Australia’s second great diversified miner reported earnings late yesterday that nicely capture Australia’s new economy. Our second largest miner and the nation itself has become fantastically dependent upon the fate of a single commodity: iron ore. And there seems little the company can do about it.
Over the 2013 calendar year, Rio Tinto delivered $51 billion in revenue, down 15.8% on 2011. Profits collapsed from $6.8 billion to -$3 billion on the huge writedowns in the aluminium and coal divisions.
But that is past and not the story that matters for the future.
Rio is quite simply a failing diversified miner, with the emphasis on “diversified”. A look into its different divisions shows just how dependent Rio has become on iron ore. Pilbara dirt accounted for only 44% of the group’s revenue but 90.1% of its profits. Copper contributed the other 10% or so.
Rio does all sorts of stuff — aluminium, coal, diamonds, minerals even salt — but they contribute next to nothing to its bottom line. In short, Rio is a giant Fortescue with a bunch of failing businesses tacked on to make it appear diversified and unattractive to suitors.
That’s fair enough, but in the long term the company looks worryingly exposed to emerging macro trends. Treasury confessed yesterday to the Senate that it had over-estimated the durability of Australia’s terms of trade boom and that it now expects iron ore and coal prices to resume falling steadily as the tsunami of supply that is building in both sweeps ashore.
This is without considering some of the more bearish scenarios being put about by Ross Garnaut and Bob Gregory that Chinese demand growth is also likely to wane for iron ore and fall outright for coal. One thing Treasury does not seem to have learned is that markets have a habit of ignoring imbalances until they correct rather suddenly.
Can we say better for Rio?
Well, it does have exposure to copper, which is a big component in consumer goods and should fare well as China shifts its growth model from investment drivers to consumption drivers. That’s something.
But Rio is the only miner to not yet alter its capex plans for iron ore expansion over the next three years following the big price falls last year. Nor has it altered its strategy of driving as much iron ore to market as is possible. Given it has forecast its cash cost for iron will fall near the $30 mark per tonne, this makes a certain amount of sense as it can take market share even as the price falls. (It does come with the risk that price falls will overtake volume gains.)
Rio has also recently appointed its former long-term head of iron ore operations, Sam Walsh, to head the firm. And Walsh has wasted no time in mooting divestment of parts of the struggling aluminium operations.
This is welcome enough given the division makes only $3 million off revenues of $10.1 billion. But again, one can’t help wondering whether the appointment of an iron specialist is altogether forward thinking. And reducing the aluminium business will necessarily increase the weight of iron in revenue if not profits.
Given Rio is still digging its way out of the big aluminium purchase of Alcan, there’s likely to be little market appetite for any new large-scale acquisitions that might offer diversified earnings potential.
It seems Rio, like Australia, is fused to the fate of iron ore.