Iron ore operations in Western Australia's Pilbara region are affected following last week's tropical cyclone Veronica. As a result, Rio now expects FY 2019 iron ore production to come in at the lower end of its previous guidance of 338M-350M metric tons, with storm damage and an earlier fire at the Lambert A port facility causing the loss of ~14M mt of annual production.
However, we believe that the production cuts will not have any major impact on RIO's stock valuation. We expect RIO to maintain its valuation of $62 per share, driven by an earnings per share (EPS) of $5.16 in 2019 and a forward price-to-earnings (P/E) ratio of 12x.
EPS of $5.16 in 2019 is a reflection of expected net income of $8.9 billion, driven by projected revenue of $39.4 billion, and a net income margin of 22.5%.
Net income margin increased from 21.9% in 2017 to 33.7% in 2018. Such a large increase in margins reflects profits from the sale of the coal business and a few aluminum assets, lower interest expense due to the bond buyback program of 2018, higher capitalized interest, and profit from the sale of a stake in the Grasberg operations, partially offset by higher mining, exploration, and evaluation costs. We expect net income margin of 22.5% in 2019, though lower than the margin in 2018 which was bloated by non-recurring gains, but higher than in 2017. Margin growth is expected to remain robust primarily due to lower interest expense and productivity improvement.