Rio Tinto (RTP)
Q4 2005 Earnings Conference Call
February 2nd 2006, 5:00 AM.
Paul Skinner, Chairman
Leigh Clifford, Chief Executive Officer
Guy Elliott, Chief Financial Officer
Heath Janson, analyst
Jeremy Gray, CSFB
Sophia Hares, UBS
John MacKinnon, Deutsche Bank
John Komets, West-tech
Tom Louis from Deutsche Bank
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” in fact describes a wide variety of expenditures and we pay a considerable attention to analyzing and managing them appropriately. Certainly, some cost representing an investment well others are probably unavoidable. There is a good and a bad cost story. We give particular management attention to consulting bad costs, we are an intelligent procurement shipping or recruitment strategy, and tight operational control can pay significant dividends.
Now let me go into the impact of costs on our business in 2005 in a little bit more detail. In this Slide, we’ve analyzed the year-on-year cost variances expressed in earning terms, the aim is to illustrate those cost which Leigh described as making good business sense, and there is cost which are currently having a negative impact on the whole industry. As you can see, we are investing extra resources in business improvement, exploration, and resource development. These will add value to our business overtime. Such costs account for over $70 million of the negative variance.
Leigh mentioned the impact of rising energy cost on our business, this is visible here in the earnings variance of $130 million. As a rule of thumb for every $5 a barrel rise in the oil price, our net earnings are reduced by $30 million. However, since we are a net energy producer, we also benefit from higher prices from our own energy products, which of course you’ve seen in our coal and uranium earnings.
Higher input prices and cost of production captured the typical cost of the mining industry operating at full set. For example driving raw material cost, increased maintenance and the use of contractors to manage and increased overtime costs. An element of these costs of production can also be classified as investment cost, one example, if the expenditure incurred in additional moly extraction at KUC, and another is the pursuit of high cost but highly margin production in our Iron ore businesses.
One-off costs in 2005 include a number of items, with the most notable being the Rio Tinto minerals reorganization costs. Higher non-cash cost relates to increasing depreciation inline with higher capital expenditure plus additional provisions for closure costs. We are pulling all this together, the groups total costs in 2005 were $12 billion. If you exclude selling costs and adjust for inflation cost per unit of production rose around 5% in 2005. Additional selling costs that we incurred were generally related to shipping costs that were recovered in revenue. Now although we are not complacent, we believe that our cost performance last year compares well with the industry as a whole. Now finishing of our waterfall chart, you can see that the combined effect of other items on an earnings wasn’t material at $31 million. Negative items mainly related to the exclusion earnings from divested businesses, were offset by positive items, principally relating to tax, provision adjustments, and insurance. So this brings us to the 2005 underlying earnings number of about $5 billion.
As this slide shows, Rio Tinto has historically been a strongly cash generated business, even in times at low commodity prices. However, 2005 set a new record for our group’s cash flow. As Paul said earlier, our cash flow including dividends from jointly controlled entities and associates totaled $8.3 billion. This represents a rise of 85% from 2004. In part these very strong cash flow reflects the benefit of timely capital expenditure in the past. I’ll talk about our future capital spending in a moment.
The group’s net debt reduced by $2.5 billion over the course of 2005 to end the year at $1.3 billion. Our gearing ratio is therefore 8%, which we recognize to be low. The capital management initiatives we've announced today were are still gearing to a more appropriate level. Although we don’t have a gearing target, we will continue to monitor the strength of our balance sheet, and if necessary we will take additional measures to ensure that the Company doesn’t become over-capitalized. Equally important is the need to retain sufficient flexibility to take advantage of major portfolio opportunities which may arise.
In 2005, our capital expenditure was $2.5 billion, reflecting continued and growing investment in the business. A significant part of this investment which related to the expansion of our Iron ore operations in the Pilbara, for the energy copper and diamond product groups also increased their level of capital expenditure in 2005. In 2006 and 2007 we would anticipate an even higher rates of capital expenditure for the group. In excess of $3 billion in each year. This level of spend will underpin our growth for several years to come. It remain subject of course to the rigorous analysis which is always been undertaken at Rio Tinto, but it will enable us to deliver volume metric growth in 2006 well about our long run average of 6%.
