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Rio Tinto - $3.2bn share buyback confirmed

George Salmon | 20 September 2018 | A A A
Rio Tinto - $3.2bn share buyback confirmed

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No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

Rio Tinto plc Ordinary 10p

Sell: 5,839.00 | Buy: 5,841.00 | Change 48.00 (0.83%)
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Rio Tinto has confirmed it intends to return the proceeds of the sale of its Australian coal assets, $3.2bn post-tax, to shareholders via a share buyback.

This is in addition to the c. $1.7bn remaining from pre-announced and ongoing buyback plans.

The shares moved slightly higher on the news.

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Our view

Rio might technically be a diversified miner, but iron ore is really what it's all about.

It accounts for almost 60% of group EBITDA (earnings before interest, tax, depreciation and amortization) and with production costs at the flagship Pilbara mines as low as $13.40 a tonne, Rio's cost of production is incredibly low. Market prices are around $62.30 a tonne - digging up some dirt and selling it for four and a half times what it costs is an attractive proposition by anyone's standards.

Of course sensitivity to commodity prices is a curse as well as a blessing. When prices collapsed in 2015/16 Rio was forced to embark on a brutal cost cutting exercise. The situation wasn't helped by the mountain of debt on the balance sheet.

Following a root and branch review, most of the group's coal assets have been let go. Rio is now firmly focused on industrial metals (plus a smaller diamonds business) and is investing in future capacity to safeguard long term earnings.

With debts back in hand, and expenses significantly reduced, Rio is in a position to pass the benefits of higher commodity prices back to shareholders. When times are good the mining mega groups are cash machines, and the heady mix of dividends and buybacks are proof of how rewarding that can be.

The group has adopted a policy of paying out around half of earnings as a dividend every year. This should help keep the balance sheet healthy over the long term, so seems a sensible move to us, despite the implication dividends will be volatile as commodity prices shift. The shares currently offer a prospective yield of 5.5% next year.

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Half Year Results - 1 August 2018

Sales rose 3.1% to $19.9bn, with positive price movements in aluminium and copper. Increased iron ore, bauxite and copper volumes helped to offset coal disposals in Energy & Minerals business.

Underlying EBITDA (earnings before, interest, tax, depreciation and amortisation) rose 2% to $9.2bn. Iron Ore remains by far the largest contributor, with EBITDA up 1% on the previous year at $5.7bn as higher volumes offset a weaker price environment. Across the smaller divisions: Aluminium delivered EBITDA of $1.8n (+10%), with Copper & Diamonds at $1.4bn (+76%) and Energy & Minerals $1bn (-28%).

Operating costs were $392m higher in the half than a year earlier, as increased raw material costs in Aluminium and Energy & Materials more than offset efficiency and productivity gains. Productivity gains added $0.3bn to free cash flow in the half, taking the cumulative total since 2017 to $0.5bn.

The portfolio continues to be shuffled, with $5bn of disposals agreed in the first half. Rio continues to invest in selected new projects, including the Amrun bauxite mine in Queensland, Oyu Tologi copper mine in Mongolia and Resolution Copper project in Arizona.

Payment of $1.2bn in Australian taxes, increased capital expenditure, the dividend and share buyback collectively meant that net debt rose $1.4bn in the half to $5.2bn. As a result, the gearing ratio, measuring net debt as a percentage of total capital, rose from 7% to 10%.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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.