S&P downgrades Rio outlook

RATINGS agency Standard & Poor's says Rio Tinto's debt is rising faster than expected and has downgraded the outlook for the diversified miner to negative, while reaffirming its single-A credit rating.

Unless Rio makes large asset sales or iron ore prices remain above $US120 a tonne, S&P warns, its debt will continue to rise through 2013-14, risking a credit downgrade.

Rio reported gross debt of $US26.7 billion as of December 31, up 24 per cent on a year earlier, higher than S&P expected.

Rio is aiming to retain its single-A credit rating and is targeting $US5 billion in cost savings over the next two years. It is also seeking to sell assets including its struggling Pacific Aluminium division and the diamonds business.

S&P highlighted Rio's exposure to volatile iron ore markets, assuming iron ore prices of $US120 a tonne in 2013, easing back to $US110 a tonne in 2014. Spot prices for iron ore imported into China are now at $US151.90 a tonne

S&P is primarily concerned about a two-thirds decline in the ratio of Rio's funds from operations to its adjusted debt, which fell from 85 per cent in 2011 to just 30 per cent in 2012, as a result of weaker cash flows caused by lower commodity prices and the lagged impact of higher income tax payments levied on the previous year's profits.

S&P expected higher funds from operations (FFO) in 2013 and said if Rio could lift the ratio of FFO to debt above 40 per cent the ratings outlook would revert to stable.

Deutsche Bank analyst Paul Young said it was difficult to judge the significance of S&P putting Rio on negative watch, saying: "The question is, how significant do debt markets and lenders think it is?"

He said S&P took a more conservative view of Rio's future cashflows, being unwilling to "bank" income from divestments or cost-cutting.

Deutsche analysts believed Rio would raise significant funds from both avenues and Mr Young said even if S&P was to downgrade Rio's credit rating, for example from single-A to BBB+, it would be temporary and would not have a material impact on Rio's funding costs.

Rio Tinto had $US7.1 billion in cash at the end of 2012, he said, more than enough to meet loan maturities of $US2.2 billion this year and about $US2.6 billion in 2014.

"It's not as though they don't have (funding) options," Mr Young said.