Rio Tinto Q4 2005 Earnings Conference Call Transcript (RTP)

Rio Tinto (RTP)
Q4 2005 Earnings Conference Call
February 2nd 2006, 5:00 AM.

Executives:

Paul Skinner, Chairman
Leigh Clifford, Chief Executive Officer
Guy Elliott, Chief Financial Officer

Analysts:

Heath Janson, analyst
Jeremy Gray, CSFB
Sophia Hares, UBS
John MacKinnon, Deutsche Bank
John Komets, West-tech
Tom Louis from Deutsche Bank
Steve, Liberty

Presentation

Paul Skinner, Chairman

Good morning everybody and welcome to the presentation of Rio Tinto’s results for 2005. Leigh Clifford here with me in London; and Guy Elliott, our CFO joins us from Melbourne. Good morning, well good evening to you Guy. The sequence of the presentation today is that I will start with a summary of the results and outlook. Leigh will then provide an overview of our performance during the year. Before he hands over to Guy for a detailed review of our financial results, and then Leigh will do a wrap-up with some comments on a development project and growth opportunities before we take questions.

Underlying earnings grew strongly in 2005 to almost $5 billon, a rise of 118%
on the previous year. And as you can see from the chart on the right-hand side of the screen here, this level of earnings is well above the trend of recent years. The rise in earnings reflects very strong demand and good operational performance overall and record production levels at many business units. The contribution to earnings from increased production was in excess of $1.1 billion, I think it’s a very important point. We benefited significantly from recent investments in capacity expansion, particularly in Iron ore in the Pilbara and coking coal at Hail Creek and Alumina at the new Comalco refinery. The prices of most products were strong throughout the year although there was some softening of molybdenum and Asian thermal coal towards the yearend. This was offset by a firming in Aluminum, copper and gold over the same period.

Net earnings rose 58% to 5.2 billion, the earnings contribution from excluded items were smaller than in 2004 as we made fewer asset sales than in the previous year. So it was very good year for Rio Tinto. In addition to record earnings, cash flows from operations plus dividends were also at a record of $8.3 billion, a rise of 85%, and the effects of these strong cash flows on the business cannot be understated. It enables the group to fund our growing investment program and significantly strengthens our balance sheet. Remember with this follows a 20% rebasing of our ordinary dividend and the impact of our recent capital management program.

The group's net debt position fell to $1.3 billion at the yearend, that’s a gearing of 8%.
Our continued investment in the growth of the business is reflected in capital expenditure in 2005 of 2.5 billion, which is up 13%. This number is likely to be higher over the next few years as we pursue growth options which have already been identified in our portfolio and Leigh is going to talk to you more about that later and you will see that we have a lot in the pipeline.

Turning to our dividend, we have raised a level of our ordinary dividend in 2005 by 4% to a total of US$0.80 per share for the year, and so that's the continuation of what is now very long standing progressive dividend policy. We remain committed to an efficient balance sheet of last year's results presentation, we announced the capital return program of 1.5 billion over two years, and we have already completed close to a billion of the total through off-market and the on-market buybacks in Australia and the UK.

We are now able to announce a further capital management program totaling $4 billion which includes the balance of the previously announced 1.5 billion. These take the form of the special dividend of $1.5 billion, which reflects the fact that it was in cash flow returns, an unusually strong and you could say a special year, and a further buyback program, and Guy is going to go into that in more detail later.

Finally, in 2005 we divested shareholdings in the Lihir Gold and the Labrador Royalty Income Fund as we continue to optimize our portfolio. In that regard, it’s very encouraging to see the development of significant opportunities in new areas. The geographic scope of Rio Tinto’s activities continues to expand. The reason announcements of our exploration joint venture with Norilsk Nickel gives also an unrivaled entry route into Russia, in an area which we see to be highly prospective in exploration terms.

It represents the commitments to exploration in that country on a large scale. And Leigh is going to say more about it. In Madagascar, our Ilmenite project is seeing the initial deliveries of equipment and the project is gathering momentum. In Latin America, the solution mining trails of our Argentinean Potash project are fully meeting our expectations, and the project have moved into the final stages of feasibility assessment.

