts
Source: Datastream and with the share price achieving our target price.
All amounts in £ unless otherwise noted.
Share price data COB 18 January 2007.

Canaccord Adams is the global capital markets group of Canaccord Capital Inc. (CCI : TSX|AIM)
The recommendations and opinions expressed in this Investment Research accurately reflect the Investment Analyst’s personal,
independent and objective views about any and all the Designated Investments and Relevant Issuers discussed herein. For important
information, please see the Important Disclosures section in the appendix of this document or visit or visit
http://www.canaccordadams.com/research/Disclosure.htm.
Daily Letter | 2
19 January 2007

Full year results preview


Rio Tinto will be announcing preliminary financial results for the full year to December
2006 on Thursday 1 February 2007 and we have updated our earnings forecasts for the
period, following the company’s recent operations results. We expect attributable profit
excluding exceptional items of US$7,832 million (US$5.78/share), or US$4,081million
(US$3.01/share) for the half year and 2% lower than the consensus1 forecast. This
represents a 3% downward adjustment to our previous forecast and would be a year-on-
year increase of 58% over earnings for 12-months to December 2005.

Figure 1: Financial summary table


FYE Dec US$ million Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06E Jun-07E Dec-07E Jun-08E Dec-08E
Group turnover US$M 6,805 7,725 9,439 11,303 12,111 13,852 13,799 13,567 12,875 12,279
EBITDA US$M 2,284 2,657 4,063 5,269 6,174 7,382 7,181 6,825 6,181 5,526
EBIT (1) US$M 1,600 1,379 3,280 4,428 5,348 6,448 6,248 5,872 5,229 4,574

Attributable profit (2) US$M 993 1,279 2,087 2,868 3,751 4,081 3,980 3,743 3,346 2,929
Attributable EPS US cents 72.0 92.8 151.9 211.6 277.0 301.4 293.9 276.4 247.1 216.3
Dividend US cents 32.0 45.0 38.5 41.5 40.0 50.0 45.0 50.0 47.5 52.0

Reconciliation US$M
Attributable profit (2) US$M 993 1,279 2,087 2,868 3,751 4,081 3,980 3,743 3,346 2,929
Exceptional items US$M 618 407 78 182 45 0 0 0 0 0
Reported profit (3) US$M 1,611 1,686 2,165 3,050 3,796 4,081 3,980 3,743 3,346 2,929
1) Figure 2 below shows divisional contribution to EBIT and includes FX translation effect 2) excluding exceptional items. 3) including exceptional
contributions and NML translation
Source: Company data, Canaccord Adams estimates

Looking further forward, we have also adjusted our 2007 earnings estimates downward
based on our revised commodity price assumptions (Figure 3). We now estimate
attributable profit for 2007 at US$7,723 million (US$5.70/share). Contributions from the
various product sector groups as shown in Figure 2.

Figure 2: EBIT by product sector group


US$ million Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06E Jun-07E Dec-07E Jun-08E Dec-08E
Iron ore 419 468 1,126 1,661 1,491 2,211 2,283 2,259 2,002 1,776
Energy 218 391 485 652 552 382 278 320 289 286
Industrial minerals 166 200 228 163 223 284 275 275 275 275
Aluminium 244 254 296 285 548 935 1,053 850 713 606
Copper 553 669 1,176 1,678 2,588 2,542 2,257 2,095 1,849 1,557
Diamonds 151 160 169 286 151 338 309 309 310 310
Other operations 24 12 14 -13 17 2 10 6 8 7
Product Group Earnings 1,775 2,154 3,494 4,712 5,570 6,694 6,463 6,115 5,446 4,816
Other items -119 -687 -149 -156 -135 -146 -140 -143 -142 -142
Exploration and evaluation -56 -88 -65 -128 -87 -100 -75 -100 -75 -100
Rio Tinto Group EBIT 1,600 1,379 3,280 4,428 5,348 6,448 6,248 5,872 5,229 4,574
Source: Company data, Canaccord Adams estimates

1
Mean IBES consensus forecasts of ten analysts provided by Bloomberg
Daily Letter | 3
19 January 2007

Figure 3: Key input variables

average for the period Dec-04E Jun-05 Dec-05 Jun-06 Dec-06 Jun-07E Dec-07E Jun-08E Dec-08E
Rand / US$ rate 0.73 0.77 0.75 0.74 0.76 0.80 0.80 0.78 0.78
A$ / US$ rate 134.5 151.0 182.6 277.4 335.0 253.8 246.3 232.5 205.0
Oil price WTI US$ / bbl 417.4 427.8 463.1 627.3 617.8 637.5 662.5 637.5 612.5
Copper price Usc / lb 80.0 83.7 88.7 115.2 118.1 122.5 112.5 105.0 100.0
Aluminium price Usc / lb 55.3 51.5 43.7 49.3 48.3 51.3 52.5 52.5 52.5
Thermal coal (1) US$ / t 57.2 91.1 125.0 119.5 114.0 105.0 96.0 86.6 86.6
Coking coal (2) US$ / t 45.9 62.3 78.8 86.3 93.7 98.2 102.6 92.4 92.4
Iron ore lump Usc / dltu 0.73 0.77 0.75 0.74 0.76 0.80 0.80 0.78 0.78
(1) Spot price from South Africa; 2) Contract price of Goonyella brand.
Source: Company data, Canaccord Adams estimates

Production review
This week, Rio Tinto released a fourth quarter operations review for the period ending
December 2006.