Now let me talk about returning capital for shareholders. This slide illustrates the progressive ordinary dividend policy, which the company had in place for many years. We believe it to be unrivaled in this industry. The ordinary dividend is intended to represent a level of payout which we believe to the sustainable in all market circumstances, and it reflects the underlying growth of the business overtime.
Following the 2004 results, we rebased dividend by 20% to a level which we believe the growing scale of the group can sustain over the long-term. This year we've increased the ordinary dividend by close to 4%, somewhat more than US inflation for the year to $0.88 per share. Over two years therefore, our ordinary dividend has increased by around a quarter, and we are committed to sustain it. Paul mentioned earlier that our outstanding cash flow this year have continue to strengthen our balance sheet. This is not withstanding our high level of capital expenditure, our rebased ordinary dividend and the buyback of $1 billion of share within one year of announcement. As I said at our investment seminar we remain committed to saving a measured cost between our desire for our strong balance sheet to be able to take advantage of opportunities as they arise, and an efficient balance sheet.
In the current environment of strong economic returns we are aware of the potential of our balance sheet to become overly strong. We therefore announced today that we intend to undertake a further buyback program of $ 2.5 billion before the end of 2007. This includes the balance of the previously announced program, as previously the completion of this buyback will depend on market condition and the need for corporate flexibility. We will therefore be seeking further approvals to buyback shares at the respective Rio Tinto Plc. and Rio Tinto Limited AGMs later in the year. We've also declared a special dividend payout totaling $1.5 billion or $1.10 per share in addition to the ordinary dividend. This special dividend will be payable to shareholders at the same time as our ordinary dividend in April.
The special dividend reflects the unusually good returns for our business in 2005, it does no relationship to future levels of payout under our ordinary dividend. It should be seen by investors as the return of capital and the means of managing our balance sheet, not a forward commitment. When combined with the buyback of $2.5 billion this will mean a return of $4 billion to shareholders by the end of 2007. This level of capital return does not impact our capacity to take advantage of opportunities as they arise. When it is complete, the cumulative total capital return to shareholders from the beginning of 2005 until the end of 2007 will be $5 billion. Now let me hand you back to Leigh who will complete the presentation.
Leigh Clifford, Chief Executive Officer
Thank you Guy. I would now like to conclude today's presentation with look at our growth options and the way we go about creating new opportunities. Rio Tinto is always seeking to be creative in its approach to finding value opportunities and I think Hope Downs is one example of this. We are now close to finalizing our decision on that project and discussions with potential customers are well advance. In fact the response is being overwhelmingly positive. Once approved the first phase of production will commence in 2008 and an initial capacity is likely to be 23 million ton. This project which has further expansion potential beyond the first phase will contribute to our leadership position in the Iron ore industry in Australia.
Turning to another example, our announcement last week of the establishment of a joint venture exploration venturing and development agreement with Norilsk Nickel of Russia is the good example of what I’ve said before is about the importance of innovated alliances. Russia has a history of world-class mineral discoveries and it remains highly prospective. The scale of the opportunity is very significant, the proposed area of exploration is about the size of western Europe.
The joint venture breaks new ground for mining development in Russia. It will combine the skills and resources of Norilsk Nickel with values of Rio Tinto, a really strong combination. It offers Rio Tinto unrivaled entry into Russia in partnership with the leader and not in country's mining sector. It also represents a long-term strategic commitment to Russia, which leverages our exploration capability and it illustrates our willingness to pursue value-adding opportunities wherever they arise. I would now like to look at our other projects and growth options in a little more detail. And its important to distinguish between capital expenditure relating to the replacement or extension of declining productive assets and capital relating to genuine growth opportunities and we believe that Rio Tinto compares well in this regard.
As highlighted here, those of our projects which would extend the lives of existing operations and maintain their production levels. The total committed capital spend in this area is $1.3 billion and I am not very surprised the projects in the advance study phase require $2 billion in addition.
Turning now to those projects which have the potential to deliver future growth of the business, I have listed here projects which will provide additional volumes overtime. Most will be familiar to you and several were outlined at our Investment seminar last year. Our committed spend on this type of project is $3.5 billion. Again it would not surprise me if projects in the advanced study phase required at least a further $7 billion of capital expenditure. We remain committed to exploration as a means of generating future projects and in 2005 our pretax expenditure on exploration and development was $250 million, up almost a third on the previous year, and this expenditure is delivering results. I think it is encouraging to note that our exploration group deliver over 1 billion tons of Pilbara mineralization to our Iron ore business in 2005.
