THE DISTILLERY: Rio resolve

Jotters dig around Rio Tinto's interim profit figures, while some are downcast on the latest NBN revelations.

Rio Tinto again demonstrated its relative calm compared to rival BHP Billiton during yesterday’s interim profit numbers. Chief executive Tom Albanese was confident, observes one commentator, despite the much lower figures. But investors should remain acutely aware of two problems Rio has. The first is its aluminium business; it’s a problem full stop. The second is its iron ore business, which is a problem because Rio is so seriously dependent on the stellar unit.

Firstly, The Australian’s Barry Fitzgerald examines the demeanour of Albanese, which contrasted greatly with the tone at BHP, despite the 34 per cent interim first half profit reduction.

"Underpinning his confidence was the fact that Rio had done a bit better than the $US4.9 billion the market tipped. There was no sense of the panic that seems to have taken hold at the likes of BHP Billiton and Xstrata over the impact of the slump in commodity prices on free cashflow, and by extension, what that means for Rio's ability to invest a planned $US16 billion this year and a little less than that next year. Mind you, it has been taking on debt to maintain the pace of expenditure, most of which goes to the bold plan to take annual output in the Pilbara from 230 million tonnes to a whopping 353 million tonnes from mid-2015.”

The Australian’s Financial Review’s Matthew Stevens strikes a similar tone of caution amid better-than-expected numbers.

"On the evidence of the numbers supporting Rio Tinto’s better than consensus profit story, you might be forgiven for pondering whether global mining’s much-vaunted cost crisis has suddenly abated. But you would be wrong. Yes, Rio’s numbers reflect a gentle release of the pressures building on both its structural and cyclical cost lines. Rio noted last night that total cash costs were broadly flat half on half and, after adjusting for volumes and grades, unit cost increases slowed to less than 3 per cent on the June half of 2011. But that is largely the result of less than gentle enforcement of a new prudence by the reputationally rehabilitated duo of chief executive Tom Albanese and his chief financial officer, Guy Elliott.”

Meanwhile, Fairfax’s Malcolm Maiden reminds his readers of Rio’s problem child, aluminium. Parental challenges for this unit remain.

"Aluminium is a chronic problem. Rio has sold assets and cut costs, has more assets up for sale and booked a $US8.9 billion write-down on the business last February. Its crucial assumption when it bought Alcan – that prices would rise over time – has not been borne out as Chinese smelting capacity expands, and even after the February write-down it has almost $US27 billion invested in a division that is earning next to nothing. Iron ore, on the other hand, is an $US18.5 billion business with annualised earnings of $US9.5 billion, based on this half-year result. That's a return on funds invested of 51 per cent. Rio set itself a target of extracting a 40 per cent profit margin from the expanded aluminium business after it acquired Alcan, but if China maintains its presence in the market that is not possible. The real question will be when Rio will announce more write-downs, and, ultimately, whether it should be in the business at all.”

And Business Spectator’s Stephen Bartholomeusz argues that one of Rio’s vulnerabilities is its greatest strength, it’s iron ore business.

"Rio did generate an extra $US366 million from volume increases as its massive expansion of its Pilbara iron ore operations continued, but that was more than offset by $US584 million of volume losses related largely to its copper and gold businesses. The result highlighted again just how good Rio’s iron ore business is, but also how dependent the group is on them, a dependency that will only increase as Rio continues its multi-phase expansion program within the Pilbara. The iron ore operations contributed $US4.75 billion of the $US5.1 billion of underlying earnings – about 93 per cent – and about 80 per cent of earnings before interest, tax, depreciation and amortisation. Given the quality of the business that’s not a bad thing, and it does explain why Rio has focused a large part of its investment program on expanding it. But it does highlight the relatively poor performance of the rest of the group.”

The other big topic out of yesterday’s news cycle was the revelation that the national broadband network is going to cost a little more than expected and less people and connecting that the government would have hoped.

The Australian’s John Durie argues that NBN Co chief executive Mike Quigley has done about all he can three years into the gig, but now he faces a mighty challenge to get a positive return by 2019. Indeed, The Australian Financial Review’s Geoff Kitney explains that fewer than 60,000 premises appear destined to be connected to the national broadband network in a year’s time, compared to the half a million figure the government was hoping to take to the next election. The Australian Financial Review’s Chanticleer columnist Tony Boyd foresees a great big mess, almost regardless of the number of connected users, because of the Coalition’s pledge to stop the project dead in its tracks by 2013.

In other company news, Fairfax’s Adele Ferguson says the key to this profit season will be the outlook commentaries from management, as the profit guidance downgrades have been factored into the share prices. Fairfax’s Insider columnist Ian McIlwraith says John Howard’s former secretary of cabinet Paul McClintock is kind of following in the footsteps of his father at David Jones. The Australian’s Criterion columnist Tim Boreham has put a buy on professional services consultancy Coffey International is a buy, with its share prices having spent about two-and-a-years in a decline of some kind.

Meanwhile, Fairfax’s Peter Cai investigates the signals from China that it wants to reform the way iron ore prices are set to gain greater control. An important read, particularly in the wake of Rio’s results. The Australian’s commodity price watcher Robin Bromby reminds readers that the end of the commodities super-cycle doesn’t mean the definitive end of strong prices across the board. Some will perform well, the writer argues, especially if there’s a third round of quantitative easing.

In local news, Fairfax’s Ian Verrender rekindles his firefight with executive remuneration. The Australian’s economics editor David Uren remakes the case that the budget surplus target for Labor is becoming more of a stretch.

And finally, Fairfax's Tim Colebatch finds that Australian borrowers are leaving the big four banks at an increasing rate for a cheaper interest rate.