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Rio Tinto - Canadian and South African facilities shut

Nicholas Hyett, Equity Analyst | 24 March 2020 | A A A
Rio Tinto - Canadian and South African facilities shut

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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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Changes to quarantine rules in Canada and South Africa have led Rio Tinto to minimise activity and shutter its facilities in both countries. That will impact production, although Rio has yet to give details of the likely impact.

The shares rose 4.8% in early trading.

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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 last year.

With production costs at the flagship Pilbara mines under $15 a tonne, Rio has the potential to produce at incredibly low costs. Average market prices are currently in excess of $80 a tonne - 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. Since then debt has been reduced to 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.

That's just as well because we suspect conditions are about to get an awful lot tougher.

Demand for industrial commodities, like iron ore, rises and falls with the economic cycle. The coronavirus outbreak looks certain to spark an economic slowdown, even if we do avoid a painful recession. That will impact demand, potentially hitting prices. So far the iron ore price has actually held up surprisingly well. But as reduced demand starts to feed through the supply chain we worry that might not be sustained.

It doesn't help that lockdowns in producing countries looks set to hit production. Lower production being sold at lower prices has the potential to decimate revenues and profits.

There is a glimmer of light at the end of the tunnel though. China makes up just over 70% of global Iron Ore demand and a sizable slug of global commodity demand generally. Chinese industrial output plunged over the first few months of this year, but now seems to be slowly rumbling back into action. Whether that can be sustained remains to be seen, but it's a relief nonetheless.

It's still too early to say just what the impact on global commodity prices will be, but in our opinion Rio's profits will be hit. This is important because the group says it'll pay out around half of earnings as a dividend every year. If profits fall dividends will too and, as Rio's policy allows it to flex in line with market conditions, even this is by no means guaranteed.

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Full year results (26 February 2020)

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.

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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