This together with our successful bid for the La Granja copper deposit in Peru enhances our prospects in that continent. While most of our existing assets located in Rio Tinto’s traditional areas of operations, I think these recent examples I’ve given illustrate our intentions to progressively broaden our geographic scope.

Turning to outlook. 2005 was another strong year of economic growth globally, and particularly in China. As we look at the Asian regions today, we see few indications of slowdown. In fact, we are encouraged to see signs of well balanced growth in Japan, which we should not forget and the chart shows this, represents 19% of our total revenue, in 2005, still not withstanding China’s growth remaining ahead of China.

In other regions, Europe and particularly Germany is looking more positive. Most of the risks in our opinion continue to lie in the USA, where we do have some continuing concerns have the potential impact of the imbalances in that economy.

But I have to say that the US economy is generally surprised that’s on the upside in recent years. Stocks of most metals and minerals remain low, and the supply response by the industry to current market prices has been impacted by infrastructure and various other constraints, not happening quite as fast as people would wish.

As we enter 2006, markets remained strong; on balance we believe that the prospects for the year ahead look favorable. But against this background our focus will be the continue on enhancing all aspects of the operational performance and the development of additional growth options for the future.

In your pack, you’ll find a more detail paper on our view of the economic outlook from Derek, Head of Economics, and Derek is here with us today.

So that’s the introduction, so Leigh, if I can now hand over to you to take the presentation forward.

Leigh Clifford, Chief Executive Officer

Thank you Paul, and good morning everyone. I’d like to touch briefly on our safety performance in 2005. Before looking at group earnings and then covering the operations in more detail. The improvement in safety recorded at our operations in recent years continued in 2005 with a further reduction in our lost time injury frequency rate. Our all injury frequency rate also declined. We remain fully committed to ensuring a safe working environment for all our employees and safety is a key metric in our assessment of operational performance as well as in management's remuneration.

Turning now to earnings. With the exception of industrial minerals, each of our product groups had a substantial earnings increase in 2005. Copper, so arise at 135% driven principally by strong prices for Copper, Moly and Gold. Iron ore had the largest increase in the earnings of 205%, and as well we were able to capitalize on strong market conditions by rising production. Energy increased earnings by about 70% with a stronger pricing environments for thermal and coking coal as well as Uranium. Aluminum earnings increased by 18% mainly due to higher prices and record both side Alumina and Aluminium metal production. Diamond earnings increased by 49% principally due to recovery in production lag off and a strong demand for the product. Finally, industrial minerals earnings fell by 23%, and as we disclosed at our Investors’ seminar in October, earnings were affected by a number of one-off items including provisions relating to the restructuring of the product group.

On an underlying basis, prices excluding one-off items in each year industrial earnings were at a similar level in 2004 and 2005. Even at times of weaker commodity prices than prevail today, Rio seemed to have generally enjoyed EBIT margins in the 20% to 30% range. We believe in the long-term, our EBIT margin profile is amongst the best in the mining business. In 2005, the Group’s EBIT margins rose to 37% as we enjoyed a very strong pricing environment. We were able to achieve these margins in spite of industry wide cost pressures and shortages and I would now like to explore those in a little more detail. The shortage of many mining related inputs has the potential to act as a constraint on the development of additional industry capacity. Although Rio Tinto has a global graduate recruitment program and regional findings gains the various skills, skilled people are in short supply everywhere. We have spoken before about the shortage of large offer of tires, a situation which developed in late 2004. That may take another two years to resolve due to the production constraints.

Rio Tinto continues to explore means of extending a lot of its tires through load optimizing, road surfacing and generally improved management and re-trading. And I can assure you this is a focus at our operations globally. Our tire position in 2006 will be hard but we believe manageable. However, a particular concern and I use them as an example but there are shortages of other mining related suppliers in regional pockets. Our global procurement strategy and longstanding supply relationships are enabling us to cope with this challenge. And it's important to say that, we have not lost a ton through these sorts of shortages and you've heard of a number of companies which quite stretched at the present time.

As the mining industry goes for the current cycle of commodity price string is perhaps inevitable that cyclical cost pressures build. When we analyze cost in our own business, we can see that the trend of cash cost efficiency improvements was very marked following the formation of the deals seen in 1995, started to reverse in 2003 but at the same time those metal prices started decline. In 2004 and 2005, the adverse trend continued and we along with the rest of the industry saw some of our operating margins eroded by cost inflation and supplies of equipment, people and other inputs.

