Rio Tinto Alcan Explores Cost Cuts Amid Challenging Market Conditions

Rio Tinto (NYSE:RIO) Alcan is exploring various options to cut costs at its plants amid challenging conditions in the aluminum market. Right now, it is focusing on doing so at its facilities in Quebec, Canada where it is exploring the option of reopening collective agreements for about 1,500 Quebec employees. ^[1]

Aluminum has been trading at low prices for sometime now, reflecting weak global macroeconomic sentiments. Rio Tinto has set itself a target of achieving annualized cost savings worth $500 million by reducing capital expenditures, cutting support costs, and freezing hiring as it adjusts to a slowdown in Chinese economic growth.

We have multiple reasons to believe that if the company is not able to cut costs significantly at these facilities, it might opt to shut down at least some of them. The reasons include Rio’s already declared intentions regarding the future of its aluminum business, its long-term business strategy, as well as environmental standards in Quebec. The company doesn’t see the aluminum business as aligned with its business strategy and is also keen to boost its financial performance, which is being affected by businesses not profitable or scalable.

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Aluminum Headaches

Rio Tinto bought Canada’s Alcan in 2007 at a high valuation of $38 billion. It took significant debt on its books and then the market turned adverse due to the global financial crisis. This dragged down demand and prices for aluminum, thus making the business a potential liability. Aluminum prices fell 20% last year and a further 15% in the first half of 2012. Rising costs of electricity, which constitutes the major cost component for aluminum smelting, put further pressure on margins and continue to do so. ^[2]

Rio Tinto announced last year that it intended to sell a number of aluminum businesses in its portfolio to streamline the division. As mentioned above, owing to rising costs and falling prices, the company believes that the aluminum business is no longer aligned with its overall business strategy. It has also stated that is not going to keep operating businesses that are not commercially viable. Some of its assets have been put on the block for sale already, but due to what Rio feels are low valuations, they have not been sold yet. Rio has indicated that the strength of its balance sheet allows it to sell at the time of its own choosing.

Company representatives met Canadian Auto Workers union representatives last week to discuss employee concerns about the weak global aluminum market, cost-reduction efforts, and the planned closure this year of its cathode facility in Arvida, Quebec. About 50 employees affected by the closure will be relocated to other facilities. The Arvida facility faces an additional challenge because it will no longer meet Quebec’s environmental standards as of 2015. The union spokesperson said that Rio has not taken a decision so far on seeking to reopen some collective agreements, but the option remains on the table. Other options to achieve savings include changing of work rules.

We think this is an indicator of things to come. The company will definitely be looking to cut costs wherever possible and shut down plants if it needs to. It has already shut down its Lynemouth aluminum smelter in the U.K. at the end of March this year, and is looking to renegotiate power purchase agreements for some others. ^[3] The company’s intentions regarding closures of non-viable businesses were reaffirmed in a round table meeting of CEO Tom Albanese with a select group of analysts in August. ^[4]

Aluminum constitutes a relatively small portion of Rio’s business, so we don’t expect problems in this segment to have a significant impact on the company’s overall Trefis valuation.

We have a Trefis price estimate for Rio of $45 which is nearly 7% below its market price.

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1. Rio Tinto Alcan mulls cost reductions to survive slowdown, CBC News [↩]
2. Rio Tinto to Sell 13 Aluminum Businesses, WSJ [↩]
3. Rio Tinto sets date for UK aluminum smelter closure, March 6 2012 [↩]
4. Cheap Mining Assets Unlikely to Tempt Rio Tinto, WSJ, August 16 2012 [↩]