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Rio Tinto - Iron Ore price boosts profits

Emilie Stevens, Equity Analyst | 26 February 2020 | A A A
Rio Tinto - Iron Ore price boosts profits

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Rio Tinto plc Ordinary 10p

Sell: 4,167.50 | Buy: 4,170.00 | Change 0.00 (0.00%)
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Full year revenues rose 6.5% to $43.2bn, buoyed by a rise in Iron Ore prices, with underlying EBITDA (earnings before interest depreciation and amortisation) rising 16.9% to $21.2bn.

A final dividend of $2.31 was announced, taking the full year dividend to $4.43, equivalent to 70% of underlying earnings.

The shares fell 1% 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 - accounting for three quarters of cash profits this year

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.

However, depending on how the coronavirus epidemic pans out the machine could come under strain over the next year. China makes up just over 70% of global Iron Ore demand and a sizable slug of global commodity demand generally. If that knocks global commodity prices, Rio will inevitably suffer.

That's important because the group says it'll pay out around half of earnings as a dividend every year. If profits fall dividends will too. The policy seems sensible to us though, allowing Rio to flex cash expenses in line with market conditions.

The shares currently offer a prospective yield of 6.7% next year.

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Full year results

Iron Ore revenues rose 29% to $24.1bn with underlying EBITDA rising 41% to $16.1bn. Robust Chinese demand together with constrained seaborne supply meant average Iron Ore prices were 37% higher at $85.9 per tonne. This increase more than offset a 3% drop in production and unit cash costs rising to $14.4per tonne (2018: $13.3 per tonne).

Aluminium revenues fell 15% to $10.3bn with underlying EBITDA declining 26% to $2.3bn - driven by a 15% decline in aluminium price. These results were somewhat offset by higher bauxite sales and lower operating costs.

The Copper & Diamonds division saw revenues fall 10% to $5.8bn with underlying EBITDA falling 25% to just over $2bn. This largely reflects a 7% decline in the average copper price. Both Copper and Diamond production volumes fell over the year reflecting lower quality output.

Energy & Minerals revenue fell 6% to $5.2bn and underlying EBITDA declined 18% to $1.8bn. However, excluding the impact of coal assets which were sold in 2018, profits rose 41%. Production and price improvements in titanium dioxide and iron ore pellets boosted results.

Free cash flow finished the year 31% higher at $9.2bn. This reflects a significant increase in cash generated by operations - largely thanks to higher Iron Ore prices, while capital expenditure remained stable at $5.5bn.

Increased returns to shareholders, and a change in accounting rules meant net debt finished the year at $3.7bn. That's up from a net cash position of $255m last year which was boosted by disposals.

Looking ahead, Rio expect stable economic conditions but are still evaluating any impact of the coronavirus. Next year's Iron Ore shipment is expected to be between 324 - 334 metric tonnes, that's similar to this year's levels but down from previous guidance due to cyclone disruption in Australia. Capital expenditure is expected to be around $7bn, a little less than a third is maintenance spending.

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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 disclosure for more information.