RBC upgrades Rio Tinto but target price remains on downside

Rio Tinto shares have been upgraded by analysts at RBC Capital Markets after the miner adjusted its dividend policy.

RBC, which upgraded to a 'sector perform' rating from previous 'underperform', said Rio changing its dividend policy has allowed the company to not only re-secure the balance sheet, but to also opened up optionality through the potential to use financial distress in the wider industry to their advantage.

"The insulation of the balance sheet should see long-term investors more willing to wait out the down cycle and also removes potential for further cash crunch," the broker said, writing before the company on Tuesday confirmed the sale of its Bengalla coal interests for $617m.

There is also potential for some unwelcome volatility in the payout, RBC's analysis suggests that "material free cash beyond the policy should give income investors more confidence" than the forecast 2017 3.1% dividend yield indicates, although of course this could be reduced by any M&A and associated capex.

Rio remains beholden to iron ore prices and, although there are likely to see numerous false dawns prior to a fundamental recovery in iron ore, such as the current actions by Chinese policymakers, the underlying medium-term supply/demand disequilibrium remains unfavourable for pricing.

Now that the balance sheet has become secured, RBS sees Rio as likely to enjoy a "modest" valuation uplift through the cycle.

"We highlight that spot analysis, especially in this volatile environment, can lead to rapidly changing relative metrics, but for now we see RIO and BHP in a more equivalent position following Rio's dividend cut."

A price target set at 1,800p is roughly 5% below the FTSE 100 miner's closing price on Monday.