Our new Russian exploration joint venture illustrate that continued focus on exploring for and acquiring options for future growth externally as well as creating options within our own Iron extensive portfolio of assets. It is probably safe to say that we see the potential for two or three of our most advanced exploration caustics to progress to discovery classification over the next year or so and transition to the product groups for the venture development.
So in summary, our business is in great financial shape generating record cash flows through strong operational performance and a focus on project delivery we produced record volumes in many of our product groups. At the same time we are managing the cost pressures of the industry is currently facing. The range of organic growth opportunities we have is excellent, and we remain committed to exploration as a means of discovering future resources. Reflecting these opportunities, we will be spending at least $3 billion in each for the next two years, as we invest capital in maintaining and growing the business. Notwithstanding our investment program, our cash flows enabled the group to plan to return $4 billion of capital to shareholders over the next two years.
And finally, as we enter this year with markets strong, still strong and the supply response limited, we believe that the outlook for 2006 is positive. Perhaps on that note we can turn and take your questions. Over to you
Q – Heath Jansen
Good morning, Heath Jansen here, just a couple of questions. One first of all on the capital management, just in terms of, is there any preference in terms of buying back of PLC stock out of the Limited stock for that $2.5 billion, and is there a minimum amount to shareholder representation that you want to maintain of the Limited shares, and is that one of the reasons why you’ve done a special dividend of 1.5 billion – of $4 billion buyback? And then just second on the CapEx program, and I will saw you talking lot of that in Aluminum or Alumina, how long before we see approvals that costs just to see that Aluminum smeltings going forward and probably because a consensual price on your chart, in contextual rather than feasibility size, could you just give us an update on that please?
A - Leigh Clifford
Perhaps I could invite Guy to address the first question about, which of the two share we would prefer to buyback, and mainly for CapEx question to you, Guy?
A - Guy Elliott
Heath, we have always been care I think about this but when it comes to on-market buybacks, we would buyback the lower prices of the two shares if we were in the market, and today that’s the PLC share, and of course that’s where we have been buying in recent months. But the situation could change and at some point we could buyback limited shares, we are going to approach the shareholders at the AGM to ask them to give us the flexibility to pursue any of various ways of buying back shares including the off-market approach which we adopted successfully last year in Australia. I am not saying that we will buyback off-market in Australia, we will just see the option to do so, because we can't really foresee exactly how markets will behave over the next two years. So I think what you can see from that is, we want to retain the option to get to return capital to shareholders in a number of ways. So by the time we paid this special dividend we would have used 3 of the 4 obvious routes to buying back the anyone that weren’t used in a immediate future as the buying back on market of Limited shares. Now you referred to a minimum amount of shareholder representation in Australia. Now that is something that we watch very closely because we are conscious of the tension between wishing to buyback shares and return capital to shareholders, and at the same time the desire for liquidity and a really meaningful presence on the Australian markets, so that will way with us to some degree. Is that why we done a special dividends? No not really, I think that the reason we have done a special dividend is that, there is several constituencies here, and they will have slightly different tax requirements and for these reasons not everybody likes buybacks and so to some degree we have addressed that by making the special dividend payment, and in addition to that, its the quickest way of returning money to shareholders. It’s going to take us a bit of time to return $1.5 billion by buyback we could like that but we really wanted the competition number of objectives at the same time
A - Leigh Clifford
If I can respond to your comments on Aluminum, firstly let start with the book side and we are investing in a new ship loader at Weipa, new power station so our capability will expand book side is quite considerable. We don’t really want to be in the book side market, rather be in the alumina and perhaps in the metal side of the market. In terms of Alumina, we call Alumina plant the basic operation that plant a chemistry of it and the process is going well, we have had some problem with the digestion pumps and that’s really being now supplemented with additional pumps, modifications to the pumps and I believe that’s something that we will overcome in the short-term, that's an engineering issue not a process issue. Once we've got the real confidence in the performance in the capability of CAR one, we are in a better position to make judgments on CAR two certainly spend money on preliminary work on CAR two and that decision will be taken having regards to the market circumstances and obviously the capital environment. We also obviously have the scope to potentially expand the coal refinery but that we had to clear up the ownership issue, that’s behind us now, there is a bit of work obviously involved in any feasibility study there. In terms of aluminum smelting, and for flat mater alumina in general we have a number of options that we are progressing rigorously, but as with all of those sort of things in this stage of their valuation, I am not at liberty to speak but let me say we have, we believe there’s some value creating options out there and I hope, during the course to the next year I think some of those will come to version.
