Weak commodity prices are holding miners' feet to the fire. Lower prices are dropping straight through to sales and profits are tumbling in response. Rio pooh-poohed a merger approach from Glencore last year, so it faces particular pressure to look after its investors, having denied them a takeover premium.
The evidence so far is that Rio is delivering. CEO Sam Walsh has described Rio as a cash machine. This reflects the tens of billions sunk into boosting Australian iron ore production, which has now given Rio’s mines some of the lowest production costs on the planet. Even in today's weak pricing environment, Rio is still making healthy margins as these interims demonstrated. Cash costs for iron ore production are now as little as $16.40 per tonne in Rio’s Pilbara mines, compared with average market prices of $56 in H1, so Rio's ability to keep generating cash is not in question.
The stock has fallen with the broader mining sector and now stands at little more than half its 2011 peak level. On current consensus forecasts, Rio Tinto offers a yield of over 5.5%, but please remember this is variable and not guaranteed. Earnings are very weak, and likely to remain so, but Rio Tinto is sticking with its dividend policy. How long it has the appetite to do so, in the face of falling commodity prices is the $64,000 question.
Just as earnings expectations have fallen with weaker commodity prices, they could recover equally sharply, if those commodity prices rebound. That makes Rio an interesting recovery situation. There’s no sign of a rebound yet, but the dividend is there in the meantime.
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- Consolidated sales of $18.0bn were $6.4bn down on 2014, reflecting a $7.1bn fall in commodity values, partly mitigated by underlying volume growth.
- EBITDA margins were 38% versus 41% in the prior year.
- Underlying earnings of $2.9bn were $2.2bn lower than in H1 2014.
- Rio has achieved $600m of cost savings in H1, and feels confident to raise the planned full year target from $750m to $1.0bn. Costs are now some $5.4bn below the 2012 base level.
- Total capital expenditure fell to $2.5bn, including $1.2bn of sustaining capex, plus $1.3bn of growth project expenditures.
- Total returns to shareholders of $3.2bn.
Underlying earnings of $2.9bn after tax were driven by iron ore, which generated $2.1bn, a 55% decline. Copper and Coal earnings dipped 40% to $0.4bn but Rio benefited from 54% growth in the Aluminium contribution, to $0.8bn and a reduction in the Other Items/Exploration spend, which improved by $0.2bn.
Rio expect Chinese demand for iron ore to continue rising in the long run, but in the near term, prices are under pressure from 110m tonnes per annum of new supply. Rio believe this is leading to large quantities of higher cost production exiting the market. Rio's own iron ore production rose by 13.4m tonnes, or 11%. The buoyant market conditions in Aluminium have ceased and by the end of Q2, 40% of smelters globally were loss-making once more.
Copper demand has been weak, sufficient to compensate for slower ramp-up of new low cost supplies that are coming to market. Coal prices remain weak in the face of higher supplies, themselves enabled by earlier efficiency drives that have lowered marginal costs in the industry.
Rio Tinto expect to deliver $1.0bn of cost cuts, including lower exploration spending, with total capex declining to $5.5bn, from over $8bn in 2014. Capex of $6.0bn is planned for 2016. Sustaining capex is around $2.5bn p.a. within these totals.
Rio Tinto expects to repurchase $1.0bn of shares in the second half of the year.
The group expects commodity markets to remain weak, with new supplies of low-cost production impacting on price levels.
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