Rio Tinto: 2013 Operational Review And Outlook
Rio Tinto (NYSE:RIO) has released its operations review report for 2013. The company said that it has beat its own estimates with respect to the production of iron ore, which constitutes the bulk of Rio’s portfolio. It reported record quarterly iron ore production, primarily on increased production from its Pilbara mines in Australia.
The production of each of iron ore, copper, bauxite, aluminum, thermal coal, and titanium dioxide was higher in 2013 as compared to 2012. This is especially laudable for iron ore and copper because a cyclone at the end of December hampered operations in the Pilbara iron ore region and an accident at the Bingham Canyon mine affected copper mining operations. [1]
The main takeaway from the report seems to be Rio’s assertion that it is focused on combating increasing costs and delivering higher returns to shareholders. The company announced cost savings worth $2 billion relative to 2012 and asset divestments worth $3.5 billion. The litmus test for retaining or selling a business in the portfolio has been its potential to generate high returns while simultaneously providing a significant scope for future expansion. The businesses which fail to meet both objectives simultaneously are potential divestiture candidates.
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Operational Performance
The global iron ore production figure at Rio’s facilities stood at 266 million tonnes, of which 209 million tonnes was its own share. This was 5% higher than the previous year’s figure. Most of Rio’s iron ore production comes from the mines in the Pilbara region of Australia. Production from this mine stood at 250.6 million tonnes, of which 199.9 million tonnes belonged to Rio. The shipments of iron ore stood at 259 million tonnes. Iron ore prices in 2013 stayed largely between $130-$140 per tonne in the second half of the year, defying all expectations. This was mainly because the expected slowdown in China failed to dampen demand for iron ore to feed the steel industry. [2]
You can check the effect of iron ore shipments on Rio’s Trefis valuation using our interactive graph below:
Copper production rose by 15% as compared to 2012, mainly due to recovery in ore grades at Kennecott Utah Copper and ramp up to full capacity at Oyu Tolgoi. The production figure stood at 631.5 million tonnes which exceeded Rio’s revised guidance of 590,000 tonnes following the accident at Bingham Canyon.
While the production of bauxite and alumina rose by 11% and 12% respectively, driven by increased third party demand for bauxite and expanded refining capacity at Yarwun, the production of aluminum declined by 10%. Aluminum production suffered as it took time to ramp up production to normal capacity following resolution of the Alma labor dispute.
There were some other key notables as well. Rio managed to generate operating cost savings worth $2 billion relative to 2012. It announced the sale of non-core assets worth $3.5 billion, of which $2.5 billion was completed in 2013. The company also reduced its capital expenditure by more than $1 billion, against a target of $750 million.
Strategy And Perspectives
From the latest available investor seminar material, we conclude that the company is giving importance to reducing costs across its operations, and isn’t likely to approve any new, large-scale capital-intensive projects in the near term. It, however, intends to remain on track with expansion plans in the Pilbara iron ore region. The aim is to expand extraction capacity to 290 million tonnes a year by the end of the first half of 2014. The overall capital expenditure in future is expected to come down from this year’s figure. [3]
The company also aims to generate further cost savings worth $1 billion in 2014 to take the overall savings level to $3 billion relative to 2012.
Rio is betting on rapid urbanization to drive demand for steel and thus iron ore. It considers China to be a key market until the mid-2020’s. It already derives about 80% of its earnings from iron ore, the bulk of which is sold in China. It wouldn’t be a stretch to say that Rio’s fortunes are closely correlated to China’s. Rio expects countries in South-East Asia and India to offset flat and then falling consumption in China after mid-2020’s. [4]
However, we are skeptical that Rio’s optimism with respect to iron ore prices is well-founded. There is a lot of production capacity coming online over the next 2-3 years and China is consciously trying to reorient its economy to a consumption-driven model from an investment-led model. The combination of these factors is likely to cause iron ore prices to bottom out around 2018, thus adversely affecting Rio’s cash flows and profits.
We have a Trefis price estimate for Rio of $55 which will be revised once the fourth quarter earnings results are out next month.
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