Rio Tinto: Result 2017

That this would be a strong result was never in doubt. Iron ore, copper and even coal prices have risen and, in aggregate, higher commodity prices added US$4.1bn to Rio Tinto's full-year profit.

The best thing about this cracking result from Rio, though, was disciplined capital expenditure and thoughtful project development. It's easy to be conservative and show restraint in a low price environment when growth options are limited and debt discouraged. Yet resource markets are unquestionably strong and Rio's restraint continues.

Operating cash flow swelled by 60% to over US$13bn and the miner generated a staggering US$9.5bn in free cash flow. Yes, that's close to US$10bn cash after capital expenditures.

We've seen profit figures like this in the past but they have always been accompanied by grand ambition and copious cash outflow. No longer.

Rio will use US$6.2bn to fund dividends and buy backs while pursuing several high-quality, high-return projects even as it divests its coal interests.

Once divestments are complete, Rio will comprise the world's best iron ore business, a high-quality copper business, industry leading aluminium assets and a collection of esoteric specialty minerals. The business has never looked better.

Cost control

If we are gushing, it is because portfolio tweaking has been accompanied with impressive cost control and stunning efficiency gains.

Rio's iron ore business is forecasting unit production costs of just US$13 a tonne – it is the highest margin iron ore producer in the world. A further US$5bn in productivity gains have been outlined over the next few years as Rio reaps the benefit from investment in automation and efficiency gains; the business is a world leader in the use of driverless trains and trucks.

Rio's balance sheet continues to strengthen and now carries net debt of just US$3.8bn – a token sum. It is only a matter of time before some banker or private equity firm targets Rio for a lazy balance sheet and encourages acquisition and volume growth. Rio has held steadast and, hopefully, stupidity can be avoided.

Stronger aluminium

Iron ore is, of course, the key commodity, generating about 70% of earnings but aluminium remains a bright spot and now contributes over US$1.5bn in earnings to the group. Five years ago, aluminium profits totaled just US$50m.

Importantly, these assets are low cost and underutilsed with Rio nursing significant latent capacity in both power generation and output which could be cheaply utilised if prices rise. Earnings from the division have improved but could still rise substantially as industry conditions improve.

We've been iron ore sceptics and must acknowledge we've been wrong. China's dominance of both output and sales has made that market more opaque than ever and our negativity on the commodity has softened into neutral ignorance.

It's not expensive

Although Rio's share price doesn't appear dear on multiples – using spot prices places it on an enterprise value to earnings before interest, tax, depreciation and amortisation (EV/EBITDA) multiple of about 4 times – this is not the way to value a miner.

We estimate the iron ore division alone is worth over $50 a share and the aluminium business another $15 or so. That doesn't count copper, diamonds and specialty minerals which are all valuable bits of the business. Today's share price of $77 doesn't appear excessive against outstanding asset quality and best in industry costs.

We're raising our price guide and would consider upgrading Rio below $65. For now, HOLD.