Rio Tinto’s ‘good year’ in grim sector lifts shares

<p>No sign of a profit on the horizon from Rio Tinto Plc., the global mining bellwether, following its full-year report out this morning, and that […]</p>

No sign of a profit on the horizon from Rio Tinto Plc., the global mining bellwether, following its full-year report out this morning, and that is of course in line with expectations.

With iron ore prices losing more than 50% during 2014 alone, extending their decline of the last three-plus years, mining investors have long since ceased expecting profits, instead placing the emphasis on miners’ ability to keep hiking production, tightening efficiency, cutting costs and incrementally raising pay-outs.

On that somewhat upside-down basis, Rio Tinto has had a ‘good year’.


Forget profit, check out that production

Yes, underlying earnings continued to be eroded—down 9% to $9.3bn—in keeping with slumping global demand and the continuing collapse of prices.

But Rio still expects to juice-out what appears to be maximum production from existing capacity, with 2015 iron ore shipments seen running at “100% basis” from Rio’s Australia and Canada operations and with 350 million tonnes forecast in 2015.

Another closely scrutinised metric is capital expenditure: this is forecast to decline below $7bn in 2015 and to remain at around $7bn in 2016 and 2017.

That would suggest more than 50% of capex would have been lopped off Rio’s peak around $15.6bn just two years ago, and a fair fall from the $9.9bn in the 12 months to June 2014. The forecast also slightly edges consensus estimating 2015 capex at $7.5bn.

Broadly speaking, investors are also likely to find this year’s shareholder pay-out and planned payments satisfactory. This year’s total cash return comes to about $6bn, circa 64% higher than the last annual cash-out.

Next year’s proposed capital return of a tad more than $2bn includes $500m in an “off-market” share buyback in Rio Tinto Ltd., the Australian entity, and the balance of $1.6bn will be in shares of the UK side, Rio Tinto Plc., bought directly on the market.



Cautious on the rate of crushing rivals

As for the grim business of destroying small rival mining businesses, or at least that ultimate intent, the news is fairly good too.

Rio estimates 125 million tonnes of iron ore capacity came out of the market in 2014 and it expects at least a further 80 million tonnes to come out this year as a result of weak prices, its CEO Sam Walsh said on Thursday morning.

Still, he was not exceedingly bullish on the global production capacity reduction overall. He cautioned that he did not expect a “huge amount” of capacity to be reduced in China this year.

China remains by far the biggest producing country, with production actually increasing back above 1.3 billion tonnes, the three-year mean, in 2013.

Walsh’s comments suggest Chinese production will certainly not fall far below that rate this year.

That in turn implies a likely extension of Rio’s current cost and expense rationalisation strategy, with the dwindling global demand environment all but ruling-out any material upturn in benchmark 62% iron ore prices in the next few years.

The external production outlook therefore represents one of the few absolute negatives in Rio’s earnings report.

For shareholders, at worst, cash return increases beyond the one planned for this year might become more modest from next year onwards.



China production flattening, not falling

Still, iron ore shipments to China rose 14% last year, even as its steel output was nearly flat, according to China Iron and Steel Association officials speaking at a conference on Wednesday.

China’s own raw ore production fell in the final quarter of 2014, and industry executives estimate a third of the country’s mines have halted production, the CISA said.

Therefore, if Rio’s CEO does not see a great deal of additional progress in global production cuts this year, Chinese production looks likely to remain around flat. Especially after it emerged at Wednesday’s industry conference that 45% of Chinese iron ore mines might have been halted by the end of this year.

All in all, whilst there are few outright winners amongst mining industry giants right now, Rio probably achieved what it needed to in order to position itself optimally for the continuing challenges ahead.

In the longer-term, as the cost outlook becomes less punishing, likely in the next financial year, Rio Tinto’s 12.2 times forward price-to-earnings ratio would make it a relatively cheap way of gaining FTSE 100 exposure, given that fellow index constituents trade on average at 15.9x. (Though Rio’s current rating is built at least partly on its ramping real yield; and consensus expects the dividend yield to rise by 40 basis points to 5.1% in 12 months.)



Rio Wedge

Rio stock seems to have found its lower limit for now, juding by a wide-angle view of daily trading over about 7 years.






Though, note the stock hasn’t traded above the important 200-day moving average since August 2014, and an overhead descending trend can also be expected slice off weak attempts in the near-term to make significant upside progress.

Shorter term, City Index clients trading Rio Tinto Daily Funded Trade appear to be targetting another descending trend line that might be met between about 3085-to-3091.

A long-entry signal triggered by the attached MACD/Fast Line ‘cross’ system, earlier on Thursday, in theory, backs buyers further.



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