S&P downgrades Rio outlook
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.
Frequently Asked Questions about this Article…
S&P downgraded Rio Tinto's outlook to negative while reaffirming its single-A credit rating. The agency said Rio's debt is rising faster than expected — gross debt was US$26.7 billion at December 31, up 24% year‑on‑year — and warned that without large asset sales or sustained high iron ore prices the company's debt could keep rising through 2013–14, risking a ratings downgrade.
S&P flagged Rio's exposure to volatile iron ore markets and modelled iron ore at US$120 a tonne in 2013 easing to US$110 in 2014. If iron ore prices remain above about US$120 a tonne or Rio completes big asset sales, S&P says that would help prevent further debt increases; spot iron ore prices imported into China were around US$151.90 a tonne at the time of the report.
Rio is targeting US$5 billion in cost savings over the next two years and is seeking to sell assets, including its Pacific Aluminium division and its diamonds business. The company has said these measures are aimed at retaining its single‑A credit rating.
The FFO-to-adjusted-debt ratio measures how much cash Rio generates relative to its debt. S&P highlighted that the ratio fell from 85% in 2011 to about 30% in 2012 because of weaker cash flows and higher tax payments. S&P said if Rio can lift that ratio above 40% (with higher FFO), the ratings outlook would likely revert to stable.
At the end of 2012 Rio had US$7.1 billion in cash. Deutsche Bank noted that was more than enough to cover loan maturities of about US$2.2 billion in 2013 and roughly US$2.6 billion in 2014, giving the company room to manage upcoming debt repayments.
Deutsche Bank analysts said that even if S&P were to downgrade Rio from single‑A to BBB+, they expected any downgrade to be temporary and not to have a material impact on Rio's funding costs, suggesting the company would retain access to funding options.
Investors should watch Rio's debt trajectory, progress on planned US$5 billion cost savings and asset sales, and iron ore price moves. Because S&P took a conservative view of future cash flows (not assuming divestment or cost‑cutting proceeds), a failure to improve cash generation or complete sales could increase downgrade risk.
Deutsche Bank's Paul Young said it's hard to judge how seriously debt markets will react to S&P's negative watch. He noted S&P is being conservative by not 'banking' divestment or cost‑cutting income, while Deutsche analysts believe Rio can raise significant funds from asset sales and savings and that funding options remain available.
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