Q - Heath Janson
Q – Jeremy Gray
Jeremy Gray from CSFB, congratulations on the number. Just on Moly prices, do you say firm despite the recent pullback, can chemical support similar production that was in '06 and '07 that we saw in '05? And just I left a few question, was Utah Ken’s copper project in Russia discussed when you are with them last week?
A - Leigh Clifford
In term of Moly production in '06, I mean Tom is here only to give into more detail with you later, there comes a limit about maintaining the levels which I think were about 32 million pounds this year, but we ended in strong production going forward in 2006, I think Tom maybe could comment on how 2007 is looking, you want to make a comment on that?
A – Tom
Hey we have, we have been doing in the fourth quarter of last year. Fourth quarter of last year that without any extra work you would have a little bit less Moly in 2006 compared to 2005, but that our efforts underway including with our ITP initiatives where to reaching objective to get closer to 2005 level, and that work in underway as we speak. We are also doing some drilling work and recognizing if these market stay stronger for a longer period of time, if we can find opportunities to find new pockets of Moly in that, we will certainly endeavor to do so
A - Leigh Clifford
As regard roughly, can I say that its a competitive environment in Russia and I wouldn’t want to foreshadow anything as regards join venture, I mean to say the join venture will certainly be looking at Greenfield exploration, exploration which might have taken place in the past and whereas within laws of the Russian federation we might be looking at individual development projects but we wouldn’t be going beyond that.
Q – Sophia Hares
Good morning, Sophia Hares from UBS, quite a few details on operating cost, another issues project cost, could you expand on that and also I guess the question is to what extent do you think project cost could actually slowdown the expansions going forward, in other words, are there some projects which often seems on the joint board of denouements but because project costs are rising substantially, you could come to your decision that its actually going to be delayed?
A - Guy Elliott
I think Leigh will take that please.
A - Leigh Clifford
Let me say, in terms of our operating cost, operating cost being impacted by the sorts of things that Guy referred to but of course in many of the areas, particularly say in the United States and Canada and West Australia, Queensland, you are competing with the same skills, be they electricians, welders, etc. etc. labor. And we have seen project cost rise but I think it’s a testimony to our teams in Western Australia but they are able to bring for the Iron ore project, I mean on budget, and certainly a couple of months ahead of schedule. Look it's fair to say, going forward cost pressures on new projects are significant. I'm not aware of any project which we've abandoned because all of a sudden the construction costs rose about that previously anticipated. It's fair to say that some costs on review higher, but portion we have got some very good, good old buddies. I think it’s a broader question that you raised and it affects. It affects a number of our competitors and some who are inspiring competitors as to the rigor with which they have been able to evaluate those projects. It is a pretty demanding environment, and I think in some cases people are underestimating the supply side ability, in other words the ability to access equipment and might be an essential part of that project, it was overestimated.
A - Guy Elliott
So did I say underestimate.
A - Leigh Clifford
So, did I say underestimated – for me underestimating the cost.
A - Guy Elliott
Okay, who would like the next questions? Looks that is a very clear presentation.
Q – John MacKinnon
John MacKinnon from Deutsche Bank, you mentioned that ongoing rationalization or optimization of the portfolio, you outlined what assets you might be picking at that, I am assuming in terms of disposal, given the account those of the markets? And the second question is on the CAR project. And can I ask if it was actually possible in 2005 at the EBIT level, and what the size the CAR two costs - study costs were in 2005, and what they going to be in 2006?
A - Leigh Clifford
If I could just take a brief falling on portfolio, and leave the CAR questions to Leigh and Guy. I think we have over the last two years worked through enormous strategic components of our portfolio pretty thoroughly. There was a very big disposal program in '04, there were a number of minor disposals in '05. I'd say we are very close to now to a portfolio which we would regard as reasonably optimal, and wouldn't encourage you to think that there are many significant disposals lying ahead of us. I think that would be my response to that question, next on CAR.
