Rio Tinto (NYSE:RIO) surprised markets yesterday by announcing a $14 billion writedown of assets in its aluminum and Mozambican coal businesses. It simultaneously announced the departure of its CEO Tom Albanese who had overseen these acquisitions. The writedown will be recorded as a post-tax non-cash impairment charge of $14 billion in the company’s 2012 full year results. 
Of the $14 billion, a charge of $10-11 billion will be taken against aluminum assets while approximately $3 billion will be taken as a charge against the Mozambican coal assets. Smaller writedowns of the order of $500 million will account for the rest. The writedown on aluminum assets is to be taken mainly in the Rio Tinto Alcan division, but assets in the Pacific Aluminum division will also account for a portion of it. 
The massive writedown would have made continuance of CEO Tom Albanese unsustainable. Not only did both these acquisitions take place under his watch, Rio Tinto has already once incurred a $8.9 billion writedown in 2011 on account of the Alcan acquisition made in 2007. The Mozambican assets were also acquired as recently as 2011, when Rio acquired Riversdale for $4.2 billion. The writedown of $3 billion thus wiped out nearly 75% of the value of the acquisition.
The news is definitely bad news for this year’s financial results. We now expect Rio to show negligible profit if any when it announces results on February 14. Sam Walsh, who was announced as Albanese’s replacement, is 63 years old. It thus seems likely that he is an interim replacement and will be succeeded by somebody younger 2-3 years down the line. Given his professional background, we expect Rio Tinto to be in consolidation mode for sometime.
Rio Tinto acquired the Canadian aluminum company Alcan in 2007 for $38 billion. It was seen as an expensive acquisition at the time, but Rio was probably banking on soaring metal prices and the booming Chinese economy. It may also have been very keen to diversify away from iron ore, which even today constitutes nearly 80% of its earnings. Unfortunately, the global economic conditions deteriorated soon after and the demand for aluminum slumped. Rio has been forced to shut down some of the facilities, lay-off workers, and write down asset value at the aluminum division by $29 billion since 2009. It has also put some facilities in its aluminum division on the block for sale, but hasn’t yet found any willing suitors ready to pay the price it wants. The aluminum business continues to bleed losses. 
The value of Mozambican assets had to be written down because of logistical issues and revision of estimates about recoverable coal reserves. Rio had initially planned to transport coal by barge along the Zambezi river, but the government never approved the proposal. Mozambican coal has proved difficult to get from pithead to port because of infrastructural issues which are expected to last for at least a decade more. Also, at the time of acquisition, coking coal was fetching $290 per tonne but today the price is nearly $165 per tonne. 
What Does It Mean For Financials?
Rio reported underlying earnings of $15.5 billion in 2011 and a net profit of just $5.8 billion, mostly due to the $8.9 billion impairment charge it had to take against the aluminum assets that year. The net earnings declined by 59% year-over-year. 
In 2012, Rio reported half yearly net earnings of $5.9 billion, down by 22% year-over-year due to lower iron ore prices. While iron ore prices shot up dramatically in the fourth quarter of 2012, Rio will still not make up for the poor performance in the first half of the year. The earnings, not taking into account the impairment charges, will therefore be lower compared to 2011. With impairment, we expect Rio to post a net loss or a negligible profit. 
Sam Walsh, the new CEO, is 63 years old and has been with Rio Tinto for two decades and heads the iron ore business. His strength is considered to be his expertise in operations. These facts, combined with the latest company operational review, hint at the likely future strategy. Rio will probably devote most of its attention to the iron ore business and expand production capacity in the Pilbara region of Australia to about 360 million tonnes by 2015. Also, Walsh’s contract is valid for three years. We expect that Rio will focus only on organic growth and improvement in productivity and efficiency. In any case, it’s clear that diversification of Rio’s business is a distant probability for now.
While Rio will be eager to get rid of the aluminum assets it has already put on sale, we think that investors would now ask for substantial discounts on the price tag. Since the aluminum market hasn’t picked up dramatically, it lowers Rio’s ability to negotiate for what it thinks is the right price.
We have a Trefis price estimate for Rio of $45 which will be revised once the fourth quarter earnings results are out.Notes:
- Rio Tinto impairments and management changes, Rio Tinto Media Release [↩]
- Rio CEO Albanese Steps Down as $14 Billion Writedown Looms, Bloomberg [↩]
- Rio Tinto CEO pays price of calamitous acquisitions, Reuters [↩]
- Miner Rio Tinto Ousts CEO as Bad Bets Cost Billions, WSJ [↩]
- Rio Tinto Media Release, Rio Tinto [↩]
- Rio Tinto Media Release, Rio Tinto [↩]