RBC Capital upgrades Rio Tinto to 'top pick'

RBC Capital Markets has upgraded Rio Tinto to 'top pick' from 'outperform', saying the stock is as inexpensive as it's been over the past five years following the recent pullback.

"We believe the market is taking too negative a view on the medium-term iron ore market, and this is obscuring a growing, low cost, high free cash flow story," RBC said, adding that Rio's low-cost operations, strong balance sheet, and potential for increased cash returns should see the market tighten the valuation over the coming months.

The Canadian bank pointed to a sustained recovery in iron ore prices as a possible catalyst for the stock. It argued that if prices rise or remain at current levels, there is a big change for consensus earnings upgrades and a further re-rating alongside a reduction in balance sheet risk. It also argued that Rio's valuation is likely to improve once general sentiment around China improves.

However, if iron ore prices were to fall, this would hit Rio as the concentration in cash flow generation in iron ore leaves the company exposed to falling prices.

In addition, RBC pointed to risks from US/EU steel tariffs on China, which could cause a drop in Chinese steel production. "Chinese steel demand is crucial to Rio Tinto's business model; should tariffs arrive or productive capacity be removed as part of China's rebalancing, this would pressure estimates."

RBC maintained its 4,400p price target on the stock.

At 1000 BST, the shares were up 1.3% to 3,142p.