No Fourth Quarter Surprises for Rio

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Rio Tinto’s fourth-quarter production was broadly as expected. Second-half exploration expenditure of almost USD 1 billion was higher than forecast. The stronger 2013 reflects increased iron ore production, higher alumina prices and improved copper production and costs. Stronger iron ore output is in line with company guidance for expansion in the Pilbara, from 2012′s record 199 million tonnes to 290 million tonnes by end 2013, and then 360 million tonnes by first half 2015. Targets are slightly improved on prior estimates as discussed below.

Rio CEO Tom Albanese said “Markets remain volatile, but our business continues to perform well. Across the group we are taking action to roll back unsustainable cost increases. This further enhances our resilience and competitive edge as we enter 2013.” Despite healthy share price improvement from four-month lows of AUD 49, at AUD 66 the shares remain at a meaningful 25% discount to analysts’ fair value estimate.

Fourth-quarter iron ore production of 52 million tonnes was down marginally on the prior quarter, though above expectations. Debottlenecking and productivity improvements saw nameplate Pilbara capacity increase from 230 million tonnes per annum (Mtpa) to 237 Mtpa by end 2012. The rise was achieved on minimal capital spend and sees first-half 2015 capacity target lifted by the same 2% increment, from 353 Mtpa to 360 Mtpa.

Pilbara sales volumes have lagged production over prior quarters while Rio built stocks in anticipation of expansion to 290 Mtpa. Fourth-quarter 2012 Pilbara sales marginally exceeded production. The iron ore performance continues to impress though being such a high proportion of group earnings is a cause for some concern. Around 50% of our Rio Tinto fair value estimate derives from iron ore. The next largest contributor is aluminium at 30%, followed by copper at 15%. The 30% for aluminium assumes alumina prices improve to over USD 400 per tonne, up from current USD 330 per tonne levels for spot.

Fourth-quarter alumina production fell 2% to 2.6 million tonnes, ahead of expectations. Gove output fell short and the NT refinery may be mothballed late this month following a strategic review. Critical to any stay of execution will be securing long-term gas supply to remove reliance on highcost heavy fuel oil. Gove represents a declining 25% share of Rio alumina output globally as the more efficient Yarwun refinery expansion in Queensland has taken up slack since July. Even without Gove, Rio will still be producing alumina in excess to in-house requirements for aluminium smelting. Also, the aim of the game is profitable production, not production for production’s sake.

Fourth-quarter mined copper production rose 24% to 164,000 tonnes, as we forecast. Copper grades recovered at Kennecott in the United States and at Escondida in Chile. Rio’s Oyu Tolgoi mine in Mongolia began commissioning in November. First concentrate production is expected within weeks but commercial production won’t be until mid-2013. Oyu Tolgoi capacity is 425,000 tonnes of copper and 330,000 ounces of gold. Rio’s effective one-third share furnishes the company with an additional 140,000 tonnes of copper, a meaningful 20% increment on group 2012 production. Oyu Tolgoi would seem an obvious place for Rio to spend some dollars to clean up the rest of Turquoise Hill (nee Ivanhoe) in time. Traditionally, Rio has been very patient when it comes to acquisitions.

 

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