A - Guy Elliott
Maybe I can just say Guy responded to a specific EBIT question. When we look at alumina business as a whole, alumina business obviously was profitable during the year, and I'm just not quite sure how we treated some of the capitalization, so well I respond the Guy too, Guy can be having a look at that. CAR two costs was some as I recall, certainly over $10 but $15 or $20 million that sort of number during the year. There was a fair bit of done, so as you can appreciate we are in pretty good shape to respond when the circumstances arise. There has been been quite of bit of work done on CAR two and pre-planning forward. Can I just come back on CAR one, I think the important thing is, this was the first Greenfield alumina plant for 20 years. And in terms of the chemistry and the operation of the process gone very, very well. One element and its essential element the digestion comes big, positive displacement pumps, of caustic soda pumps. Frankly, we've had some issues which manufacturing fault issues and I believe that the steps we are taking with losing capacity, and changing some of the parameters of those pumps will get a seer over the next six months. But I can assure you with applying very diligent efforts to it. John, probably you are best to respond to the question on alumina contribution.
A - Leigh Clifford
And all I'm going to say is that CAR was certainly cash positive during 2005 and the second thing I can say is that the CAR two study cost which we wrote off during the year amounted to $7 million aftertax.
Q - John MacKinnon
A - Leigh Clifford
Q - John Komets
Yes, John Komets from Westtech (phonetics), if you could comment on Iron ore, particularly we have been seeing that it appears with the Chinese steel making industries is in serious surplus at the moment, what are you expecting to happen in terms of Chinese steel production, and will that affect any of your productions for Iron Ore exports into the nine months?
A - Leigh Clifford
Can I say firstly, I realize there is quite a diversity of performance in the Chinese steel industry. I think when you talk to anyone of the Chinese steel industry, they recognize that there is going to some necessary rationalization, but I think we tend back to the fundamentals that steel demand in China, and we’ve got to take a bit of a medium and obviously a long-term perspective here. Now I don’t believe anyone who has spent as much effort an analysis as we have of Chinese steel demand and I am satisfied we have got a very hand along that. And the investments we are making are not for next month, for the month after, thereafter the medium return. Interestingly the Chinese steel industry has been consuming a lot of very inefficiently produced an expensive domestic iron ore, but also if I had say to you that the demand we are seeing today, I mean I am talking about this incident for China from Chinese steel mills to iron ore is very, very strong. And their demand our relationship and I am talking about out relationship is with the major Chinese steel producers. We don’t, there’s enormous number of producers in China and a wide variety of economic performance, but our relationships is with the bar-gangs, Shal-gangs, Mar-gans, I-gangs, with the producers of China, so we are very, very well placed. And I am satisfied with the expansions that we are undertaking, a very, very mindful of the long-term and the medium-term demand in China.
A – Guy Elliot
If I could just add briefly, I had the opportunity last week with the Davos meeting to hear one of the Chinese Vice-premiers who is responsible for the economy and who has been responsible for putting together the new 5 year plan for China, which will be published in March, and I have to say which is one of the most clear confident and convincing presentations of the business plan if you like with, that I heard in some while and our view remains strongly net positive towards the developments of the Chinese economy with a progressive movement from investment as the meeting component towards consumption, and while we not at all complacent. I think we remain very confident of the way in which China will develop as a market for our products.
Q – Tom Louis
Tom Louis from Deutsche Bank, I have a question on iron ore, I see you delivered 26% of your sales on a CIF basis, how does that compares with last year and would you see that sitting over the next few years, and also just the Indian what sales into China do you see as you expand along side in Australia, do you see, if you are looking to displace at that Indian tonnage and where do you see Indian exports into China over the next 3 or 4 years?
A - Leigh Clifford
Well, the last one was a pretty detailed question that I don’t have on the fingertips, but if I can come back to the first one. We as Tom, people have suggested our Rio Tinto is not in the favor of CNA, we meet the customers needs and if the customer wants to buy, that’s fine with us, we would like to provide CIF, and increasingly we have been as our sales into China are expanding results CIF, we also are selling to some dedicated through dedicated stockpiling facilities in China, so we again I will obtain a ship, and we have a number of their shipping people both in China, and I can’t remember the expansion in sales but I know our bulk sales rose to around, maybe Guy can look through this while we speak, that rose to around 40 million tons, this is totaled CIF sales issued with our shipping group and I didn’t visage that would increase going forward. And as regards to India spot sales, I mean India has always been in the Chinese market and India is often been a spot seller and it tends to be a characterized by very much being a spot seller. I don’t envisage that we are going to tight India's share of the market, I would like to think we can maintain, possibly increase that share of the market, but you can appreciate that the Indian iron ore is high quality and the Chinese who want to have a diversity of supply, but at the same time the Indian is a pretty diverse, the Indian suppliers are a pretty diverse supplies, I would like to think about quality reliable as we are.
