At the beginning of the year Rio Tinto (LSE: RIO) (NYSE: RIO.US), along with all the global miners, made big write-offs. Now the story is all about cutting costs, reducing capital expenditure and focussing on shareholder returns. It’s a reaction to slowing demand from China and past irrational exuberance that led to over-priced acquisitions and indulgent mega-projects.
Costs
At an investor day in London yesterday, Rio demonstrated that it was doing all the right things. It’s on track to meet its target of paring $2bn from operating costs this year, and is targeting an extra $1bn of savings next year. Exploration spend has been halved, saving another $1bn. And capital expenditure is on a rapid downward path. Reductions of a fifth this year and in each of the next two years will see 2012’s $18bn spend reduced to around $8bn in 2015. The miner has also sold over $3bn of assets.
Much of the cash is being used to reduce Rio’s debt pile. Net debt, which stood at $22bn in June, will be cut to $19bn by the year end, and 2014 should see further reductions.
Iron ore
It’s not all cost-cutting. Rio is increasing capacity in its giant Pilbara iron ore mine in Australia, which produces some the world’s lowest-cost iron ore. Though it has a wide portfolio of minerals, the iron ore division contributed 85% of 2012’s earnings (and copper 10%), and subsequent sales of non-core assets have come from other divisions.
So Rio is a play on demand for iron ore. Operational gearing will see a big rise in profitability if and when demand picks up. That hinges on China, which consumes two thirds of the world’s iron ore. The company sees steady growth in demand from China over the next 15 years, with substantially growth from India contributing to a doubling in global demand by 2030.
Shares in the miners have sunk this year, with Rio losing 10%. That makes them an interesting counter-cyclical buy, especially if you have faith in the recovery of the world economy and plan to be a long-term holder. It’s not certain that the shares have yet touched bottom but brokers earnings forecasts, which were on a downgrade cycle for much of the year, have started to turn.
Dividends
What’s more, that new-found focus on shareholder returns means that Rio is committed to a progressive dividend policy. It yields 3.5%, around average for the FTSE 100 though lower than its peers.
