Rio Tinto (ASX: RIO) released its half-year result earlier this week and, on the whole, it was a good one.
Higher prices and volumes allowed the company to offset rising costs (especially in relation to labour and inputs). The meant 2018 first half underlying earnings before interest, tax, depreciation and amortisation (EBITDA) of US$9.2bn, up slightly on the US$9.0bn earned in the first half of 2017.
Sharply lower net interest costs contributed to a 12% rise in underlying earnings, from US$3.9bn to US$4.4bn.
With the company now pursuing a “value over volume” strategy, investors continue to be showered with cash. Dividends were raised 15%, to US$1.27 per share, and more buybacks announced. An additional US$4bn in after-tax proceeds from the disposal of non-core assets will also be returned to shareholders in due course.
And although net debt rose slightly, to US$5.2bn, compared to US$5.0bn at 31 Dec 17, it remains modest compared to the large cashflows generated by Rio.
(A few) clouds on the horizon
However, it appears investors were expecting even better results, and have marked Rio shares down 6%, to $76.81, at the time of writing.
One reason could be that cost inflation has returned to the mining industry after years of cost deflation. In the result, Chief executive J-S Jacques noted that “inflationary pressures are being experienced across the industry”.
So it remains a question as to whether commodity prices can keep rising to allow Rio to continue to offset rising input costs, especially given the company’s sterling efforts to cut controllable costs in recent years likely mean there is less scope for it to continue to do so in this area.
If they don’t, then margins will likely fall.
Still a bet on iron ore
And while the company is investing in a couple of major growth projects – namely the expansion of its Amrun bauxite operation in northern Australia and its majority-owned, Oyu Tolgoi underground copper mine in Mongolia – investing in Rio essentially remains a bet on the iron ore price.
This is illustrated in the divisional (or “Product Group”) results. Iron Ore earned US$5.7bn in EBITDA in the first half of 2018. This represented 57% of total divisional EBITDA and significantly more than the total EBITDA of US$4.2bn earned by the Aluminium, Copper & Diamonds and Energy & Minerals divisions combined.
Commodity prices are notoriously hard to predict and I don’t claim any special skill on that score. However, at least Rio – like counterpart BHP (ASX: BHP) – has a portfolio chock full of Tier 1, long-life, low-cost mining assets. This places it in good stead to keep throwing of lots of cash if commodity prices remain at around current levels or go higher, while also putting it in prime position to deal with the next mining bust.
And until that next bust, I prefer to watch Rio – and BHP – from the sidelines.