(Updates to add Citigroup’s estimate in eighth paragraph.)
Aug. 8 (Bloomberg) -- Rio Tinto Group Chief Executive Officer Sam Walsh said the world’s second-largest mining company is on its way to becoming a “cash machine” for investors as an 18-month cost-cutting drive starts to bear fruit.
“We’ve got the vision that we can in fact deliver on increased shareholder returns,” Walsh said yesterday in an interview after Rio reported an estimate-beating 21 percent jump in earnings and raised its dividend. “Investor returns are very important to me personally and to the board. But it’s getting the balance between growth and shareholder returns.”
BlackRock Inc. is among major mining investors that have campaigned for shareholders to get priority after CEOs frittered away cash on failed acquisitions and a $250 billion investment spree that flooded metals markets. Rio has stripped out $3.2 billion of expenses since 2012, reaching a target six months early. Yesterday it said it intends to carve out a further $1 billion by the end of next year.
“This does become a cash machine” and that enables “material increases in shareholder returns,” the 64-year-old Australian CEO said in London, referring to the benefits of beating its cost-reduction target. “It’s good news for the organization, it’s good news for investors.”
Rio yesterday increased its dividend by 15 percent and made a commitment to raise the payment further. The London-based miner reduced projected spending for this year by $2 billion, after trimming $1.9 billion off net debt since the end of 2013.
Rio’s first-half underlying profit of $5.1 billion rose from $4.2 billion a year earlier. It exceeded the $4.5 billion average estimate of 10 analysts surveyed by Bloomberg. Net debt fell to $16.1 billion, meeting Chief Financial Officer Chris Lynch’s previous target for debt to be in the “mid-teens” prior to considering boosting returns.
“The priority for the company this year is strengthening the balance sheet,” Investec Plc analyst Hunter Hillcoat wrote yesterday in a note. “It is making excellent progress.” That “could offer upside potential to future shareholder returns,” he wrote.
Rio could return $2.6 billion to investors next year, $3.2 billion the year after and $5.5 billion in 2017, assuming a net debt target of $15 billion, Citigroup Inc. analyst Heath Jansen wrote today in a note to clients. Rio may buy back $3.5 billion of shares next year and still keep net debt within its targeted range, Macquarie Group Ltd. estimated in a report today. That’s down from its March projection of $10 billion after iron-ore prices declined.
“There’s pretty good scope there for the board to have some fairly good news there in the early new year,” Rio Chief Financial Officer Chris Lynch told reporters on a conference call yesterday.
Rio rose 0.2 percent to 3,378 pence by 8:43 a.m. in London.
Bond investors are also showing their approval, with the cost of protecting Rio debt against non-payment dropping yesterday to 84.5 basis points, the lowest level in three months versus the benchmark iTraxx Australia index of credit-default swaps, CMA prices show.
“This was certainly a very strong result and one which supports Rio’s credit profile and ratings,” Michael Bush, the Melbourne-based head of credit research at National Australia Bank Ltd., said today in a note. The company’s credit metrics are “unequivocally” stronger than the comparable period a year earlier, he said.
The miner is rated A- at Standard & Poor’s and Fitch Ratings, the seventh-highest grade, and the equivalent A3 at Moody’s Investors Service.
Sales of iron ore, which accounted for almost 90 percent of Rio’s profit last year, will influence how well Walsh’s cash machine is supplied, said Jeff Largey, an analyst at Macquarie. Key to prices for the ore is demand for the steelmaking raw material in China, Rio’s largest market.
“The size of shareholder returns could depend heavily on how iron-ore prices evolve during the second half of the year,” Largey said by phone in London. “The best outcome for shareholder returns is if iron ore prices recover in the fourth quarter due to a Chinese steel mill re-stock.”
The price of the raw material slumped 30 percent in the first half as global mine expansions led by Rio deepened a glut. Prices will extend a drop through 2015 when an increase in supply is set to accelerate, Goldman Sachs Group Inc. said this week. The bank kept its forecast for the steelmaking ingredient at an average of $80 a ton in 2015 from $106 this year.
“If iron-ore prices flat-line through year end, it may limit Rio’s flexibility when it comes to returning capital to shareholders,” Largey at Macquarie said.
Rather than preparing for mergers and acquisitions, Walsh said he is focused on growing through existing projects. These include Rio’s Pilbara iron-ore business in Western Australia, copper projects in Peru and the U.S., a $20 billion iron ore project in Guinea and an expansion of its Oyu Tolgoi copper and gold operation in Mongolia.
“We are not looking at any major M&A,” Walsh said in the interview. “It doesn’t mean that that’s for all-time. But I believe we’ve got enough organic growth to actually meet our growth targets certainly in the near to medium term.”
--With assistance from Benjamin Purvis in Sydney.