Record Returns To Shareholders Along With Sharp Rise In Margins Were The Highlights Of Rio Tinto’s FY 2018 Results

Rio Tinto (NYSE: RIO), a leading global mining player and one of the largest iron ore miners in the world, reported its FY 2018 financial results on February 27, 2019, followed by a conference call with analysts. The company beat market expectations for revenue as well as earnings during the year. RIO reported net revenues of $40.5 billion in 2018, 1.2% higher than the $40 billion of revenues in 2017. Higher revenue was primarily a result of increased volume of iron ore and copper, along with higher price realization for aluminum and copper, partially offset by the impact of lower iron ore prices and loss of revenue from the divestment of all of its coal operations in 2018. The company reported earnings of $7.93 per share in 2018, about 62% higher than $4.90 in 2017. The superior earnings in 2018 mainly reflected higher revenues, gains from the sale of the coal business and RIO’s interest in Grasberg operations, and lower interest expense on the back of the company’s bond-buyback program.

We have summarized the key takeaways from the announcement in our interactive dashboard – How Did Rio Tinto Fare Amidst Lower Iron Ore Price Realization In 2018 And What Is The Outlook For 2019? In addition, here is more Materials data.

Key Factors Affecting Earnings

Slower Growth in Iron Ore: Revenue from the iron ore segment grew by 1.3% to $18.5 billion in 2018 compared to $18.3 billion in 2017. This was led by a 3.2% increase in Rio’s share in iron ore shipments to 280.8 million tons in 2018 from 272 million tons the year before, mainly due to mine expansion and productivity improvement measures across the integrated system. However, the revenue growth from the segment remained subdued and below expectation due to lower price realization. Iron ore price realized decreased from $67.10 per ton in 2017 to $65.80 per ton in 2018, driven by a 1% decrease in China’s iron ore imports in 2018, which marked the first annual drop since 2010. However, we expect revenue from iron ore to increase in 2019 and beyond on the back of higher shipments and prices, as demand from steelmakers has bounced back in January 2019. Additionally, the successful deployment of AutoHaul, the world’s first automated heavy-haul, long distance rail network along with new investments to sustain production capacity – such as the $2.6 billion investment in the Koodaideri mine – would drive future growth in the segment.

Higher Aluminum Revenue: Revenue from aluminum increased by 10.8% to $12.2 billion in 2018. This is mainly due to a significant rise in the average realized price per ton to $2,470 in 2018 from $2,231 in 2017. FY 2018 saw aluminum supply remaining in deficit for most part of the year as lower margins led to economic curtailments in China and globally. This has led to higher aluminum prices during the year. However, a sharp rise in prices was partially offset by lower shipments. Aluminum production declined by 3% (y-o-y) in 2018 on the back of an ongoing lock-out at the non-managed Becancour smelter, which began in January 2018, and a power interruption at Dunkerque Aluminum in the first quarter. We expect aluminum revenue to rise in 2019, though at a subdued rate with price increasing modestly.

Higher revenue from copper segment: Revenue from copper increased by a whopping 33.6% in 2018, driven by increased copper and gold volumes which were driven by higher grades. The rise is also connected to productivity improvements and increased plant throughput at Rio Tinto Kennecott, a return to capacity at Escondida, higher gold grades at Oyu Tolgoi, and a greater metal share at Grasberg. Additionally, average price realized per pound of copper also witnessed an increase of 6% during the year. However, we expect copper volume to decline sharply in 2019 as RIO has sold its interest in the Indonesian Grasberg mine in December 2018. Lower shipments would likely lead to a significant decline of about 38% in copper revenues in 2019.

Divestment: Rio Tinto’s Energy and Minerals segment was the biggest drag on the company’s revenue for 2018. Following the completion of the sale of Rio Tinto’s interests in Kestrel and Hail Creek in August 2018, production of coal attributable to Rio Tinto ceased completely. This move has led to a sharp drop in revenue from the segment, which decreased by 26.6% to $5.7 billion in 2018. With 2019 being the first full year of RIO without the coal business, revenue from the segment is expected to further decline by about 8% in 2019.

Profitability: Net income margin increased from 21.9% in 2017 to 33.7% in 2018. Such a large increase in margins reflects profits from the sale of the coal business and a few aluminum assets, lower interest expense due to the bond buyback program of 2018, higher capitalized interest, and profit from sale of stake in Grasberg operations, partially offset by higher mining, exploration, and evaluation costs. We expect net income margin of 22.5% in 2019, though lower than the margin in 2018 which was bloated by non-recurring gains, but higher than in 2017. Margin growth is expected to remain robust primarily due to lower interest expense and productivity improvement.

What Lies Ahead?

Going forward, we expect iron ore and aluminum to drive revenue growth for Rio Tinto. With alumina prices falling as the commodity’s global deficit nears an end, aluminum margins are expected to rise going forward (as alumina is an input for aluminum players). Also, though the exit from the coal business is expected to hit Rio’s revenue growth in the short term, this move is expected to help the company focus on its high-margin core operations. Additionally, lack of coal assets could make Rio more attractive to investors as capital moves away from fossil fuels. The company has a robust capital spending plan in place, which would support its large pipeline of projects and would likely add to production and shipment growth in the near term.

Rio Tinto announced record returns to shareholders of $13.5 billion, which included $6.3 billion of cash returns from operations – comprising the $1.0 billion share buy-back announced in August 2018, and record $5.3 billion full year ordinary dividend – and $7.2 billion of supplementary cash returns (announced in February 2019) from divestments – comprising a special dividend of $4.0 billion and $3.2 billion of share buy-backs. Thus, though we expect total revenues to decrease over the next two years on account of the sale of all of coal and part of copper and aluminum operations, we believe that focusing on core operations, coupled with the ongoing measures toward improving the balance sheet structure and enhancing shareholder returns, would drive the company’s value and stock price in 2019.

We have a price estimate of $62 per share for the company, which is higher than its current market price.

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