Rio Tinto is getting over its existential angst about a lack of diversification.
The not-so-diversified miner relies on iron ore for more than 70% of its cash flow, and the price of the steelmaking commodity has tumbled by about 50% over the past year. Yet Rio on Thursday boosted its dividend and announced a $2 billion share buyback. Stranger still, that doesn’t look too foolhardy.
Rio’s efforts have created space to increase returns to shareholders, even at a time when iron ore, copper and other commodity prices are under pressure. Cost cutting helped shore up profitability. Capital spending of about $8 billion was $1 billion lower than expected. A large improvement in working capital helped Rio’s net debt drop sharply. At 19%, net debt to total capital is below the bottom end of Rio’s 20% to 30% target range.
The miner’s $14.3 billion in cash flow from operations last year nicely covered its capital expenditure and about $4 billion in dividends. The planned buyback would only push its gearing to 21%.
For the moment, it looks as though Rio can keep this up. There is a clear risk that iron ore stays lower for longer. About 300 million metric tons of low-cost production is set to come onto the market before mid-2017, according to Morgan Stanley, 18% growth from last year’s supply. Even this year, Rio’s expectation for high-cost production coming off the market won’t balance added supply, with little confidence in the strength of China’s demand.
Were iron-ore prices to languish at current levels, it would knock this year’s earnings and cash flow down by roughly $4 billion compared with last year’s. That would leave Rio able to cover its reduced capital spending plans of $7 billion and part of its dividend. Weak copper translates into another $600 million hit at spot prices. Yet there are other factors working in Rio’s favor: The Australian dollar and oil price at current levels would add about $1.5 billion compared with last year.
Rio, notably among the biggest miners, has scope to chop further. Only a third of its planned investment this year is sustaining, or essential, spending. Roughly $1 billion of Rio’s 2015 budget has yet to be approved by the board, part of which relates to the underground expansion at the Oyu Tolgoi copper mine, a project that could easily be delayed further given the continuing standoff with the Mongolian government.
From 2016, a significant chunk of Rio’s forecast investment is unapproved. That reflects a slight paucity of growth options but in troubled times means easier flexibility to rein in spending.
In reality, Rio had all-but-promised investors a buyback. And it is going into the market with shares still trading at a discount to an average of large-cap mining peers, according to Jefferies. Some of those rivals face greater balance-sheet pressure. Rio still isn’t terribly diversified, but it is making a virtue of being predictable.
Source: The Wall Street Journal
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