Iron ore production during the fourth quarter was 35 million tonnes, 2% lower compared
with the previous quarter, primarily due to the impact of maintenance activities. Year-
on-year production increased 7% to 132.8 million tonnes, reflecting expansions in
response to strong global demand. We estimate the draw on inventories at Hamersley,
Robe River and IOC in the final quarter were 2.1, 0.4 and 1.4 million tonnes respectively.

Mined copper production increased to 209,800 tonnes during the period, 15% higher
than the third quarter as a result of industrial action at Escondida. Grasberg also
benefited from access to higher grades than the preceding three quarters. Year-on-year,
total copper mined in 2006 increased by 2%, over a period that saw the average copper
price increase by 84%.

Refined copper production for the quarter was 29% lower than the third quarter mainly
Figure 4: Group EBIT 2007E
due to the effects of scheduled maintenance shutdown at the Kennecott Utah Copper
smelter. Kennecott Utah also produces molybdenum and production declined by 11%
Alum compared with the third quarter due to lower grades and recoveries.
Fe ore
17%
31% Bauxite production in the fourth quarter was 10% higher than the previous quarter due
to a high level of equipment availability and minimal plant downtime. Furthermore,
Copper
24%
production for the full year to December 2006 increased to record levels of 16.1 million
Ind min tonnes. Yarwun (the renamed Comalco Alumina Refinery) reached design capacity
10%
Energy
Diam. during the final quarter and achieved a production record for the quarter and the year.
4%
14%
Total alumina production for 2006 increased 10% to 3.2 million tonnes, while aluminium
production declined 1% to 844,700 tonnes.
Source: Canaccord estimates US coal production set quarterly and annual production records as the capacity
expansions at several mines ramped up. Production of hard coking coal declined by 12%
compared with the third quarter, attributable to lower volumes at Kestrel from operating
in the zone of a known fault line.

In other business groups, titanium dioxide feedstock production increased by 12%


compared with the previous quarter, reflecting strong demand and the successful
completion of the expansion of the UGS plant. Uranium production declined 13% year-
Daily Letter | 4
19 January 2007

on-year, largely as a result of production disruptions in the second quarter brought about
by heavy rains.

In our view, this production report highlights industry supply difficulties. Generally
Production report highlights
industry supply difficulties production increases year-on-year were modest compared to the surge in demand seen
through 2006. This relatively weak increase in production from one of the biggest and
most efficient producers underscores our belief in the sustainability of some commodity
markets. We note that in 2006, Rio Tinto delivered 11% less copper than it did five years
ago into a global market that is now demanding around 16% more2.

Rio Tinto also asserted that input shortages are maintaining cost pressures, especially in
the iron ore business. We estimate full cash costs of iron ore production have risen
steadily from US$8.70/t in the December quarter of 2003 to US$19.3/t for the December
quarter of 2006. Currently these costs have been masked by higher prices, but we
expect all producers will have a major task in front of them when, as we believe,
commodity prices weaken.

Figure 5: Key operations production report

'000 tonnes unless specified (attributable) Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07E Dec-07E Jun-08E Dec-08E
Alumina 1,201 1,489 1,474 1,633 1,616 1,737 1,737 1,737 1,737
Aluminium 419 412 447 408 442 389 389 389 389
Copper in concentrate 380 378 414 389 416 398 395 394 394
Copper cathode 795 880 895 429 563 751 768 772 772
Nickel 7,374 7,466 6,720 6,058 7,142 7,250 7,115 7,093 7,093
Zinc in concentrate 16,635 20,689 14,947 15,531 19,632 19,363 19,381 19,386 19,387
Iron ore (including pellets) 81,985 77,303 76,338 79,627 82,796 84,497 85,698 85,645 85,694
Metallurgical coal 3,186 3,051 3,533 2,507 2,918 3,150 3,150 3,150 3,150
Energy coal 290 268 292 272 282 300 300 300 300
Crude oil and condensate. '000 bbl 2,401 2,774 2,730 2,649 2,753 2,596 2,596 2,596 2,596
Total hydrocarbons '000 boe 725 689 673 726 664 699 699 699 699
Diamonds '000 cts 615 649 662 697 718 640 640 640 640
Source: Company reports, Canaccord Adams estimates

Valuation
In our view, Rio Tinto may have reached a peak in earnings in 2006 – we are estimating
US$7.8 billion (US$5.70/share) against our revised commodity price assumptions and
believe the momentum in earnings growth seen in the preceding years is unlikely to be
maintained. In our opinion, risks to the downside on our estimates are limited; only a
period of global economic slowdown substantially greater than our forecast would result
in a significant reduction in volumes and prices across the commodities. Conversely, we
believe the possibility of unexpected supply disruptions in the industry may continue to
offer upside to commodity prices and earnings forecasts.

