On balance, Rio Tinto's first-quarter production was in line with expectations. Higher-than-anticipated iron ore and copper output offset lower thermal and coking coal volume. That's not to say there wasn't plenty of red production ink versus the final quarter of 2008, but this came as no surprise. Iron ore production was surprisingly strong, steady at 31.6 million tonnes, and sales volume actually rose 12% following an undershipped final 2008 quarter. This was particularly surprising, given the well-telegraphed rain interruptions in the Pilbara. Copper output rose strongly with Kennecott mining chasing copper and gold ores following the decline in the molybdenum market and improved Grasberg grades offsetting weaker Escondida grades and recoveries. Energy was a different story, with coking coal falling off a veritable demand cliff, wet weather in the Hunter Valley limiting thermal production there, and US thermal output generally softer. Alumina and aluminum output declined in line with guidance.
Our valuation is marginally stronger despite clipping some volume expectations, particularly in the aluminum division. We softened the severity of the assumed iron ore price decline from 50% to 40% for the 2009 Japanese fiscal year beginning April 1. Copper prices have been notably stronger, with London Metal Exchange stockpiles falling for the first time in some considerable months on Chinese buying. Iron ore and copper accounted for a combined 72% of Rio's $17.4 billion fiscal 2008 earnings before interest and tax. Any price improvement in these elements is well received.
We have changed our fair value uncertainty rating to high. Rio has $41 billion in net debt and 180% net debt/equity, and we very much dislike its plans to hook up with Chinalco. We see this as the end of the great independent business it once was, instead with confused allegiances and tainted vested interests. If the Chinalco deal is quashed, either by Australia's foreign investment review board or shareholders, and alternative funding is put in place, our view could quickly change to the positive, more so if the existing board is replaced.
In some respects, near-term risks for Rio have diminished. The dramatic copper price increase aids the cash-flow cause. Further, frozen debt markets have thawed somewhat and Rio recently priced a $3.5 billion bond issue, expensive as that was at around 9% and a virtual 50% premium to similar issues that BHP Billiton--with its pristine balance sheet--recently completed. Along with completed asset sales, and excluding the proposed Chinalco asset sell-downs, funds should go some considerable way to covering the $8.9 billion of debt scheduled for repayment in October. This isn't the end of it, however, and until a conclusive remedy to the longer-term debt bogey is put to bed, Rio Tinto's share price is unlikely to meet full potential and our valuation.
