Only a few years ago Rio Tinto (LSE: RIO) was the mining sector’s model company. Specialising in mining iron ore the company had the lowest production costs and highest profit margins of its peer group. Moreover, the company boasted a strong balance sheet and returned most of its profits to investors via dividends and the occasional share buyback.
Similarly, BP (LSE: BP) was once the pride of the UK oil industry, with a world-beating oil trading arm, cash-rich balance sheet and the largest portfolio of renewable energy assets operating alongside the core hydrocarbon asset portfolio.
However, during the past five years, Rio’s fall from grace has caught many investors, analysts and even the company’s management by surprise. And BP’s fortunes suddenly turned on that fateful day in 2010 in the Gulf of Mexico.
Rebuilding reputations
Both companies are now trying hard to restore their reputations and profitability. BP has put the majority of the Gulf of Mexico disaster behind it now, having agreed on a multi-billion dollar settlement with US authorities last year. And while the company is now facing another problem — the depressed price of oil — at least it can now focus its efforts on just this one main issue.
Rio is trying to grapple with low commodity prices, namely weak iron ore and coal prices. What’s more, after years of fruitless spending during the commodity boom, the company is suffering from a debt overhang and expensive glory projects are failing to live up to expectations.
Still, both BP and Rio have what it takes to stage a comeback, and they’re both already making solid progress.
Making progress
Rio has slashed its dividend payout to investors and has abolished its progressive dividend policy, a sensible decision that will see the company paying more out to shareholders during periods of excess profit, and less when profits fall. This gives the company financial flexibility, room to pay down debt, and make select acquisitions.
Also, Rio continues to report the best profit margins in the industry, has slashed capital spending, and is cutting costs further to deal with the downturn. Not only will this strategy enable the company to remain profitable while times are hard, but when commodity prices recover the group will see an explosive recovery in profits.
Meanwhile, BP is aggressively cutting costs, selling assets and positioning itself for a protracted downturn.
BP is already saving billions from a lower cost base. Controllable cash costs in 2015 were $3.4bn lower than in 2014 and are on track to be close to $7bn lower in 2017. Just like Rio, BP’s actions now will accelerate the company’s recovery when commodity prices improve. Indeed, according to City analysts Big Oil as a whole, which includes the likes of BP, will have cut the break-even cost of a barrel of oil from an average of $80/bbl in 2014 to less than $60/bbl in 2017.
BP has plenty of financial firepower to wait for the oil price to recover. As of 31 December, BP had total debts of $53bn, cash of $26.6bn and a net debt-to-equity ratio of 27%.
