Markets: Rio Tinto's services surgery

If airline and mining services executives listened yesterday to Rio Tinto’s chief financial officer Chris Lynch, they could be forgiven for suppressing a shudder. Lynch is embarking on further surgery in order to get $US5 billion of cost cuts this year and next. He has already made $US977 million in operating cost savings in the first six months of 2013. 

Nothing, it seems, will be spared at Rio in an effort to get costs down. The world’s biggest iron ore miner has about 1,500 cost cutting projects. In Western Australia, Qantas Airlines’ Network Aviation and Virgin Australia’s Skywest can’t expect the same profits on routes to the Pilbara from Perth. Lynch says Rio is pushing for more competition. No doubt Lynch still thinks the company is paying too much for airline seats and will pressure the airlines to cut their prices if they still want Rio’s business.

For Qantas and Virgin this could not come at a worse time. A rising oil price and a weaker Australian dollar are hitting their bottom line. Both rely on flights to the mining camps for a substantial chunk of their revenue. In Qantas’ case, it’s about 25 per cent of its Australian profit. Virgin badly needs the fly in and fly out business. It expects a 2013 loss of as much as $110 million. Its brand has suffered further damage this week after its ticketing system experienced yet more problems that resulted in long delays and very unhappy customers.  

Virgin’s shares are down 7.7 per cent this week to 42 cents. Qantas has fallen 1.2 per cent to $1.23 during the same period.

Mining services companies are in a similar dilemma. Rio’s contractor spending will fall in the second half of this year and into 2014, says Lynch. He says Rio is renegotiating mining services contracts. It wants those who keep the company’s mining equipment and transport equipment running, and its workers housed and fed, to accept less money. Global mining equipment contractors too will have to offer Rio better rates, as will those providing accounting, banking and legal work.

Among the mining services shares that have fallen this week, Emeco’s shares have plunged 16 per cent to 21.5 cents, Boart Longyear is down 6.4 per cent to 51 cents and WorleyParsons has slid 3 per cent to $21.30. 

The mining titans are singing from the same hymn book. Sam Walsh, Rio Tinto’s chief executive, talks mostly of costs savings and productivity improvements. He wants Rio Tinto’s employees to treat the company’s money “as if it was their own”. BHP Billiton’s chief executive Andrew Mackenzie, himself a former Rio executive, stresses the same themes, particularly productivity improvements. Some of this is to convince a sceptical institutional investor audience that they do really get it. The fund managers, who were happy to ride the tide of the mining boom, now want more parsimony. That is affecting companies far and wide.