Rio Tinto’s Profits Expected To Fall On Weak Iron Ore Prices

Rio Tinto (NYSE:RIO) will release its half-yearly results on Thursday, August 8. The company has already released its operations review report for Q2 where it reported a strong performance despite challenging weather conditions. It reported a record quarterly iron ore production primarily on increased production from its Pilbara mines in Australia. Iron ore constitutes the bulk of Rio’s portfolio. Copper, thermal coal, aluminum, and titanium dioxide production were all higher in the second quarter on a year-over-year basis. The production of coking coal showed a decline due to the planned shutdown of the Kestrel Mine coal handling preparation plant for upgrade works. ((Second quarter 2013 operations review, Rio Tinto Media Release))

While the operating results are impressive, it remains to be seen to what extent profit margins have slipped as a result of lower prices, particularly for iron ore. There were some notable developments in the second quarter. Rio sold its Eagle nickel and copper project in Michigan for $325 million and its 80% stake in the Northparkes gold and copper mine for $820 million. The first shipment of copper from the Oyu Tolgoi project in Mongolia finally took place in July after multiple delays and disagreements with the Mongolian government. ((Rio Tinto agrees sale of Eagle project, Rio Tinto Press Release))

See Full Analysis for Rio Tinto Here

Operational Performance

Iron ore production for the quarter was reported at 66 million tonnes while total shipments stood at 61.3 million tonnes. While the production was higher by 1% on a year-over-year basis, sales were higher by 7%. The company maintained its yearly iron ore production guidance of 265 million tonnes. You can check the effect of iron ore shipments on Rio’s valuation using our interactive graph below.

At 146,200 tonnes, mined copper production was 10% higher year-over-year. The production grew due to a sustained recovery in ore grades at the Kennecott Utah Copper and Escondida mines. While the production of thermal coal showed a 22% year-over-year growth, the production of hard coking coal declined by 12% due to the planned shutdown of the Kestrel Mine coal handling preparation plant for upgrade works. Bauxite production was 21% higher than in Q2 2012 driven by higher requirements at the expanded Yarwun alumina refinery and increased third party demand. Aluminum production was 15% higher than the corresponding quarter in 2012, reflecting the resolution of the lockout at Alma and the resumption of production following the power outage at Shawinigan.

Notable Developments And Outlook

The biggest development this quarter was the commencement of copper shipments from Rio’s $6.2 billion Oyu Tolgoi mine in Mongolia. While the company has been producing since February, shipments had been held up due to its continued wrangling with the Mongolian government over a number of issues. The Mongolian government wanted a higher share of profits and was not in favor of allowing Rio to repatriate profits from the country. It also wanted access to the company’s sales contracts signed with Chinese customers. The commencement of shipments from July 8 indicates that these pending issues were resolved. In the first 10 years, the annual output at Oyu Tolgoi is expected to average 330,000 tonnes of copper and 495,000 ounces of gold. (Rio Tinto’s First Copper Shipment From Oyu Tolgoi Marks A Milestone, Trefis)

The sale of its Eagle and Northparkes assets reflects the Rio management’s commitment to achieve cost savings of $5 billion over the next two years and generate significant cash from the sale of non-core assets and businesses. ^[1]

Rio has maintained its target of expanding iron ore production capacity to 290 million tonnes in the Pilbara region of Australia this year even in the face of challenging weather conditions. Also, the recovery at its Bingham Canyon copper mine is coming along better than expected. A landslide in April had shut down operations for some time at this mine and production is not yet back to previous levels. Mined and refined copper output for the year is expected to suffer by 100,000 tonnes and 75,000 tonnes respectively. However, this is 25,000 tonnes better than initially estimated. Taking this into account, Rio’s share of mined and refined copper for the year is expected to be 565,000 tonnes and 230,000 tonnes respectively.

China’s economic growth has slowed down considerably this year. Data for the second quarter showed a growth rate of 7.5%. The manufacturing sector is sluggish and exports are shrinking. This indicates a decreased appetite for commodities which is not good news for Rio Tinto. Since China is the world’s biggest consumer of commodities, its economic performance influences global commodity prices quite significantly. Still, Rio remains unwavering in its plans to go ahead with a major expansion in iron ore production capacity to 360 million tonnes by 2015. We will be interested in the management’s comments in the earnings conference call about how it plans to protect profits from the resulting fall in prices. ^[2]

We have a Trefis price estimate for Rio of $56.

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

1. Rio Tinto agrees sale of interest in Northparkes, Rio Tinto Press Release [↩]
2. China’s Slowing Economy, An Illustrated Guide, WSJ [↩]