Today I am looking at why I believe Rio Tinto (LSE: RIO) (NYSE: RIO.US) is set to experience deteriorating earnings over the medium to long term.
Commodity prices set for fresh weakness
The effect of macroeconomic uncertainty whacking investor confidence, combined with worsening supply/demand balances across many of its key markets, continues to threaten Rio Tinto’s earnings prospects. This caused underlying earnings to crumple 18% in January-June, to $4.2bn.
And analysts expect Rio Tinto’s key markets to suffer sustained frailty over the medium term. In particular, Bank of America-Merrill Lynch expects iron ore — responsible for around three-quarters of the firm’s underlying EBIDTA in 2012 — to slip from an average of $125 per tonne in July-December to $110 in 2014. Other key markets copper and aluminium are also expected to suffer from declining prices over the next year.
Trouble in Mongolia
Rio Tinto received bad news last month in the underground development of its gigantic Oyu Tolgoi copper mine in Mongolia, after the government there said that the company’s project financing plan needed to be approved, a situation which could take some time to be resolved.
The update follows earlier tussles with the Mongolian government over how Rio Tinto future revenues from Oyu Tolgoi should be distributed, and the firm warned that lengthy delays should be expected. The mining giant has been planning for maiden production to occur in 2016 but the saga could disrupt this timetable.
Major divestments still to be executed
Relentless earnings pressure due to subdued commodity prices and high operating costs has forced Rio Tinto into an extensive cost-cutting and streamlining exercise, which includes spinning off a number of its most underperforming assets.
However, the effect of a poor outlook for commodity prices having a massive effect on deterring buyers from pitching what Rio Tinto deems to be a fair price for its most unproductive non-core businesses.
Last month the company halted the sale process of its Pacific Aluminium business as it did not consider bids to match the arm’s true valuation, and in June decided to initiate a u-turn on selling its diamond assets. And the protracted sale of its Iron Ore Company of Canada business also looks set to rumble on.
Rio Tinto has received some cheer in this area, however. In July it sold its 80% stake in Northparkes gold and copper project to China Molybdenum Company for $820m, and followed the sale of its US Eagle nickel and copper business in June to Lundin Mining Corporation for $325m.
But still has some way to go in its asset sales drive to cast adrift its heavy loss-making divisions and tidy up the balance sheet, a situation which could become harder as already-poor market conditions look set to worsen.
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> Royston does not own shares in Rio Tinto.
