Following the interim results of fiscal 2010 on August 5, the analysts’ opinions are mixed on Rio Tinto (RTP) emanating from the new pricing system, which increased its commodity prices by more than 30% on an average and the huge amount of capital expenditure planned by the company.
In the first half Rio shifted away from annual pricing system to focus on a quarterly pricing system. The quarterly iron ore price is based on a three-month average of price indices for the period ending one month before the onset of the new quarter.
Rio reported outstanding interim results for the first half of fiscal 2010. Net earnings attributable to ADR holders of Rio Tinto during the period were $5,845 million, a huge jump from $1,624 million reported in the first half of 2009. The increase was due to the upward movement in the prices of commodities buttressed by lower cost and a slight improvement in the global economy, which enhanced the demand for rough diamonds. Earnings per ADR were $3.00, more than double of $1.36 recorded during the same period in the previous year.
Underlying earnings, i.e. earnings excluding impairment charges, gains from asset disposal and other items, increased to $5,767 million from $2,565 million in the year-ago period. On a per ADR basis, underlying earnings were $2.94, up from $1.63 in the prior year.
Consolidated sales during the first half, moved up by 33.8% to $25.209 billion from $18.846 billion in the prior year, driven by higher average realized selling prices for all major commodities.
Detailed discussion of the earnings release can be found at: Higher Pricing Pushes Up Rio Tinto
Agreement of Analysts
There seems to be no general agreement among analysts regarding the outlook on Rio. Over the last 7 days, out of 6 analysts covering the stock, 2 analysts have increased their estimates for fiscal 2010 and 2011, while an equal number has lowered them.
The mixed reaction is attributable to the huge leap in commodity prices on one hand and an increase in capital expenditure for fiscal 2010 and 2011 on the other. Analysts are concerned about the decent returns from the planned investments of the company based on the slower market recovery.
Rio has planned to make a capital expenditure of $4.2 billion in the second half of fiscal 2010, making it $6.0 billion in fiscal 2010, and has declared $9.0 billion of capital expenditure in fiscal 2011.
Magnitude of Estimate Revisions
For fiscal 2010, estimates moved up to $6.46 per ADR from $5.64 per ADR based on stronger pressure by the analysts to move up their estimates. For fiscal 2011, estimates went down to $6.73 per ADR from $6.79 based on the fact that there are more analysts who are pessimistic than optimistic.
We are expecting a significant increase in cash inflow for Rio in the near term based on the divestment program carried out by the company. During February 2008, Rio had planned to make a divestiture of $10.3 billion. Since 2008; total divestment has exceeded $10 billion. Moreover, Rio is awaiting Apollo Global Management, L.P. and Fonds Stratégique d’Investissement to purchase a 61% stake in Alcan Engineered Products.
Increased cash flows helped decrease net debt to $12.0 billion at the end of the first half of fiscal 2010 from $18.9 billion at the end of fiscal year 2009. This is going to continue in the short term. Hence we upgrade our short term rating to Buy, equivalent to a Zacks #2 Rank.
Rio’s agreement with the Chinese company, Chinalco, for the development and operation of the Simandou iron ore project in Guinea and the proposed joint venture with BHP Billiton Ltd. (BHP) to produce iron are expected to be accretive to earnings. The joint venture is expected to generate cost synergies of $10 billion and would definitely push up the bottom line.
China’s rapid industrialization and urbanization will strengthen the demand for Rio’s products in future. China is expected to grow by 9% in 2010 and Chinese steel consumption is expected to increase 6.7% to 579 million tons in 2010. China is expected to remain the largest consumer of metals in the foreseeable future and hence the medium-term outlook for metal commodities remains encouraging.
Management expects global demand for the company’s key products such as iron ore, copper and aluminum to double by 2022, primarily driven by China, India, and other emerging economies. Rio’s investment in various growth projects will enable it to capitalize on long-term demand. We reiterate our long term recommendation of Neutral based on the uncertainty in market movements.