After a loss last year, Rio Tinto posts $US4.6 billion annual profit thanks to the global commodity rally

Rio Tinto’s iron ore mine near Karratha in Western Australia’s Pilbara region. Image: Aaron Bunch/Getty Images

Rio Tinto’s first profit increase since 2013 gave a glimpse of what a turnaround in commodity prices can do to the biggest miners.

The world’s second biggest miner posted a net profit of US$4.6 billion for full-year 2016 compared with a loss of US$866 million a year earlier. Underlying profit climbed 12% to US$5.1 billion, the company said as it sold assets and cut debt by about 30% over the year. The result marks a turnaround from 2015, when the world’s No. 2 miner posted its worst underlying earnings in 11 years and scrapped its generous payout policy amid tumbling commodity prices.

Miners are rebounding from a a commodities downturn that forced asset sales, cost curbs and a cut in investment to check supply amid a glut. Iron ore, Rio’s main profit driver, surged more than 80% last year thanks to Chinese stimulus that boosted steel output, leading to better demand. Analysts say the resources sector will gain from improved prices for commodities, on top of deep cost cutting and expanded volumes. Mining companies have been steadily setting results guidance higher and higher for the six month to the end of December.

“We enter 2017 in good shape. Our team will deliver US$5 billion of extra free cash flow over the next five years from our productivity programme,” Chief Executive Officer Jean Sebastien Jacques said in a statement. “Our value over volume approach, coupled with a robust balance sheet and world-class assets, places us in a strong position to deliver superior shareholder returns through the cycle.”

Rio reiterated its aim to improve operating cash costs and said it sees capital expenditure to be around US$5.0 billion in 2017 and about US$5.5 billion in each of 2018
and 2019.

The company generated operating cash flow of US $8.5 billion and cut cash costs by US$1.6 billion. It has sold assets worth US$2.45 billion so far in 2017 and plans to invest in three growth projects in bauxite, copper and iron ore, it said. It returned US$3.6 billion to shareholders and plans share buy back of US$500 million over the course of 2017. The dividend fell 21% to 170 cents a share, reflecting a new policy aligning the payout to earnings.

Consolidated sales stood at US$33.8 billion, US$1.0 billion lower than last year, primarily due to lower average commodity prices, and lower market premia for aluminium, Rio said. Operating profit margins improved to 38% in 2016, compared with 34% a year earlier, reflecting the positive impact of the cash cost improvements.

Still, there are worries over whether the turnaround in commodity prices will be sustainable. Analysts from National Austyralia Bank to HSBC are calling for a drop in prices. David Pleming, head of Europe, the Middle East and Africa metals and mining at HSBC, says that after some seasonal strength in the first quarter of this year, the iron ore rally “will give up its gains as we progress through the year”. Beyond the current quarter, Pleming says the bank’s long term price forecast is for spot prices to decline to $US52 a tonne, representing a decline of 35% from it’s current level of about $US80 a tonne.

This chart shows the rebound in iron ore prices

Part of the reason behind the call is an expected ramping up of supply from seaborne markets. Significant iron ore supply growth is expected to come on stream over the next two years, driven primarily by the majors: Vale’s, Hancock’s Roy Hill Rio Tinto’s Pilbara, BHP Billiton’s expansion, HSBC said. At the same time, he expects demand growth will remain tepid, rising by just 1% and 2.1% this year and next. While Chinese domestic iron ore production is expected to contract, demand from the nation will also slip. China, the largest consumer of iron ore globally, imported 1.0247 billion tonnes in 2016, the highest annual total on record. That demand was fueled by not only domestic production cutbacks but also a rebound in construction activity following a lift in fiscal stimulus from the Chinese government.

And this charts shows China port inventories

CEO Jacques just before he took over in July said he planned to grow the company through investing in existing projects and expanding profitable operations, rather than focusing on acquisitions. He has also moved away from coal as part of a plan to cut the firms underperforming assets. Last month, Rio agreed to sell most of the company’s thermal coal assets to a firm controlled by China’s Yanzhou Coal Mining Co. for US$2.45 billion. The sale would leave Rio with just two remaining coal mines once completed.

“Today’s results show we have kept our commitment to maximise cash and productivity from our world-class assets, delivering $3.6 billion in shareholder returns while maintaining a robust balance sheet,” he said. “At the same time, we strengthened the portfolio and advanced our high-value growth projects as we look to the future.”

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