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Rio Tinto - Profits Halve, Dividends to Follow

Steve Clayton | 11 February 2016 | A A A
Rio Tinto - Profits Halve, Dividends to Follow

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Rio Tinto plc Ordinary 10p

Sell: 4,529.50 | Buy: 4,531.00 | Change -47.50 (-1.04%)
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Rio Tinto's 2015 full year results show a sharp fall in profits due to lower commodity prices. The company announced further multi-billion dollar cuts to operating budgets and capital spending plans. Rio Tinto maintain the full year dividend for 2015 at 215 US cents per share, but say the current level of dividend payments will constrain the business and that a more flexible policy is appropriate going forward. The full year payment for 2016 will be not less than 110 US cents per share.

The shares reacted badly, in a weak wider market, falling over 8% in early trading.

Underlying earnings fell 51% to $4,640m (2014: $9,305m) and after impairments, a loss of $866m was declared. Capex fell from $8.1bn to $4.7bn and debts rose by $1.3bn to $13.8bn, leaving the gearing ratio at 24% (2014: 19%), still within the company's 20-30% target range. Lower commodity prices led to turnover falling from $47.6bn to $34.8bn and EBITDA margins were squeezed from 39% to 34%.

Operating cash costs were managed down by $1.3bn, taking the total annualised cost reduction since 2012 to $6.2bn. Net cash generated from operations fell 34% to $9.4bn (2014: $14.3bn) and Rio Tinto managed to reduce working capital to generate a further $1.5bn. Operating costs will be reduced by $1.0bn in 2016 and again in 2017, whilst capex falls further, to $4bn in 2016 and $5bn in 2017, an overall reduction of $3bn compared to previous plans.

Rio Tinto returned a total of $6.1bn to shareholders in 2015, taking the five year total to more than $25bn. A dividend of 110 cents, assuming no further buy backs, will reduce the 2016 run-rate to $2.0bn. Rio's revised dividend policy is to pay out between 40% and 60% of underlying earnings over the cycle, taking into account recent results, the commodity outlook, longer term growth expectations and the objective of maintaining a strong balance sheet.

Underlying earnings fell for each of Rio Tinto's product groups, with Aluminium the most resilient, down 6% to $1.1bn and copper and coal the hardest hit, down 67% to $0.3bn. The giant iron ore business, which accounts for most of the group's income, saw underlying earnings halve to $4.0bn.

Rio Tinto say that high-cost marginal supplies of commodities are exiting, across most of their markets, but at a modest pace, unlikely to have a strong positive price impact in the short term. Macro-economic risks abound, but Rio believe the longer term demand prospects remain positive and will in time support a recovery from the current cyclical low phase.

Our view:

Rio Tinto spent the last few years promising that even in tough times, the company could be a "cash machine" paying out large sums to shareholders. Clearly they did not see the depth of the cyclical slow down in front of them. The announcement of a rough halving of future dividends is reality's brusque arrival in the boardroom.

The future policy could be roughly translated as "we'll pay out about half of what we make, working out what's affordable, year by year, with one eye on the economic weather forecast". That seems sensible; committing a cyclical business to paying out the same, or more each year than the last can only work when the cycle is moving upwards. As Rio found out.

Their management of costs has been exemplary; both opex and capex have been sharply curtailed in response to the downturn, but production volumes have risen. When the cycle turns up is another matter. Big producers like, Rio Tinto themselves, BHP Billiton, Vale of Brazil and Australia's Fortescue Mining, are still raising production, offsetting the beneficial impact of higher cost mines shutting down. It could be some time before supply and demand reach balance, allowing the cycle to turn up once more.

In the meantime, even after the dividend cut, Rio, at a current price of 1615p is offering a yield of around 4.7%, so far have its shares fallen. The company have said they intend to pay at least 110 US cents this year, and they presumably will not want to cut two years in a row. Rio is likely to make less in 2016 than it did in 2015, given commodity price falls; consensus suggests profits will fall over 40% leaving net income after tax at just $2.5bn.

Such a fall would leave a 110c dividend covered just 1.25x, which means Rio's dividend payments will remain under question, especially if commodity prices stay on the floor. So after all the huffing and puffing, the protestations and the arguments, Rio have put themselves back into the position of offering an attractive yield, the sustainability of which is uncertain, making the stock little more than a play on the iron ore price, which may, or may not recover, somewhere down the line.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.