The world's third largest mining company Rio Tinto (NYSE:RIO) is consolidating its assets as Ivanhoe Mines (IVN) CEO and founder Robert Friedland resigns. Rio owns 55% of Ivanhoe, and the two companies recently reached a financing deal worth $6 billion that will push forward construction on Ivanhoe's Oyu Tolgo mining project in Mongolia. Additionally, Rio will be filling seats among Ivanhoe's executive, which in my mind, essentially adds up to a takeover.
If Rio does acquire Ivanhoe, even on an informal basis, the former's profit margins are likely to expand exponentially, since Ivanhoe will mostly pay for itself once its newest mine becomes more established, in my opinion. In this way, the profits that Ivanhoe produces for investors will flow into Rio's coffers with little ongoing expenditure on the bigger company's part.
Currently, Rio's balance sheet is in good condition, especially when compared to the debt load it had a few years ago. To me, this shows wise management in the face of financial tension, and this ability to keep a good grip on the situation could extend to Ivanhoe's operations if Rio controls it more closely. It also indicates that Rio is one of the strongest stocks for the long-term, because short-term economic problems like the European Union's debt crisis and China's slowing growth probably will not faze this company, in my view. The gradual recovery of the economy in the United States will also bolster demand, which should increase the company's revenue.
On the other hand, Rio is dealing with rising operational costs, as are many companies today. In Australia in particular, new taxes to boost the economy and for environmental protection, such as carbon emission and mining taxes, are going to drive up costs for companies in the country, in my opinion. With few other feasible markets to move into, I wonder how Rio is going to keep its dividend at its steady 2.57%. My bet would be that it will have to reduce its payout for investors- which does not necessarily mean that the stock won't bounce back. On the contrary, I believe that Rio has proven that it can handle rough patches as long as its shareholders show a little faith. Thus, it might have to do some internal reshuffling, but in the long run, I expect to see the dividend grow again, and possibly even surpass what it is today.
Other factors could also affect Rio's immediate value. Protesters outside Rio's annual general meeting in London, England drew attention to what they see as pollution problems, as well as to the fact that the company has been locked in a dispute with its workers since October of last year. Some say that the company's attempt to reduce wages is a violation of the Olympic Charter, but so far the Olympics Committee has not responded to the pressure to remove this company as a sponsor. If they do decide not to keep Rio, it could be bad news for the stock, especially since its performance is already down this year. To me, however, it seems much more plausible that the company will simply turn to other pursuits, because it never seems to have a shortage of ideas for expanding.
One source of income for the company could come from the sale of Rio's diamond assets to another company. BHP Billiton (NYSE:BHP) is in the same boat, although some analysts predict that they could turn them into spinoff companies through an initial public offering. Currently, supply is not meeting demand, and total global demand is expected to grow by around 5% each year until 2020. This means that either way, Rio and BHP's diamond assets are likely to grow in value, so investors might wonder why they would want to sell them. My answer would be that they probably understand the volatility major markets, like Japan, Europe, and the United States. Selling them off now will bring in some cash, since interest is high, but then Rio and BHP will not be responsible for managing operations in case demand does not increase as predicted. To me, this is a smart move that will improve each company's liquidity.
In an accidentally beneficial turn of events, BHP and Rio, as well as Vale (NYSE:VALE), have had to reduce output of iron ore due to weather conditions. Although normally this could cost the company money, in this case, it has helped to keep prices higher than they would be as demand is also falling, especially in China, which has been a major buyer until now. With a 10% decrease in production, Rio has kept its margins safe without even trying. Vale had an even more significant drop of 15%, which tells me that Rio has an advantage over its competitor, since it has produced relatively more iron ore. That being said, BHP's production only went down 8%.
Even precious metal sales seem to be dwindling for some. Freeport-McMoRan (NYSE:FCX) posted its first quarter results with per-share income, down $0.77 compared to last year. However, even though Rio likewise missed the mark for iron ore and aluminum, I believe that its hold on Ivanhoe, coupled with its past history of tackling debt effectively, puts it in a good position to weather the storm. Its diverse streams of revenue should help keep it afloat long enough to determine what the most profitable next step is, so that shareholders can rest assured that it is worth holding out, in my opinion. If the company knows when to slow down production in order to meet demand at a profitable level, then I think it will do just fine in terms of maintaining its margins and quarterly dividends, even if it has to reduce its overall income for a short period of time.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.