Walsh takes charge of miner at the right time
Tom Albanese lost his job as Rio CEO last month when the write-downs were foreshadowed, and Rio's new chief executive, former iron ore division boss Sam Walsh, said the right things when he discussed Rio's result on Thursday evening.
He would bring greater clarity and accountability to decision-making, he said, and ensure that Rio invested only in assets that offered returns that were well above its cost of capital, and were superior to returning cash to shareholders.
That comment and comments that Rio was aiming at "significant cash proceeds" from asset sales and would balance the use of capital between returns to shareholders and capital expenditure signal that the group is looking for ways to boost shareholder returns, and perhaps at sending more money directly to shareholders. A 15 per cent increase in full-year dividend despite the big impairment charges was perhaps another: the group does not boost the dividend unless it believes it can defend it.
Rio would not funnel cash back to its investors in volumes that threatened its single A credit rating, and Walsh said that Rio was not dramatically changing course. He also said, however, that Rio would not invest in growth for growth's sake.
Rio's new determination to avoid costly mistakes needs to be tested in the field. The group said much the same thing after it realised that its $US38 billion takeover of Alcan in 2007 had been a disaster - three-quarters of the purchase price has been written off after the latest $US11 billion aluminium division hit - and then went out and bought the Mozambique coal business that has separately produced an impairment charge of $US2.9 billion.
Walsh knows the iron ore business he ran until last month is surging. Its earnings fell by 31 per cent from $US13.3 billion to $US9.2 billion in 2012 but it still carried the $9.3 billion underlying group profit, and iron prices are now higher.
They averaged $US128 a tonne in 2012, were as low as $86.70 early in September, and finished the year at $145 a tonne. Iron ore is $US155 a tonne now, and has averaged $US151 a tonne in 2013.
We can't know if the iron ore price strength will continue. Demand from China is, as usual, the key. But every $US1 a tonne extra is worth about $US200 million of revenue that flows cleanly to Rio's earnings. At $US155 a tonne, in other words, the uplift if sustained is worth about $US4.6 billion: Sam Walsh may have taken over at just the right time.
mmaiden@fairfaxmedia.com.au
Frequently Asked Questions about this Article…
The article says Rio Tinto took a $US14.4 billion impairment charge that hit reported results. Even excluding impairments, its underlying operating profit fell sharply in 2012 (from about $US15.55 billion to $US9.3 billion), so the write‑downs were a big headline item but the business also experienced a material fall in operating earnings.
Sam Walsh is Rio Tinto’s new CEO and the former head of its iron ore division. The article notes he’s promising greater clarity and accountability, that Rio will invest only in projects that deliver returns well above its cost of capital, and that the group will balance capital spending with returns to shareholders — all signals investors watch closely.
Iron ore has jumped from around $US86.70/tonne in September to about $US155/tonne, according to the article. It explains every $US1/tonne increase is worth roughly $US200 million of revenue flowing to Rio’s earnings, so the price strength — if sustained — could add billions to Rio’s profits (the article estimates about $US4.6 billion at current levels).
The article points out Rio increased its full‑year dividend by 15% despite the impairment charges, suggesting management is looking for ways to boost shareholder returns. However, Walsh said the company won’t return cash in amounts that threaten its single‑A credit rating and will balance returns with necessary capital expenditure, so any extra payouts are likely to be measured and conditional.
According to the article, Rio will only back assets that offer returns well above its cost of capital and that are superior to simply returning cash to shareholders. In short, management is signalling a tighter, more disciplined approach to approving new projects to avoid costly mistakes.
The article says Rio is aiming for 'significant cash proceeds' from asset sales and intends to balance the use of capital between shareholder returns and capital expenditure. That means selling non‑core assets could free up cash to boost dividends or buybacks, but the company will weigh this against maintaining its credit rating and funding worthwhile projects.
Yes. The article highlights that Rio’s $US38 billion takeover of Alcan in 2007 turned into a costly mistake — much of the purchase price has been written off after large hits in the aluminium division — and the Mozambique coal purchase also produced a $US2.9 billion impairment. These examples explain why management is stressing discipline.
The article flags a few watch‑points: the sustainability of higher iron ore prices (which depend heavily on demand from China), the execution of Sam Walsh’s tighter investment discipline, the pace and impact of any asset sales, and the company’s commitment to protect its single‑A credit rating while returning cash to shareholders.
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