In the current environment, some cost increases are inevitable such as revenue related government royalties. Other costs are in fact desirable and make good business sense, such as increased exploration and project evaluation spending or the extra issue of region cost they were associated with production of Moly at – increased Moly at Kennecott. As we look ahead in 2006, cost pressures are likely to continue in most areas. Current labor cost inflation reflects the industry’s lack of investment in skilled personal in recent years.

Labor cost, which today represent around 20% of total cost tend to rise overtime. And we managed this through productivity improvements. Energy represents another major cost to Rio Tinto, around 12% of that total cost. And the scenario where we believe we maybe in for a period of prices which are relatively high compared to recent history. Obviously we continue to seek improvements in our energy efficiency.

In some other areas there has been a switch to supply side response, and we are seeing some cost decline. An example would be ocean freight rates, which have declined recently due to an increase in shipping capacity. That’s particularly saw at in types their sources. We take all cost seriously and that committed to controlling them. But overall compared to the industry in general I think our cost performance in 2005 was quite reasonable. And Guy will provide some more details in our cost performance later in his presentation.

Let me now review our product groups. Firstly Copper, the Copper group enjoyed EBIT margins of 59% in 2005 as Copper and Moly prices was strong for most of the year. Moly softened towards the end of the years as Paul said, so we didn’t see any material volume impact on our sales of Moly to Europe, and more recently the market has turned a little, its up around close to $25 now. Gold strengthened towards the end of the year and we benefited from being the top ten gold producers in 2005, the production picked up at most of our sites.

Generally our operations performed well. At Kennecott, our focus on maximizing Moly production greatly enhanced overall margins, notwithstanding a rise in associated cost and this is where the associated cost rate with additional concentrate expense etc. associated with increasing Moly production. Our access to roasting contracts was a particular advantage.

In simple terms we sacrifice some copper production to achieve record Moly production and earnings in excess of $700 million. We will continue to monitor the relative prices of copper and Moly to ensure that mining planning maximizes value. The scheduled smelter shutdown in the second quarter was completed successfully; an additional plan maintenance work lasting up to 50 days will be undertaken in the third quarter of this year. I’ll just count data, production from Norti (phonetics) commenced at the end of the third quarter.

And the first cathode production from the sulphide leach operation is expected in the middle of 2006. At Freeport production picked up strongly in the fourth quarter and at Northparkes underground production reached a monthly record towards the end of the year, and Palabora continued on an improving trend.

Finally, we were pleased to approve in September Rio Tinto’s share the Cortez Hills development in Nevada. Cortez has over the year consistently offered surprises in terms of cost activity and it's ability to add reserves. Turning to Iron ore, in Iron ore demand remained strong throughout 2005 driven particularly by China.

Imports of Iron ore to China were estimated to be $275 million tons last year, a rise of nearly one-third. Operationally our iron ore business in the Pilbara performed well. Production reached record levels at the same time as we continue to the - Brownfield mine expansions at Tom Price, Marandoo and Nammuldi. Also construction of the first Phase of additional port and rail infrastructure capacity was completed on budget and ahead of schedule. And I think this is a tremendous achievement in the challenging environmental construction, environmental in Western Australia. We are now embarked upon the second phase of the expansion in Zantia which will raise our total port and rail infrastructure capacity around to 200 million tons. Additionally work is under way on the expanse of the Yandi mines to 52 million tons a year. Remember Yandi was developed it was 15 million ton operation in 1999, now I think that illustrates the significant option value inherent in a long life world class resources like Yandi. At Hismelt the hot commissioning phase was completed in October 2005, and the plant is current in the ramp up phase, the full production expected to be reached over a three-year period, in fact the recent campaign run for 48 days. Finally we are pleased to see IRC having a good year after a very difficult year in 2004. We are now seeing the benefits of improved productivity. Full year coal production was that a record 13.3 million tonnes more than 10% ahead of the previous record.

Turning to Energy. In Energy our coal operations generally performed well but we were constraint by rail and port infrastructure capacity. Rio Tinto coal Australia's earnings benefited from increased production and sales with coking coal at Hail Creek. The addition of 2 million tons of capacity of Hail Creek remains unscheduled for completion in mid 2006. The thermal coal operations were impacted by infrastructure limitations but generally used up their allocated port capacity. The Expansions of PwC's at Newcastle and the Dalrymple Bay Coal Terminal now underway, an additional port capacity is expected to come online after 2007.