A - Guy Elliott
That’s just again a small edition on India. With the impression I have is that’s going forward, we will see a situation where India will look to be adding increased value locally to its resources, not least those of iron ore and one can envisage a situation as the Indian economy continues to grow, but there may be less iron ore available to international markets from India. And that may well be a factor, I am not suggesting this year or next year, but certainly over the next ten years, as we look at India's export capability in Iron ore.
A - Leigh Clifford
I think it’s a very good, it’s a subject of quite vigorous discussion in India. Guy, do you have the, say the bulk shipping CIF statistics?
A - Guy Elliott
The number is 26% for - but if you look at Iron Ore group as a whole, its 34 million tons in 2005, which compares to 20 million tons in 2004, so you can see a very considerable increase. If you look at China the number is more than doubled to 28 million tons. So I think you can see very clearly that the direction in which we are moving towards more CIF delivery.
A - Leigh Clifford
So that additional 6 million tons is spread over salt, coal and few other bulk commodities.
Q - Steve
Steve from Liberty, another question to Guy perhaps. Guy, you talked about the geo in the late stand then one or two in the balance sheet strength that continues to strengthen and to take advantage of major portfolio opportunities that may arise and in the old days that used to mean to buy the stress sellers, and I guess many of the users were suspect although its just stress sellers and are now in the same issue that you have in cash, and the other week really 15% around back of an acquisition which was the message that the market loves acquisitions and I guess every corporate in your too has a same issue in that. How does one justify buying assets in the market that have moved to 300% if they use historical commodities assumptions and this is the usual all questions that arises after this presentation but I just wonder, am I says on the back of the demand at the minute?
A - Leigh Clifford
Well, let say I hand over to Guy, you might get usual load answer but, Guy?
A - Guy Elliott
I mean we didn’t actually just meant we buy distressed asset, it is true in the past from time-to-time we have picked up assets at low points in the cycle, that as I think the Hope Downs transaction because it was an acquisition it was a joint venture. But as that illustrates it is possible actually to do really value creating transaction add strong points in the cycle. And you just got to be clever about it I think, I don’t think its just a matter of picking up distressed assets, what is now very competitive environment and as you would like to say not very many people in distress, I mean in the fullness of time we think the cycle probably will time and at that time we will I am sure will be able to pick up some assets but we don’t have to wait until that happens if we can pick up. Now the other point you said was you can’t make acquisition if you use historic prices. Well we have said quite clearly in our investment seminar the process through which we go to establish what we think the equilibrium prices are. And while we yes we do observe history, particularly the history of costs. We are not saying slavishly that all prices are again to return, just on historic norm, we’re actually saying that they are going to return to something approaching marginal cost and its a very important question as to whether that cost has changed. So I don’t think you should therefore conclude that we have raised our long-term prices because in several cases we have as high as 25% since 2003, and say we haven’t done at all prices we done at one or two, and I think that’s a combination of creativity and opportunity will perhaps enable us to do some M&A, I can’t tell you when but then really - and that’s why we want to preserve a certain amount of flexibility on the balance sheet.
A - Leigh Clifford
Can I just said add a comment to that. I have often said when we are looking at how to grow the business, certainly M&A and the Hope Downs type joint ventures are important. Well often say the importance of alliances then they want to say what do you mean by alliances, well what I mean is a risk, that’s an example of an alliance which potentially can lead to substantial investments in growth in the business, and I would like to think we’ve got a key both in Brownfield Greenfield expansion M&A when its attractive in alliances like the minerals project which we described earlier, don’t forget our on the line rate of growth from the establish portfolio is running at 6% has gone to sometime, we think it will for sometime.
Guy Elliott, Chief Financial Officer
Any last question otherwise we will certainly be available out in the lobby. Are we done? We are done. Thank you.
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