Rio Reviews Business After Recent Earnings Results

Rio Tinto (NYSE:RIO) has been in the news quite frequently following its half yearly results. The global economic weakness has taken a heavy toll on mining companies across the board and is being reflected in their share prices. In its latest earnings release, Rio has made it clear that it would only take up projects which provide its shareholders with a certain degree of return. As a result, the company is doing a comprehensive business review of projects and a lot deliberation is being done on the business strategy going forward.

Rio Tinto is a global diversified miner with a product portfolio that includes basic metals such as iron ore, copper and aluminum and energy products such as coal and uranium. It competes with other mining giants like Vale (NYSE:VALE), Freeport McMoran (NYSE:FCX) and Barrick Gold (NYSE:ABX).

Rio’s Aluminium Business

Aluminium prices have been falling for quite some time now, while input costs have been rising rapidly. This has put a question mark over the viability of several of the aluminum smelters that Rio is operating. Rio has identified certain aluminium smelter projects which it would like to divest and has begun reporting financial numbers for them separately. The market has come up with its own moniker “Pacific Aluminium” for the collection of these projects. The company is mulling all options for these projects, including possible closures. This was reaffirmed in a round table meeting of CEO Tom Albanese with a select group of analysts this week. ^[1]We think that the company could decide to focus more on bauxite mining operations in the future and scale down significantly its smelting business. As we reported earlier this week, Rio has already shut down a smelter in the UK and has called for a renegotiation of power purchase agreements for some others in a bid to maintain their viability.

Rethinking The African Business

Rio’s push to grow its African business has been stalled by a combination of low commodity prices, tardy government approvals, and a lack of sufficient infrastructure to manage logistics and operations. The CEO, Tom Albanese, indicated as much when he stressed the need to deploy capital in a manner conducive to the maximization of returns.

Rio’s African business comprises of mines that produce iron-ore, uranium, minerals, titanium dioxide and diamonds. Its iron-ore project at Simandou in Guinea is still awaiting action on the government’s part to finance transportation infrastructure, thus clouding the prospects of production beginning on schedule in 2015. The CEO has avoided reaffirming spending and production commitments for Rio’s African businesses. We believe that this represents uncertainty among Rio’s top brass about plans for Africa, at least in the short term. ((Rio Tinto steps back from African growth plans, Business Spectator, August 16))

Focusing on Iron Ore

Rio is pushing for the expansion of its Pilbara region mines in a big way in a bid to concentrate on its core strength, the iron-ore business. Despite the negative economic sentiment, China has been buying all of Rio’s iron-ore produce thus far. Going forward, we believe that Rio is betting big on a fourth quarter recovery in China. It expects the government to provide monetary stimulus to the economy to support growth. The latest Chinese data on economic growth confirmed a slowdown. The silver lining for Rio was the low inflation figure of 1.7% which provides room for the expected stimulus. If the stimulus materializes, the effect would follow a time lag which explains the expectations from the fourth quarter. ((China Factory Slowdown Raises Pressure For Easing, Bloomberg, August 9))

Despite the negative macroeconomic sentiments in Europe and a weak US economic recovery, Rio’s order books are full. Rio Tinto seems to be banking on its superior asset base and the high quality of its growth pipeline to deliver future benefits. However, we believe that contagion from a full-blown Euro Zone debacle could well impede growth for the company. Barring such a scenario, as long as Rio focuses on its iron-ore operations and keeps a check on capital spending, we believe that it will be able to ride through these challenging times.

We are in the process of updating our estimates in the light of recent earnings.

Understand How a Company’s Products Impact its Stock at Trefis

1. Cheap Mining Assets Unlikely to Tempt Rio Tinto, WSJ, August 16 2012 [↩]