At Kennecott Energy, unscheduled railroad maintenance impacted our ability to raise and in some cases maintain production, notwithstanding this both Antelope and Spring Creek achieved record production and deliveries in 2005. Work on the Joint Rail Line was completed in December and we anticipate an improvement in our ability to deliver from PRB this year. KEC sells most of its coal on interim contracts. However the price outlook for PRB's low sulphur coal remains favorable as evidenced by current stock process in the higher teens by 8800 Btu coal.

In the Asian market, the price of lower volatility hard coking coal remains firm and there has been some recovery in the intermediate quality and thermal coal market is out to recent softening as evidenced by the report in recent settlements.

Turning to Uranium, we currently produced around 12% of global mine supply and are grossing the extension of The mine Life was approved in December, and this project we extend the life of the mine at current production levels for least a decade. This extension together with the ambition of 3 years of reserves at ERA in Australia along the pin opposition in what look to this strong Uranium market going forward, now I think you are all aware of the cost increases that have occurred over the last few years in Uranium.

In our aluminum product group, both side production of retail reached a record as the new way for expansion continued to raise capacity towards 16.5 million tons. Alumina production rose 33% as they come out Alumina refinery continue to ramp up and the Queensland alumina refinery set new records. We are continuous on improving the liability of tons in a digensent circuit of that Comalco Alumina refinery. Aluminum smelters performed well with record production levels being set at Boyne, Bell Bay and Enzus.

And as we mentioned in our Investors seminar in October, cost in the second half were impacted by the expensing of CAR stage II study costs. Cost increases in fuel, freight and caustic soda also impacted earnings. The Aluminum market improved towards the end of the year as net exports from China declined in the second half and higher power Alumina cost threaten the viabilities of some marginal smelters.

The outlook for Aluminum metal and particularly alumina remained favorable, and I think you are all aware of the aluminum process over the last few days. In diamonds, the rough market spread strong throughout the year. In the USA really early results indicate that luxury and online jewelry retailer performed well over the Christmas period. Whereas the other jewelry retail is experienced flat or moderately increased sales, and I think its reflected in the full year pattern, and Argyle earnings grows strongly as caret production recovered in 2005 for more historical levels.

The development of the Argyle underground mine was improved in December and work is now well underway on that project which will extend production after sustention of the open pit mining in 2008. The Argyle project is challenged by being an environmental high capital cost inflation. However this is offset by a significantly improved outlook so its down in market segment and by the support of the Western Australian government that changes in the Royalty regime and local processing requirements. A direct production rose, the grade was slightly down on 2004 reflecting the introduction of low-grade ore from the 154 north side.

Work continues and is ahead of schedule on the optimization of the Diavik mine plant. And finally, we saw good initial earnings contributions from our new Murowa diamond mine. In Industrial Minerals, as we before shed out at our Investor's seminar, a number of one-off items impacted earnings including a tax change in Quebec and restructuring charges that I mentioned earlier. For this reason, Industrial Minerals is the only product group not to show any increase in 2005. However, as supposed to earnings comparing EBITDA adjusted for one-off items we would have seen an increase of 13% year-on-year. The new organization of Rio-Tinto minerals will allow us to capture the full value at our minerals businesses, each of which has the leadership position in it's sector. Combining our various businesses will generate significant savings and give us a better focus on operations and a unified commercial approach to global markets and there is many similarities between those three products.

At Rio-Tinto on Titanium, we completed the expansion of the UGS plant in Quebec to an annual capacity of 325,000 tons and announce the further expansion to 375,000 tons in 2006. As Paul said, work on the Madagascar ilmenite project is underway and the first delivery of major equipment took place in December. At the moment, pigment produces a reporting improved market conditions and I think that always will, that product. As the longer term with a strong outlook for feedstock in particular, we believe that UGS and the Madagascar project will underpin Rio Tinto’s leadership in this sector. So, in summary, many of our businesses are setting production records, reflecting ongoing investments and good underlying performance. We remain focused on ensuing that our capital projects aboard on stream, on time and on budget and what is undoubtedly our challenging construction environment. We are very aware and managing the shortages and cost inflation which are impacting the industry. Finally we believe the company is in good operational shape, and we plan to deliver further improvements in this area through our improving performance together initiatives.

