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Rio Tinto - big dividend, but operational challenges weigh

George Salmon | 1 August 2019 | A A A
Rio Tinto - big dividend, but operational challenges weigh

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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: 4,753.00 | Buy: 4,754.50 | Change 142.50 (3.09%)
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Rio Tinto's half year results show adjusted revenue rising 9% and underlying earnings before interest, tax, depreciation and amortization (EBITDA) rising 11% to $10.3bn. The interim dividend rose 18.9% to $1.51 per share, and a special dividend of $0.61 per share.

However, the group also confirmed some operational challenges, meaning productivity boosts to free cash flow are expected to be $1bn-$1.5bn a year from 2021 (previously $1.5bn).

The shares fell 2.6% 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. At the half year stage it accounted for around 70% of group cash profits as measured by EBITDA.

With production costs at the flagship Pilbara mines under $15 a tonne, Rio's cost of production is incredibly low. Average market prices were in excess of $80 a tonne on average over the first half - digging up some dirt and selling it for five 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 as demand from key growth markets like China dried up, Rio was forced to embark on a brutal cost cutting exercise. The group remained profitable, but had a mountain of debt on the balance sheet.

That debt has been reduced to much more manageable levels. Organic cash generation has played a part, boosted by a rebound in prices, and the sale of coal assets also brought in much-needed cash.

With debts back in hand and expenses significantly reduced, Rio can both invest in future capacity to safeguard long term earnings and 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 says it'll pay out around half of earnings as a dividend every year - although it's been topped up recently with specials and buybacks. As a policy it seems sensible to us, allowing Rio to flex cash expenses in line with market conditions. But potential investors should remember this also means dividends will be volatile as commodity prices shift.

The shares currently offer a prospective yield of 7.2% next year.

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Half year results

The increase in revenue and profit is attributable to the group's Iron Ore division.

Iron Ore revenue rose 21% to $11.2bn, despite output falling 8% as a cyclone, a fire and other challenges brought disruption at Pilbara and the average price of iron ore rose 35.4% to $85.30 per dry metric tonne. While staff and other operating costs increased, divisional EBITDA rose 33% to $7.6bn.

$2.6bn Koodaideri mine is progressing to plan, with first ore expected in late 2021.

Aluminium profits fell 38% to $1.1bn as a 14.7% fall in average realised prices more than offset efficiency gains. Production was stable as Alumina declines were countered by increased bauxite production.

It was a similar story in Copper & Diamonds, where the average copper price fell 11% and the diamond market remains weak. Those declines and higher evaluation spending hit underlying cash profits by $290m, EBITDA fell just $147m to $1.2bn as a result of productivity improvements.

Energy & Minerals profits fell 5% to $1bn, but this masks an underlying rise of 113% because last year included the contribution form now-sold coking assets. Price and production boosted underlying performance.

Following the distribution of $7.8bn to shareholders and a $1.2bn increase from accounting rule changes, net debt rose $5.1bn over the half, to $4.9bn.

Looking ahead, capital expenditure is expected to be around $6bn in 2019 and around $6.5bn in 2020 and 2021. At $2.5bn a year, the maintenance element of this is slightly higher than had had previously been expected.

Find out more about Rio Tinto shares including how to invest

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.