Commodity Pricing Slide Drags On Rio Tinto’s Earnings

Rio Tinto (NYSE:RIO) reported its half yearly earnings on Wednesday. It reported underlying earnings of $5.2 billion, a 34% year-over-year decline. Net earnings were reported at $5.9 billion, a decline of 22% on a year-over-year basis. The net earnings figure is higher than the underlying earnings figure owing to recognition within the former of a $1 billion deferred tax asset. The generation of this tax asset was made possible by the introduction of the Minerals Resource Rent Tax (MRRT) in Australia. It is expected to be a one-off event.

A major portion of the decline in earnings was attributed to lower commodity prices which resulted from the weak global macroeconomic environment. ((Rio Tinto announces first half underlying earnings of $5.2 billion, Company Press Release, August 8 2012)) Rio Tinto is a global diversified miner with a product portfolio spanning basic metals like iron ore, copper and aluminum to energy products like coal and uranium. It competes with other mining giants like Vale (NYSE:VALE), Freeport McMoran (NYSE:FCX) and Barrick Gold (NYSE:ABX).

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Higher Commodity Prices, Lower Volumes and Rising Input Costs Drag Down Profits…

The effect of price movements across all major commodities in the first half of 2012 decreased underlying earnings by $1.9 billion, as compared to the corresponding period in 2011. Prices declined for nearly all of Rio Tinto’s major commodities, with the exception of gold (which was up by 14% over prices prevailing in 2011 first half), minerals and thermal coal. Copper prices were down by 14%, aluminium prices averaged 15% lower and molybdenum prices were 17% lower as compared to the corresponding period last year.

Lower sales volumes reduced earnings by $584 million, largely due to the temporarily low grade of copper and gold at Kennecott. This was partly mitigated through higher coal and iron ore volumes, in line with recently completed thermal coal expansion projects and relatively conducive weather conditions. These boosted earnings by $366 million compared with the corresponding period in the first half of 2011. The net effect of volumes on earnings, therefore, was to reduce them by $218 million.

Higher energy costs across the lowered underlying earnings by $12 million compared with 2011 first half. In 2012 first half, many operations were impacted by higher rates for fuel, diesel, and power.

Higher other cash costs during the first half of 2012 decreased underlying earnings by $388 million compared with the corresponding period in 2011. Higher costs resulted from a combination of fixed production cost inefficiencies associated with lower volumes due to grade, higher maintenance costs, and costs associated with operational readiness for the Pilbara expansion of iron ore production.

…But Rio Tinto Still Optimistic About The Future

Despite Rio having suffered a steep decline in profits, management sounded an upbeat note for the future. The company has a strong long-term demand outlook and is expecting the Chinese economy to grow by approximately 8% in 2012. The management attributes this optimism to its expectation that the stimulus measures announced by the Chinese government in the second quarter will start flowing through to infrastructure investment in the next few months. Despite negative macroeconomic sentiments in Europe and a nascent US economic recovery, Rio’s order books are full. Rio Tinto seems to be banking on its superior asset base and the high quality of its growth pipeline to deliver future benefits. The management committed itself to meeting its planned capital expenditure target of $16 billion for 2012.

Projects Remain On Track

Rio’s plans to expand iron ore production in the Pilbara to 283 million tonnes per year remain on track for completion by end of 2013. The second phase of this expansion will see production rising to 353 million tonnes per year and will be operational by the first half of 2015. The development of Rio’s Oyu Tolgoi copper-gold project in Mongolia remains on schedule and commercial production is expected to begin in the first half of 2013. Rio also concluded an agreement with Chalco to develop and operate the Simandou iron-ore mine, with commercial production expected to begin by mid-2015.

Dividends Increased To Reaffirm Positive Outlook On Business

To reassure investors, the company proposed an interim dividend of 72.5 US cents, higher by 34% than the 2011 figure of 54 cents. This hike has been announced despite the decline in profitability. We are in the process of reviewing our forecasts for the company to incorporate the latest earnings figures.

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