IPT as we call it, is bringing benefits in a number of important areas and helping us mitigate some of the cost increases the industry faces. IPT designed of replicating best operational performance across our business, the transformational initiative and it's progressing well. And we will talk more about IPT at a dedicated seminar in the middle of the year. Now, perhaps I'm going to hand over to Guy.

Guy Elliott, Chief Financial Officer

Thank you Leigh and good morning everyone. I'm going to examine our results today in our normal waterfall format. Starting off with price, now the strong price environment we experienced in the first half of 2005 continues into the second half of the year. Compared with 2004 prices increased full year earnings by $2.4 billion in 2005. Exchange rates were relatively stable over the period with the Australian and Canadian dollars strengthening by 4% and 8% respectively. The obsessing effect of the movements of the US dollar was a relatively modest $123 million. These two factors and the impact of inflation increased the earnings versus 2004 by $2.1 billion.

Looking at prices by commodity, we can see that they were stronger across all our major products. The 71.5% increase in the Iron ore price in 2005 lifted earnings by $976 million. This accounted for over 40% of the total price variance. The copper price, which averaged $1.66 per pound during the year, compared with $1.13 2004 boosted earnings by $482 million. Strong demand continued to the thermal and coking coal in Asia. And tighter energy markets in the US are feeding through the higher realized proceeds in Power River Basin Coal. Together with an improvement in Uranium prices these factors enabled the energy group to generate $501 million of additional earnings compared with 2004.

Demand in the molybdenum market has been strong and prices were sustained throughout the year averaging over $30 a pound. This contributed a further $152 million to underline earnings. Prices have been supported by supply constraints from reduced Chinese production but they eased towards the end of the year. Moly prices remained at what are historically at very high levels. Aluminum and Alumina added a $125 million jointly, well its more favorable pricing for Industrial Minerals improved earnings by a further $71 million. Most of the increase related to co-product prices with Zircon, Iron, Billets and metallic products at Rio Tinto Iron & Titanium. Lastly with the diamond market remained strong, particularly in high quality top end and smaller, cheaper diamond stones.

So Rio Tinto Diamonds achieved price increases during 2005, which delivered an additional $55 million in earnings. Now well the contribution of strong prices to our earnings in 2005 was almost a very substantial. The contribution today by volume increases was equally impressive. These account for well over 40% of the total rise in underlining earnings in 2005. This is by far the largest volume driven earnings increase that we have ever seen in Rio Tinto. In 2005, we were able to capitalize on favorable market conditions by expanding production at many of our business units. In fact timely investments in capacity expansion, and good operational performance enabled us to raise earnings from volumes in all of our product goods. The impact on 2005 earnings of rising production volumes with over 1.1 billion.

It's very encouraging to see large investments translating so quickly into strong revenue and earnings growth. Now looking at the product groups in a bit more detail, the optimization of mine production at Kennecott Utah Copper in favor of the higher Moly grade O resulted in a 130% higher production of Moly. This translated into a contribution of $457 million. Record Iron ore sales were set at Hamersley and Robe following the completion of the West Angelas expansion, and the expansion of Yandi to 36 million tons. These together with record pellet production at Iron Ore company of Canada generated additional earnings of $270 million. Increased access to higher grade Ore at Freeport was the main driver for the $164 million gain from gold volumes. KEC also benefited from higher gold grades. Sales volume improved in diamonds due to a recovery in production at Argyle coupled with the Murowa diamond operation coming on stream.

The Aluminum group benefited from increased alumina volumes from the ramp up of the Comalco Alumina refinery. And record production has three out of its four Aluminum smelters. Volumes increased for Titanium dioxide feedstocks and their related co-products at Iron & Titanium. They followed recent capacity expansions and this offset weaker markets for borates and talc. Finally, modest gains were made in the energy group mainly in hard coking coal from the ramp up at Hail Creek and from an improving Uranium market outlook.

Now we remain committed to managing industry cost pressures, but we are not adhering to them. And cost increases impacted earnings negatively by $598 million in 2005. As Leigh pointed out, the word “costs