Rio Tinto Shows Steel as Commodities Swoon – by Helen Thomas (Wall Street Journal – February 12, 2015)

Miner Increases Dividend, Unveiled Buyback Despite Commodity Price Weakness

Rio Tinto is getting over its existential angst about a lack of diversification.

The not-so-diversified miner relies on iron ore for more than 70% of its cash flow, and the price of the steelmaking commodity has tumbled by about 50% over the past year. Yet Rio on Thursday boosted its dividend and announced a $2 billion share buyback. Stranger still, that doesn’t look too foolhardy.

Rio’s efforts have created space to increase returns to shareholders, even at a time when iron ore, copper and other commodity prices are under pressure. Cost cutting helped shore up profitability. Capital spending of about $8 billion was $1 billion lower than expected. A large improvement in working capital helped Rio’s net debt drop sharply. At 19%, net debt to total capital is below the bottom end of Rio’s 20% to 30% target range.

The miner’s $14.3 billion in cash flow from operations last year nicely covered its capital expenditure and about $4 billion in dividends. The planned buyback would only push its gearing to 21%.

For the moment, it looks as though Rio can keep this up. There is a clear risk that iron ore stays lower for longer. About 300 million metric tons of low-cost production is set to come onto the market before mid-2017, according to Morgan Stanley, 18% growth from last year’s supply.

Even this year, Rio’s expectation for high-cost production coming off the market won’t balance added supply, with little confidence in the strength of China’s demand.

Were iron-ore prices to languish at current levels, it would knock this year’s earnings and cash flow down by roughly $4 billion compared with last year’s.

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