Rio Tinto Maintains Thrust On Non-Core Asset Divestments As A Response To Weak Commodity Prices

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Rio Tinto (NYSE:RIO) has announced the signing of a binding agreement to sell its stake in the Bengalla Coal Joint Venture, located in New South Wales, Australia for $606 million. [1] This latest stake sale is a part of the company’s efforts to sell off non-core assets in order to shore up its balance sheet during a period of low commodity prices. All the major commodities sold by Rio Tinto, particularly iron ore, which constitutes the cornerstone of the company’s business, are currently characterized by weak pricing environments. Given the prevailing weakness in pricing, these non-core asset sales will help Rio Tinto boost cash flows and manage its debt, affording it greater flexibility to operate during a low point in the commodity cycle.

Weak Iron Ore Prices

Rio Tinto is a diversified mining company and the world’s second largest producer of iron ore by production volumes. Iron ore sales account for around half of the company’s revenues. Thus, fluctuations in iron ore prices have a major impact upon the company’s prospects. Iron ore is the main raw material for the steel industry. Thus, demand for iron ore by the steel industry plays a major role in determining prices of the commodity. Benchmark international iron ore prices are largely determined by Chinese demand, since the Chinese steel industry accounts for the purchase of nearly two-thirds of the world’s seaborne iron ore supply. [2] Chinese steel demand growth is expected to decline by 0.5% in 2015, following on from a 3.3% decline in 2014, which is a reflection of slowing economic growth in China. [3] Weak demand for steel has indirectly resulted in weak demand for iron ore.

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On the supply side, a continuous increase in production by major iron ore mining companies such as Vale, Rio Tinto, and BHP Billiton has created an oversupply situation. [4] Rising production and weak demand is expected to widen the worldwide surplus of seaborne iron ore supply to 437 million tons in 2018, from an expected surplus of 184 million tons in 2015. [5] As a result of this oversupply situation, the weakness in iron ore prices is likely to persist in the near term. The following chart illustrates the weakness in iron ore prices over the past twelve months.

Iron Ore Prices, Source: Y Charts

Sale of Non-Core Assets

Given that iron ore prices are expected to remain subdued in the near term, Rio Tinto has been selectively divesting high-cost mines across a variety of other commodities that the company produces. Including the stake sale in the Bengalla Coal Joint Venture, the company has realized $4.5 billion from asset sales since January 2013. [1] However, this proactive approach has ensured that Rio has managed its debt well. The company’s debt relative to its market cap stands at less than 0.5x, which compares favorably with other diversified iron ore miners. [6] Rio’s low-cost core mining operations ensure that the company is operating profitably and generating robust cash flows even at a low point in the commodity cycle. Thus, Rio Tinto is well placed to face the challenges of the prevailing business conditions.

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Notes:
  1. Rio Tinto agrees sale of interest in Bengalla Joint Venture for US$606 million, Rio Tinto News Release [] []
  2. China Plans Iron Ore Subsidy for Miners Amid Rout, News Says, Bloomberg []
  3. Short Range Outlook 2015-2016, World Steel Association []
  4. BHP, Rio Gamble with Stacked Iron Ore Deck, Mineweb []
  5. Iron Ore Majors Boosting Supply as Glut, China Sink Prices, Bloomberg []
  6. Rio Tinto’s 1H 2015 Earnings Release, SEC []