The stock is currently trading at 9 times earnings for 2007 while EV is priced at 4.9
times EBITDA, on our estimates. These multiples are below the low end of the historical
trading range for this company based on our analysis of the share price against

2
Brook Hunt figures for global copper consumption in 2001 was 14.8Mt versus 2006E of 17.8Mt.
Daily Letter | 5
19 January 2007

consensus estimates of 12-month forward earnings, Figure 7. Consequently, we believe


the current share price is likely to be supported by PE expansion into a period of weaker
earnings – we note that the stock is priced at 15 times earnings in 2009E, indicating to
us that there is room for PE expansion for at least the next two years back to historical
mid-cycle levels.

To reflect the transition from mid-cycle to peak cycle, we have reduced our 12-month
forward earnings multiple from 14 times to 10 times and 12-month forward EBITDA
from 7.5 times to 6 times. This suggests a 12-month forward market price for the stock
of £25.70/share.

Consequently, we have reduced our target price for the stock from £36.00/share to
£26.00/share and downgraded our recommendation from Buy to HOLD.

With a free cash yield of 13% in 2007E, we expect the company to be cash rich as it was
last year. We therefore recommend that investors hold this stock in anticipation of
further returns.

Figure 7: Pricing history for Rio Tinto

35 3500
15 year average price is 14.2x 12-month forward earnings
Range shows + / - one standard deviation from mean PE

30 3000

25 2500

20 2000

17.4

15 1500
14.2

11.1
10 1000

5 500
Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06

Rio Tinto plc 12-month forward PE (LHS) Mean PE Rio Tinto plc share price in pence (RHS)

Source: Company reports, Datastream

Our NPV for the stock now stands at £27.17/share based on the 1,354 million shares on
issue, with cash flow discounted at 9% per annum (RFR at 4% per annum, MRP at 5%
per annum and beta of 1.0) and with terminal growth rates across all the business of
3.5% per annum.
Daily Letter | 6
19 January 2007

Investment risks
There are risks associated with the share price achieving our target price and our
financial forecasts.

In our opinion, risks to the downside on our estimates are limited; only a period of global
economic slowdown substantially greater than our forecast would result in a significant
reduction in volumes and prices across the commodities. Conversely, we believe the
possibility of unexpected supply disruptions in the industry may continue to offer upside
to commodity prices and earnings forecasts.

In addition, metal prices may not match our forecasts; as with any mining company,
there are operating risks involved in both underground and open pit mining operations;
foreign currency exchange rate fluctuations will impact both the company’s operating
costs and its revenues. There are also numerous technical and environmental risks
associated with the operation of a mining company that could have an impact both upon
the company’s valuation and our financial estimates.
Daily Letter | 7
19 January 2007

APPENDIX: IMPORTANT DISCLOSURES


Analyst Certification: Each authoring analyst of Canaccord Adams whose name appears on the front page of this investment
research hereby certifies that (i) the recommendations and opinions expressed in this investment research
accurately reflect the authoring analyst’s personal, independent and objective views about any and all of the
designated investments or relevant issuers discussed herein that are within such authoring analyst’s coverage
universe and (ii) no part of the authoring analyst’s compensation was, is, or will be, directly or indirectly,
related to the specific recommendations or views expressed by the authoring analyst in the investment
research.

Site Visit: An analyst has not visited the issuer's operations in the last 12 months.

Price Chart:*

* Price charts assume event 1 indicates initiation of coverage or the beginning of the measurement period.

Distribution of Ratings: Coverage Universe IB Clients


Global Stock Ratings Rating # % %
(as of 1 January 2007) Buy 292 55.6% 43.2%
Speculative Buy 64 12.2% 65.6%
Hold 147 28.0% 30.6%
Sell 22 4.2% 9.1%
525 100.0%

Canaccord Ratings BUY: The stock is expected to generate risk-adjusted returns of over 10% during the next 12 months.
System: HOLD: The stock is expected to generate risk-adjusted returns of 0-10% during the next 12 months.
SELL: The stock is expected to generate negative risk-adjusted returns during the next 12 months.

“Risk-adjusted return” refers to the expected return in relation to the amount of risk associated with the
designated investment or the relevant issuer.

Risk Qualifier: SPECULATIVE: Stocks bear significantly higher risk that typically cannot be valued by normal fundamental
criteria. Investments in the stock may result in material loss.

Canaccord Adams Research Disclosures as of 19 January 2007


Company Disclosure
Rio Tinto plc None
Daily Letter | 8
19 January 2007

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Daily Letter | 9
19 January 2007

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Daily Letter | 10
19 January 2007

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