Rio Tinto To See A Dent Of Over 25% In Its Profits?
Though Rio Tinto (NYSE: RIO) has seen its revenue and bottom line grow over the last three years, the company is currently in an unusual situation of shrinking margins in spite of rising revenue. The company’s profitability is expected to decline by about 26% in a year, with Trefis projecting its net income to drop from $13.6 billion in 2018 to $10.1 billion in 2019, translating into a net income margin of 23% in 2019, significantly lower than the 33.7% recorded in 2018. Deterioration in its bottom line is expected to be driven by a sharp increase in impairment charges related to two of its aluminum and copper/diamond cash generating units, exacerbated by the absence of any gains on disposal of assets (which was a significant amount in 2018). However, margins are still expected to be higher than in 2016 and 2017.
You can view the Trefis interactive dashboard – Rio Tinto: Cost And Profitability Analysis – to better understand the factors causing a sharp decline in margins, and alter the assumptions to arrive at your own estimates of revenue, expenses, and profits for the company. In addition, here is more Materials data.
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Revenue Performance
RIO’s total revenue is expected to increase by over 8% to $43.8 billion in 2019 from $40.5 billion in 2018, led solely by higher iron ore revenue due to increased global prices, which would partially be offset by lower revenues across all other divisions. To understand segment-wise revenue performance in detail, please refer to the following analysis by Trefis- Rio Tinto Revenues: How Does Rio Tinto Make Money?
Expenses and Profitability
Total expenses are expected to increase from $26.88 billion in 2018 to $33.73 billion in 2019. Sharp increase in impairment charges and absence of any gain from asset sale (which was over $4.6 billion in 2018) are the primary factors for the drop in profitability in 2019.
- Impairment Cost: Impairment charge as % of revenue has been lower than 2% in the recent past, with it being just 0.3% in 2018. However, in 2019, the metric is expected to see a sharp jump to about 5.7% of revenue, mainly driven by a total impairment of $2.35 billion recognized in the first half of 2019 itself, related to decrease in recoverable value of RIO’s 2 assets – ISAL Aluminum Smelter and Oyu Tolgoi (copper and diamond unit).
- Gain on Disposal: Rio recorded significant gains from the sale of its coal business, along with a few aluminum assets and its stake in the Grasberg mine in Indonesia, which led to gain from disposal of assets to jump to 11.4% in 2018. In the first half of 2019, there was no gain/loss recorded. We do not expect any sale of business in the second half of the year as well, and hence the metric is expected to be nil in 2019, leading to a significant dent of over $4.6 billion in profitability for the year.
- Net Operating Cost: Operating cost as % of revenue has steadily declined over recent years, with the trend expected to continue in 2019 as well. A sharp rise in iron ore prices in the first half of 2019 is expected to lead to healthy improvement in operating margins for the full year. Additionally, improving grades at Pilbara operations are expected to lead to lower cost despite a slight drop in shipments during the year.
- Derivative Loss/Gain: Derivative gains and losses have seen wide fluctuations in the recent past. Rio recorded a net gain of $647 million as foreign exchange and derivative gains on US dollar net debt and intragroup balances in 2018. With the dollar index expected to remain relatively stable in 2019, we do not expect any major gain/loss of forex for the company.
- Net Finance Cost: The company’s net finance cost as % of revenue has seen a continuous decline, with the trend expected to continue in 2019 due to lower interest expense on the back of its renewed debt reduction initiative. Interest expense is expected to drop further due to Rio’s successful deleveraging program – using excess liquidity for bond buyback – and higher capitalized interest.
- Tax Expense: Tax expense as a % of revenue was close to 10% over the last two years. The metric is likely to drop to close to 9% in 2019 due to lower profit before tax in the absence of any gains from asset sales in 2019.
- Other Expenses: Other expenses, which includes exploration cost, profit/loss related to undeveloped projects, non-controlling interests, etc., have seen a constant reduction as a % of revenue over the last 3 years. We believe the trend would continue in 2019 (as observed in H1 2019 as well) to reach about 0.6% of revenue.
Thus, net income is expected to drop from $13.64 billion in 2018 to $10.08 billion in 2019, which marks a decline of about 26% in profitability. Company’s gains from its successful debt reduction program are expected to be more than offset by its impairment cost for 2019. However, projected net income of $10.08 billion in 2019, is still expected to be higher than the profit reported by RIO in 2016 and 2017.
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