Rio Tinto (RIO) recorded strong production where it mattered in third-quarter 2012; iron ore production up 8% to 52.6 million tonnes versus 48.6 million tonnes in the second quarter. This is higher than we expected. Production continues to exceed sales to build stocks in anticipation of infrastructure expansion.
Iron ore comprised over 80% of Rio Tinto group earnings before interest and tax (EBIT) in 2011 and, despite the recent 65% plunge in iron prices to less than $90 USD per tonne, will likely contribute a similar percentage in 2012. That does reflect weakness in other commodities; Rio's fiscal 2012 iron ore EBIT is likely to fall 25% to $14.8 USD billion on our numbers. Iron ore prices of late have recovered to over $120 USD per tonne which will boost the final quarter's numbers.
The proportion of Rio earnings from iron ore remains too high for our liking. That's not to say we'd like iron ore earnings to fall, just for other segments to pull their weight
The proportion of Rio earnings from iron ore remains too high for our liking. That's not to say we'd like iron ore earnings to fall, just for other segments to pull their weight. Third quarter aluminium production was steady at 855,000 tonnes but alumina production rose 13% to 2.7 million tonnes and bauxite output increased 10% to 10.4 million tonnes. That's twice the bauxite required for Rio's alumina output and twice the alumina required for its aluminium output. Those numbers, particularly for bauxite, are hard to fathom. It's a hackneyed phrase but "shooting oneself in the foot" springs to mind. The sooner high-cost Chinese smelters have to pay a fair price for alumina, and refineries for bauxite, the sooner decent returns can return to the aluminium industry. Why prolong the agony for a paltry return on bauxite?
We expect decent margins will eventually return to aluminium when the process to de-link alumina prices from LME aluminium prices runs its course. Contracts are rolling off at the rate of around 20% per annum with 30% switched to spot as at June 2012. Rio's aluminium segment was EBIT break-even in second half 2012 and is currently loss-making. But aluminium generated up to 13% of Rio EBIT early last decade, long before the company's $40 billion USD Alcan takeover tripled the division's capacity if not its earnings. When aluminium fundamentals do eventually turn for the better, the latent earnings potential could surprise on an "iron ore" scale. A 50% increase in aluminium price to $1.30 USD per pound from current $0.87 USD levels could turn a divisional loss-maker into a $20 billion USD EBIT generator. Hopefully that will at least offset anticipated declines in iron ore price.
Third-quarter production of copper, the only division besides iron ore generating profit of any note for Rio, was steady at 132,000 tonnes mined, lower than expected. Copper generated 13% of 2011 group EBIT, a figure that could approach 20% in 2012 courtesy of iron ore's weakness; we forecast steady copper EBIT in 2012 at $3.5 billion USD. Rio forecasts mined copper production at 560,000 tonnes in 2012, a 10% increase on 2011 thanks to higher grades at Escondida in Chile and Kennecott Utah in the US, but a 20,000 tonne decline on guidance given in the second quarter.
Premium subscribers can read Taylor's full research report on Rio Tinto by clicking
