Rio Tinto Shells Out $3.7 Billion To Catch Up In Iron Ore

Mining giant Rio Tinto (NYSE:RIO) doesn’t seem to be deterred by weak iron-ore prices as it has approved a $3.7 billion iron-ore expansion to its Pilbara mine in Australia. The company intends to ramp up its annual production capacity up to 353 million metric tons by 2016 from current 230 million metric tons. The total capital expenditure would be close to $5.2 billion, of which Rio will contribute $3.7 billion and the rest will come from other joint venture partners. ^[1]

Rio Tinto had earlier invested more than a billion dollar in Pilbara mainly on fuel and power supply projects to develop a sustainable water supply using coastal water. Below we take a look at how this could impact the company, which has been grappling with a slowdown in China’s economic growth and European debt situation, along with other miners like Vale (NYSE:VALE) and Freeport McMoran (NYSE:FCX).

See full analysis for Rio Tinto here

Rio Tinto believes that its iron-ore shipments can rise by more than 50% by 2015, with demand primarily coming from developing countries like India and China. While iron-ore prices have come down to about $135-$140 from as high as $200 last year owing to slowing construction activity in China, the company still produces the commodity at one-fourth the current price. We believe, in the long term, the company’s move will create more value for shareholders given the fact that it enjoys hefty margins on the commodity compared to other minerals and metals.

Further, the company has a competitive advantage with its cost of production being much lower than other small miners and new entrants. If iron-ore prices continue to remain weak, in line with our expectation, new entrants and iron-ore producers from China and India will find it difficult to sustain lower prices. With the expansion, we believe the company will be well-positioned once the current slowdown in the global commodity market passes. However, we expect the near-term weakness to persist.

Rising Costs Could be a Concern

However, one should closely keep a watch on the alarming rise in mining costs. Rising energy prices, labor and some other input costs are largely to blame. This coupled with weak iron-ore prices could lead to further fall in EBITDA margins than we currently anticipate. Nevertheless, the company is taking steps such as investing in developing basic resources to carry out the mining operations.

We are in process of revising our price estimate to incorporate the changes in the reporting structure of the company and other recent developments.

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1. Rio Tinto approves $3.7 billion Australia iron ore expansion, Reuters, June 20 2012 [↩]