The Year 2016 In Review: Rio Tinto To Benefit From Improvement In Business Conditions Going Forward

by Trefis Team
-7.39%
Downside
48.85
Market
45.23
Trefis
RIO
Rio Tinto
Rate   |   votes   |   Share

The year 2016 witnessed a considerable improvement in Rio Tinto’s stock price, as illustrated by the chart shown below.

Rio Stock Price 2016

Rio Tinto Stock Price, Source: Google Finance

The improvement in the company’s stock price was primarily a reflection of an improvement in the iron ore pricing environment over the course of the year. In addition, the company continued to lower its average production costs, as it ramps up production from its low-cost Pilbara iron ore mines in Western Australia. Lastly, an improved outlook for copper prices towards the end of the year also helped boost the company’s stock price. In this article, we will take a look back at the salient developments of 2016 for Rio Tinto and briefly look ahead to what the next year holds for the company.

Iron Ore Prices

Iron ore prices stabilized in 2016 after two successive years of decline, with prices at the end of the year recovering towards levels seen at the beginning of 2015, as illustrated by the chart shown below.

Iron Ore Prices 5 Year

Iron Ore Spot Prices, Source: Y Charts

Iron ore prices declined over the past two years as a result of an oversupply situation resulting from an increase in output by major producers such as Vale and Rio Tinto amid weak demand conditions. Slowing economic growth from China, the world’s largest importer of iron ore, translated into weakness in prices of the commodity. However, the extended period of decline in prices resulted in production cuts from high-cost iron ore producers as well as a moderation in production from low-cost producers. The following chart illustrates the extent of the production cuts over the past few years, as estimated by Rio Tinto.

Iron Ore Supply ExitsSource: Rio Tinto’s London Investor Seminar 2016, Rio Tinto Website

The rationalization of global iron ore supply in response to low prices has helped mitigate the extent of the oversupply, boosting prices in 2016.

Lower Production Costs

Despite the subdued iron ore pricing environment in the first half of the year, Rio Tinto’s low cost Pilbara iron ore mining operations (which account for around 95% of the company’s overall iron ore production) allowed the company to maintain its profitability. Rio Tinto, which reports its results on a semi-annual basis, reported only a 300 basis point year-over-year decline in EBITDA margins (on a Freight On Board basis) for its Pilbara iron ore operations in H1 2016, despite a much greater 14% decline in benchmark iron ore prices over the same time period. [1] This was largely because unit cash costs for the Pilbara operations declined around 12% year-over-year, as the company continued to focus on cost reduction amid the challenging pricing environment. [1]

Recovery in Copper Prices

In addition to the recovery in iron ore prices, Rio Tinto’s stock received a boost from the recovery in prices of copper over the past few weeks. President-elect Trump’s plans for a $1 trillion revamp of U.S. infrastructure has raised the global demand outlook for copper, translating into higher prices of the metal. [2]

Revival in Copper Prices

Copper Spot Prices, Source: LME

The Road Ahead

With an improvement in the prices of both iron ore and copper, complemented by Rio Tinto’s low cost iron ore mining operations, the company is well placed to report better results next year. However, as the demand outlook for iron ore is unlikely to improve substantially in the near term, the upside for iron ore prices remains limited next year. Nevertheless, Rio Tinto is set to commence operations in 2017 under more favorable business conditions as compared to 2016.

Have more questions about Rio Tinto? See the links below.

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Rio Tinto

Notes:

  1. Rio Tinto’s Q2 2016 Earnings Presentation, Rio Tinto Website [] []
  2. Trump’s $1 Trillion Promise vs. Congress, Wall Street Journal []
Rate   |   votes   |   Share

Comments

Name (Required)
Email (Required, but never displayed)
Be the first to comment!