Its Official, Rio Tinto Is Slowing Down

| About: Rio Tinto (RIO)

Summary

Rio Tinto has recently released its fourth quarter production results.

The company missed production numbers.

Rio Tinto has delivered on its promise of reducing inventories that built up during the infrastructure expansion work.

The update has confirmed that Rio Tinto, the world’s lowest cost and possibly the best positioned iron ore producer, is feeling the heat of the downturn.

The next big question is around the sustainability of Rio Tinto’s dividends.

Rio Tinto (NYSE:RIO) has recently released its fourth quarter production results that show that the world's second largest iron-ore producer will continue to push up the red metal's output, though at a slower pace.

Production recap

During the quarter, Rio Tinto managed to post year-over-year growth for all commodities, with the exception of mined copper and titanium dioxide slag. The titanium diosxide slag production fell 30% in the fourth quarter and 25% for the full year as the company optimized output in light of the soft demand.

Click to enlarge

Rio Tinto Q4-2015, FY-2015 Production Review

Copper output fell 13% from last year to 111,100 metric tons in the fourth quarter, missing analysts' consensus estimate of 116,000 tons, due to the de-weighting and de-watering work at Kennecott and lower grades from Escondida. For the full year, copper production fell 16% to 504,400 tons. But with rising output from the US and the Grasberg mine in Indonesia, production is projected to increase 14% to 24% in 2016 to between 575,000 tons and 625,000 tons.

On the other hand, iron-ore production, which is responsible for most of Rio Tinto's revenues and earnings, climbed 10% in the quarter and 11% for the full year to 87.2 million tons and 327.6 million tons respectively, on a 100% basis. This was lower than the median estimate of 91 million tons, according to data from Bloomberg. Rio Tinto's actual share of production for the fourth quarter and full year was a little more than 80%. Quarterly and annual shipments rose 11% each to 91.3 million tons and 336.6 million tons respectively, on a 100% basis. The company ended up slightly missing its own annual shipment guidance of 340 million tons. In 2016, Rio Tinto expects to increase production by 6.8% from 2015 to 350 million tons, on a 100% basis.

But the raw material used to make steel has seen its price plunge more than 75% after peaking in 2011, thanks to weak steel production and demand from China. Just last month, the price fell to its lowest level since May 2009 at $38.30 per dry ton, slightly recovering to around $43 at the beginning of this week. For Rio Tinto, the average realized price fell 42.6% in 2015 as compared to last year to $48.40.

Analysis

Rio Tinto's iron ore production numbers were slightly below expectations, though with the extended downturn fueled by a supply glut, it is unlikely that it is going to be punished due to the small miss.

On a positive note, Rio Tinto has delivered on its promise of reducing inventories that built up during the infrastructure expansion work, which is evident in the higher sales levels as compared to production numbers. In Australia's Pilbara region, home of Rio Tinto's core operation which was responsible for 95% of the company's 2015 iron ore production, the company's sales exceeded production by 4.2 million tons in the final quarter as the miner tapped into its inventories. For the full year, Rio Tinto has drawn nine million tons of iron ore from inventories at Pilbara. Consequently, the company is now left with almost no bulk inventories.

Rio Tinto loads first ship from 290Mt/a expansion program at Pilbara. Copyright © 2014 Rio Tinto

But more importantly, the latest update shows that Rio Tinto is slowing production growth in response to cheap iron ore prices. The company, which has been reporting 11% annual production growth over the last two years, has now planned to significantly curtail growth to less than 7% for 2016. This has, once again, confirmed that even Rio Tinto, the lowest cost iron ore producer with one of the healthiest balance sheets in the industry, is also feeling the heat of the extended downturn in the iron ore market.

Perhaps we are entering in the final phase of the downturn when the major producers - BHP Billiton (NYSE:BHP), Rio Tinto and Vale (NYSE:VALE) -- that own some of the lowest cost mines in the world begin to take drastic steps. Remember, BHP Billiton has already slashed production growth for the current fiscal year, which ends June 30, to 6% from 13% in the prior year.

Still, Rio Tinto is still growing production and aims to set a new record in 2016. Higher production from major miners, though at a slower pace, will continue to exert downward pressure on prices.

Rio Tinto posted significantly lower realized prices which will have a negative impact on the company's revenues, earnings and cash flows. But the silver lining here is that Rio Tinto likely ended up making a decent profit in 2015, given the realized price was significantly higher than the company's estimated breakeven price of around $30.

The next big question is around the sustainability of Rio Tinto's dividends. Will the company follow in the footsteps of other miners, such as Glencore, and slash payouts, or will it continue to reward shareholders through above-average yields? Will it revisit its progressive dividend policy? I believe the persistent weakness in iron ore prices may also force Rio Tinto to make tough decisions, but it will likely be the last miner to reduce payouts. We'll likely get a better picture on the company's future outlook when it releases its full year results on February 11.

Disclosure: I/we 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.