Rio Tinto investors rewarded after tough years as commodity prices improve

7 February 2018, 17:12

If you ever wanted proof of the dramatic recovery in global commodity prices, the latest results from Rio Tinto offer plenty of evidence.

Two years ago, the Anglo-Australian mining giant reported a pre-tax loss of US$726m for 2015, following a collapse in demand from China for commodities.

Today, it reported a pre-tax profit of $12.8bn for 2017, more than double the $6.3bn notched up in 2016.

That reflects, in part, a 21% rise in the average price for which Rio sold its aluminium and its iron ore, a 42% rise in the average price at which it sold coking coal and also a strengthening in copper, whose price on the London Metal Exchange rose by 27% during the year.

All units managed to increase their profitability despite lower production.

Iron ore production - by far the biggest and most important of Rio's activities - was more or less flat, aluminium was down 1%, refined copper down 21% and hard coking coal down 5%. Only in diamonds and titanium dioxide was production markedly higher.

With prices rising, it would be tempting for some companies to sit back and just watch the cash roll in, but Rio has also been seeking to get the stuff out of the ground more cheaply and efficiently.

Jean-Sebastien Jacques, the chief executive, could point out that some $8.3bn has been cut from costs since the beginning of 2013. This was a process kicked off by his predecessor, Sam Walsh, in response to straitened conditions in the sector as the so-called 'super-cycle' - a commodities boom triggered by rampant demand from China - came to an end.

The big question is where prices go next.

Strikingly, a few days ago, the commodities team at Goldman Sachs, who have a good track record in these things, predicted big gains for copper and iron ore prices this year. That could have implications for the rest of us if it feeds through into higher steel prices in the case of iron ore and, more crucially, in the case of copper, just about everything else.

The red metal is known as 'Dr Copper' because its wide number of industrial applications means it is a good forward indicator of economic activity. A rising copper price generally points to stronger growth in the global economy.

For Rio's shareholders, in particular, the question is what the company will do with vast cash flow generated by these higher prices - some $13.9bn in 2017. Some will find its way back to investors and the record $5.2bn pay-out for 2017 announced today, along with some $4.5bn worth of share buy-backs, will be viewed as fair reward for sticking with the company after it took an axe to the dividend two years ago.

Nor has this been at the expense of investment: Rio's capital expenditure during the year rose by just under 50%. This is an especially important metric for the company because investment decisions taken today may not bear fruit for a decade or more and their benefits reaped by Mr Jacques's successors.

Yet these are also decisions that must be carefully made: one reason Rio and its rivals struggled at the end of the super-cycle was because, on the assumption that commodity prices would stay higher for longer, they all found themselves saddled with projects that were too expensive.

The industry, Rio included, has spent much of the past decade selling assets to raise cash and adjust their activities. The repairs to the balance sheet look more or less done for Rio: the seventh-largest company in the FTSE-100 said today that its net debt has fallen by almost two-thirds during the last year and now stands at its lowest level for a decade.

But, as Mr Jacques made clear today, Rio may also splash out on new assets. This may even be outside its core areas of copper, iron ore and aluminium, with Chris Lynch, the outgoing chief financial officer, suggesting "we'd just need to see something we can see ourselves being successful in".

This may generate unease among shareholders who recall how, in 2011, Rio paid $3.7bn for coal assets in Mozambique, only to sell them for next to nothing a few years later. Today's results set out how, even now, Rio is still paying for the mistakes of yesteryear with, for example, the CA$654m for which Rio bought a uranium project in Canada in 2011 being written down to nothing.

Companies are frequently accused of handing back too much of their money to shareholders when they could be investing it in the business. After the roller-coaster ride of the last few years, a lot of Rio's investors will have no problem with that.