Rio Tinto's Long-Term Profit Machine: Iron Ore

| About: Rio Tinto (RIO)

Rio Tinto (NYSE:RIO) will increase its iron ore production by a further 15% in 2013, after it rose to 253 million tons in 2012, above the target itself. The company took into consideration the recovery in China and the demand for iron ore internationally. Rio Tinto is the second-largest producer of iron ore after Vale and it has continued an aggressive expansion plan despite fears about China's stalled growth, the world's largest buyer of the commodity. Below, I will assess how Rio Tinto's decision to increase its iron ore production will increase its long-term profitability and revenue.

Rio Tinto Is Right to Concentrate on Iron Ore

According to Tom Albanese, former chief executive of the company, there is a lot of volatility in the markets, but Rio Tinto's 4th-quarter results revealed good performance, which is a good sign for investors. Rio Tinto had a target to produce 250 million tons of iron ore in 2012 after 245 million tons in the previous year. Probably this was the result of investments to the tune of $4.2 billion in its iron ore operations in Australia and Guinea.

Iron ore accounts for 60% of the company's revenue, but Rio Tinto still resisted cuts to its expansion plans despite a long period of weakness in the sector last year, believing that its supreme ore quality and low costs would yield operating margins over the cycle. In my point of view this is exemplary of great decision-making and will give good results.

During the same press conference, ex-CEO Albanese warned investors to be tolerant of slightly below-average business results. The company has isolated its aluminum division, its most expensive, in the custody of Pacific Aluminum hoping for a total or partial sale. Investors should consider this a "nip it in the bud." By concentrating on iron ore and divesting its aluminum division, Rio Tinto is ensuring that it will not spend a lot of money unnecessarily.

Iron Ore Demand Increasing

UBS predicts that Rio Tinto will have a slight decline in earnings before interest and taxes in 2012 and may result in an earnings of $13 billion, down from $15.3 billion in 2011, as the price of iron ore was below normal much of the year. But this is not the scenario that I foresee for 2013 because Rio Tinto's revenue should increase. At the end of last year, ore prices rose again by 30%, although much of this depends on the high demand from China this year. Rio Tinto predicts an annual production of 291 million tons of iron ore during 2013 before attempting to pass 360 million upon approval of the board of the company. That number already considers iron ore mines in Canada.

The company said it requires the approval of its council board to increase production to 360 million tons, which would make Rio Tinto surpass Vale (NYSE:VALE) as the world's largest producer of iron ore. It's a challenge, but not impossible for Rio Tinto to achieve this goal. Vale produced 322.6 million tons in 2011, and will announce the figures of 2012 next month.

Rio Tinto Surges Ahead of Competitors

Vale will invest $1 billion to increase the handling capacity of the port terminal of Ponta da Madeira (TPPM), Maranhão, from 115 million tons to 150 million tons. According to the company's statement, the investment includes the installation of a new docking pier, a Pier IV, and dredging works to expand the depth of the harbor. This investment also includes doubling the Carajás railroad ((NYSE:EFC)), to 115 miles. Also according to information from Vale, with an increased capacity, the TPPM may receive and load two ships simultaneously. Facing large vessels, the pier will be designed to ship between 150,000 and 400,000 tons.

BHP Billiton (NYSE:BHP) has suffered a New Year's rating downgrade by analysts. BHP was the hardest hit, with Bank of America and Merrill Lynch dropping its rating on the stock to "underperform," in part because of doubts about the company's revenue growth. The downgrade by Merrill with regard to large mining stocks in recent months were due to a decrease in these types of commodities, although the scenario is already starting to change.

Toronto-based Barrick Gold (NYSE:ABX) announced commercial production at Pueblo Viejo in the Dominican Republic, adding a new mine and a new country to its list of global operations in North America, South America, Africa and Australia. The mine is a small victory for Barrick at a time when it is struggling with huge cost overruns and a delay of one year in the Pascua Lama gold and silver mine being built between Chile and Argentina.

In turn, the mining company AngloGold Ashanti (NYSE:AU) provoked considerable protest because of ore processing in a central Colombian city 50 miles west of the capital Bogota. Hundreds of protesters gathered in Doima, a small town in the department of Tolima to protest the ore processing plant in AngloGold Ashanti site. The protesters were concerned that the processing of gold ore, which uses large amounts of water and requires chemicals, often including cyanide, would diminish and pollute local water sources.


With a market of $102 billion and an enterprise value of $116 billion, Rio Tinto is the second-biggest mining company in the world. Its profit margin is impressive at 7.26%, and its revenue is $57 billion. Though Tom Albanese resigned, he was replaced by the director of iron ore, Sam Walsh. Considering how important iron ore is going to be for Rio Tinto, this was indeed the best thing to happen to the company. I strongly believe in the future of this company because it is taking the right steps to increase its revenue by cutting on expenses and investing in iron ore processing. Moreover, by concentrating on iron ore more than other commodities, Rio Tinto will be able to give Vale a run for its money. In the long term, this strategy will help Rio Tinto to increase its revenue by exploiting commodity demand in China, India and elsewhere in the world.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.