Update: Rio Tinto Poised To Increase Shareholders' Returns

| About: Rio Tinto (RIO)
This article is now exclusive for PRO subscribers.


Metals and minerals industry has been experiencing depressed pricing environment.

Rio Tinto is working on the right strategy to cope with challenging business environment.

Rio has potential to increase its returns for shareholders.

Over the past two years, the metals and minerals industry has been experiencing depressed commodity environment. Recently, iron ore prices fell below $70, the lowest mark since 2009, due to the imbalance between supply and demand dynamics. The biggest iron ore producers, including BHP Billiton (NYSE:BHP), Vale SA (NYSE:VALE) and Rio Tinto (NYSE:RIO), are generating record levels of iron ore production.

The depressed pricing environment has been pushing a number of big miners into a troubling situation and has forced them to adopt defensive strategies. Some of them, including RIO and BHP, had adopted a defensive strategy at the right time. Meanwhile, Cliffs Natural Resources (NYSE:CLF) and some others responded late to the changing business environment, and this resulted in big losses in the past few quarters. Due to the depressed commodity pricing, metals and minerals companies have been losing their earnings, cash flows and dividends. However, Rio Tinto has been opposing these trends with its smart capital allocation strategies, diversified portfolio, and ability to produce commodities at a lower cost.

Rio Tinto recently expressed its intention to increase returns for its shareholders. The company is looking to return a significant amount of cash to investors in the form of increased dividends and buybacks. Rio's business strategy is working, and it has been considerably lowering direct and indirect costs over the past few quarters. The company had already reached its target of lowering operational costs by $3B in the first half of this year, and they are looking to lower operating and exploration costs by $5.4B by the end of 2015.

On the other hand, the company is successfully enhancing and offsetting pricing pressure with volumes and production. In the most recent quarter, Rio had generated record levels of iron ore and thermal coal production. The stake in the Pilbara mine, which is the lowest costing iron ore producer, is strengthening Rio's iron ore business, and this is allowing it to reach record production. Rio Tinto is looking to make more investments in the Pilbara mine to achieve mine production capital intensity of around $9 a ton. Its thermal coal reserves and resources in Australia will allow it to produce strong growth in coal production.

On the back of recovery in grades at Kennecott Utah Copper and shipments at OyuTolgoi, the company's copper production increased by 23% in the past quarter. The company is lowering its costs and enhancing its production to drive profitability from its copper business. In addition, Rio is diversifying its portfolio and looking to increase aluminum production, which is offering better margins. Rio Tinto is also diversifying its portfolio with its aluminum business. It has generated 23% growth in earnings from its aluminum business. It is strengthening its aluminum business by improving its world-class first-quartile smelting position and industry-leading bauxite assets. In addition, the bauxite export business is projected to generate EBITDA margin of more than 50%.

Furthermore, it is strongly working on improving its operational efficiencies and selling non-core assets. The company had sold around $3B of non-core assets and is looking to generate around $3.5B from the sale of non-core assets in 2014. Overall, Rio's strategy is working in difficult business environment as it has posted 21% growth in earnings in the most recent quarter and cash flow enlarged by 8% over the past year's quarter. On the cash side, the company is looking to lower its capital expenditure by 34% year-to-year, totaling to $8.5B in 2014. Sale of non-core assets and lower capital expenditure allowed the company to lower its debt by $1.9B in the first half of this year, which allowed achieving the debt target of the mid-teens. Moreover, the company's free cash flows are providing a complete cover to its dividend payments. In fact, the free cash flows are providing room for potential increases.

In Conclusion

Three months ago, I recommended investors to hold this stock as I predicted that Rio is working on the right strategy to deal with uncertain environments. I still have a similar opinion on this stock, as Rio's management recently expressed its intention to accelerate its shareholders' returns. Rio has potential to sustain and increase its dividends with the strong cash position, healthy balance sheet, and low-cost asset portfolio. In addition, its concentration on enhancing aluminum and copper business will add significant strength to its profits along with its continued investments in its Pilbara mine to achieve mine production capital intensity of around $9 a ton.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.