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Rio Tinto Video


 

Stock Of the Day  - Rio Tinto (HOLD)

Rio Tinto’s (RIO) recent announcements on full year results 2014 with regards to increasing the dividends by 12% to US$2.15 per share and buy-back of US$2 billion over the next one year have been received as healthy signs to survive and sustain in a troubled commodity price environment. This amounts to a total cash return of about US$6 billion to the shareholders. The volume increase along with cost reduction have enabled RIO realize underlying earnings of US$9.3 billion. The EBITDA margin has been maintained at 39%. The Company reported for consolidated sales revenue of US$47.7 billion with a US$5.4 billion (pre-tax) decline in pricing partially offset by $3.0 billion from higher volumes. The net debt has been reduced by US$5.6 billion to US$12.5 billion. About US$4.8 billion of sustainable operating cash cost improvements and exploration and evaluation savings were achieved.


Financial Results (Source – Company Reports)

There was an impairment charge of US$1.2 billion with regards to the Kitimat project reported at the half year which was mostly offset by a reversal of $1.0 billion in 2H14 related to a raise in carrying value for the Pacific Aluminium business. The Company also reported for production records for Iron ore and Hunter Valley thermal coal, while illustrating a solid operational performance in Bauxite, Copper and Aluminium. A key contributor to the earnings was the Aluminium division’s higher than RIO compiled consensus earnings. This division in particular had earnings which more than doubled to US$1,248m in 2014 and this rise is expected to continue into 2015. The Bauxite business witnessed a 38% EBITDA margin. Iron ore capex continued to be delayed. Further, Kitimat is progressing well for first production expected by the end of 1H CY15. There was an improvement noted for free cash generation for 2H Copper to >$200mn. However, this was still little lower than what the market expected.

As per RIO’s 2015 guidance, focus will be on cash generation and sustainable returns with further cash cost improvements of $750 million to be realised in 2015. The Company also expects that the capital expenditure is dropped to less than $7.0 billion in 2015 and is contained at around $7.0 billion in 2016 and 2017. It has also been stated that the Company is streamlining its product groups and corporate functions in view of managing efficiency and costs. As per this step, RIO’s asset portfolio is planned to be categorized under four product groups, namely, Aluminium, Copper and Coal, Diamonds and Minerals, and Iron Ore. Diamonds and Minerals product group will include Uranium.


Underlying Earnings (Source – Company Reports)

The Company restated its guidance of 330mt from the Pilbara in 2015. However, a delay in decision on the greenfield 20mtpa Silvergrass iron ore mine until 2016 has been indicated. Further, for Silvergrass, the growth is not sustaining capex.

Robust Product Group Earnings and Cash Flows (Source – Company Reports)

Oyu Tolgoi inventory has been reported to be normalized but more is expected from mineral sands. Rio also looks little concerned that the Company lacks the asset position with regards to Uranium as otherwise desired while indicating that Ranger 3 Deeps suffers a challenge of developing the mine and getting a return before the expiration of the mining rights in 2021.


Diamonds & Minerals: Delivering Free Cash Flow (Source – Company Reports)

The Company has also indicated risks to iron ore relative to other commodities. China domestic steel consumption has been down 1.7% in 2014 and 8% in December 2014 in comparison to that of December 2013. In fact, iron ore supply is stated to be rising at 11% while there is insignificant Chinese steel production growth. The outlook is thus highly hooked on to the outlook for the iron ore price as RIO’s iron ore business backs about 80% of RIO’s EBIT. Income growth of developing nations such as China based on its contribution to revenue, will have a high impact. The earnings are thus expected to be generally flat year on year into 2016 with commodity prices stabilizing. As of now, it may look difficult to get attracted to the commodity mix for RIO wherein challenged commodities such as iron, aluminium and coal contribute to a large portion of sales in comparison to other peers such as BHP and Glencore. As a combating means, the Company is being whispered to strike production costs to less than $US15 a tonne within 18 months owing to the waning iron ore prices. Auxiliary effects relate to cutting of jobs from RIO’s iron ore division in Western Australia which has also led the Australian Workers' Union demanding for a parliamentary inquiry into the “cartel-like” conduct of RIO. Another tiff relates to the court action with regards to owing of $205 million in bank bonds in collapsed mining services firm Forge Group.


RIO Daily Chart (Source - Thomson Reuters)
 
Based on the foregoing, we put a HOLD recommendation for this stock at the current price of $65.60.