Rio’s overall position
Rio Tinto’s asset base is world class. It has the number two position in iron ore production and the number one position on the iron ore cost curve. However, many of its aluminum assets are in the upper half of the global cost curve.
Iron ore contributes 49% towards Rio’s revenues and more than 90% towards its underlying earnings. Iron’s volumes and price outlook are important to determine Rio’s position in the industry.
Demand and supply
The iron ore market is in a structural oversupply with major players—like Rio Tinto (RIO), BHP Billiton (BHP), Vale SA (VALE), Cliffs Natural Resources (CLF), and Fortescue Metals Group (or FSUGY)—all increasing their capacities in iron ore.
We also discussed why China’s demand situation looks bleak in Key indicators for iron ore updated: No respite in sight. China is the largest seaborne customer. It consumes close to two-third of the overall seaborne shipments. Its real estate sector is weak.
The overall policy shift from investment to consumption-led growth might not be good for sectors like steel, iron ore, and coking coal.
Volume growth story
The iron ore and coking coal’s price outlook is bleak going forward. In contrast, Rio’s volumes are on an upward trend. Iron ore capacity expansion is on track for next year—to 360 million tons. Copper’s production profile is also strong.
More of an iron ore play
Although Rio is still known as a diversified player, most of its earnings are from iron ore. Recently, its diversification attempts failed. For example, the $40 billion acquisition of Alcan failed to generate expected returns.
Increasing iron ore reliance could mean decreased profitability. The outlook for iron ore’s price remains negative. We aren’t sure how much the cost improvements will help sustain Rio’s profitability. Most of Rio’s share price weakness, ~16% year-to-date (or YTD), can be attributed to iron ore price weakness. Iron ore’s price is down ~40%.
The SPDR Metals and Mining (XME) invests in above stocks.