Walsh digs deep for Rio on costs

While Rio Tinto's 2013 results may have been disfigured by the usual round of big impairment charges, Sam Walsh’s first year in charge of the group has more than delivered on the promises he made.

The underlying earnings of $10.2 billion, 10 per cent higher than 2012 earnings, were founded on better than expected cost reductions, better than expected reductions in capital expenditure, a big reduction in net debt and the previously disclosed very strong increase in production.

Walsh, who replaced former chief executive Tom Albanese at the start of last year after Rio Tinto suffered from another wave of write-downs, did have to report non-cash exchange losses of $US2.9 billion ($3.207 billion) and impairments of $US3.4 billion, but it is the improvement in the underlying condition of the company that was the result's most striking feature.

Walsh and his chief financial officer, Chris Lynch, had targeted $US5 billion of cash cost reductions over two years, with $US2 billion to be achieved in 2013. They delivered $US2.3 billion of savings.

They had indicated that they would cut capital expenditure by about 20 per cent to $US14 billion from 2012’s $US17.5 billion. They delivered a 26 per cent reduction, to $US12.94 billion.

Net was expected to be around $US20 billion. That has been reduced to $US18.1 billion – $US4 billion less than it was mid-year.

With production records set in the core iron ore business and a rebound in copper volumes flowing over the lower cost base, cash flows from operations surged 22 per cent to $US20.1 billion.

The stronger result and the stronger fundamentals in the business have, despite the focus on restoring some conservatism to Rio Tinto’s balance sheet, enabled it to lift its full-year dividend 15 per cent to 192 US cents. Walsh and his chairman, Jan du Plessis, had promised to improve shareholder returns and are delivering on that commitment, too.

The significance of the attack on Rio Tinto’s cost base and on its capital intensity is that the group was able to improve its underlying earnings base despite lower commodity prices that cost it $US1.3 billion in earnings. Exchange rates did offset that to a large extent (a $US1 billion gain) but it was the lower costs and reduced capital expenditure that drove the positive overall outcome.

While the contribution from Rio Tinto’s iron ore division dominated the results as usual, contributing $US9.86 billion of the $US10.2 billion of underlying earnings, Walsh would be pleased that after fairly brutal and continuing surgery, the aluminium business that nearly brought the group down made a positive contribution of $US557 million – albeit one that doesn’t go close to generating an appropriate return on the drastically written-down value of the assets employed in the division.

While Walsh and Lynch were very focused – and remain focused – on cutting costs, releasing capital and restoring the miner’s balance sheet, Rio Tinto still commissioned five new big projects during the year, including the Pilbara iron ore expansion to 290 million tonnes per annum and the Oyu Tolgoi copper-gold open pit mine.

They’ve also overseen the development of a new approach to lifting Pilbara production to 360 million tonnes a year at a $US3 billion lower capital cost than previously thought.

The differing impacts of commodity price movements and increases in volumes, however, explain why the focus remains on costs and capital intensity. Where lower prices did, as noted earlier, reduce earnings by $US1.3 billion, the bigger production volumes only added back $US538 million.

The iron ore price has slipped this year to around $US120 a tonne amid forecasts that it will fall further, for cyclical reasons but more particularly because the market is moving quite rapidly towards a surplus – and a large one – of supply over demand.

Rio Tinto expects to achieve its $US3 billion target for lowering operating costs this year, relative to the 2012 starting point, and to reduce capital expenditures to less than $US11 billion this year and to about $US8 billion in 2015.

Debt reduction and further strengthening of the group’s balance sheet remain a priority this year.

Walsh promised a stronger, simpler Rio Tinto more focused on shareholders when he took on the chief executive role. So far he, despite the ambitious targets he set, he has over-delivered.

Given the uncertainties around prices and China’s demand for commodities, Walsh won’t, however, have the luxury of resting on his laurels.