Financial Analysis Rio Tinto Is a Major Essay

Financial Analysis

Rio Tinto is a major mining company in the FTSE 100, specializing in iron ore. The company is geographically diversified. A close competitor is BHP Billiton, and these two firms are compared on the basis of their operations and financial statements. From a financial perspective, both firms are relatively equal. Both firms had strong years in 2008 and 2010, with a weak year in 2009 in between. Rio Tinto's results are better, largely because it benefited from a run-up in commodity prices in late 2010, after BHP's fiscal year had ended.

Rio has demonstrated a commitment to managing its capital structure effectively. The company went deeply into debt in 2007 in order to purchase Alcan, the Canadian aluminium giant. As a result, Rio has spent the past few years trying to pay down debt. Even during the down year in 2009, it was able to do so and today its gearing level is around the same as that of BHP. Rio has also been able to reduce its cost structure, and the combination of this and higher commodities prices has made this past year especially profitable for the company.

Taken as a whole, Rio's financial performance is good, but more importantly shows a strong upward trend. Rio Tinto has consistently improved most ratios in the past couple of years, and this cause for optimism among investors. There is reason for concern in that Rio is heavily dependent on iron ore prices for its financial strength, but the company has demonstrated the ability to perform well even when ore prices are relatively low. As such, Rio Tinto is a good investment for people who want to gain a blue chip mining stock from the FTSE 100.

Introduction

Rio Tinto is an Australian mining company and FTSE 100 component. Based out of London and Melbourne, Rio Tinto is involved in the exploration for and mining of aluminium, copper, iron ore, diamonds and energy resources. Rio Tinto is one of the largest mining companies in the world and is dual-listed in Australia and London (RioTinto.com, 2011). It ranks #68 on the Forbes Global 2000 list of companies (Forbes, 2010). The company has seven divisions: Aluminium, Copper, Diamond & Minerals, Energy, Iron Ore, Exploration and Technology & Innovation. Operations are global, depending on the product. Most of the non-mining activities are conducted in Western nations, while mining activities are conducted on site around the world, in both developed and developing nations.

This paper will analyze Rio Tinto in the context of its recent financial performance. The objective of this analysis will be to make a determination with respect to the financial performance of Rio Tinto. This analysis will include a discussion of strategy, trend analysis, ratio analysis and a calculation of the firm's weighted average cost of capital. The main sources of information will the company's annual report and the financial figures from Yahoo! Finance UK. Recent new reports may also be utilized to gain independent perspective with regard to recent changes at the company and in its operating environment.

The paper will also include a comparative analysis of Rio Tinto with respect to a main competitor. The competitor chosen for this analysis will be BHP Billiton. BHP is also dual-based in London and Melbourne and is also a member of the FTSE 100. In addition, the two companies are comparable in size and in their global scope. BHP operates in iron ore, aluminium, coal, manganese, base metal, uranium and other categories, so is slightly more diversified than is Rio Tinto, but in general there are many product line similarities. The two companies are natural comparables. As a result of this comparison and the prior financial analysis, an assessment of Rio Tinto will be made in the conclusion of this report.

Company Overview and General Financial Analysis

Rio Tinto's vision (2011) is "being the global mining leader…sector leadership…operational excellence, sustainable development, exploration and innovation," which provides only minimal guidance for stakeholders as these elements of strategy are self-evident for a major global mining company. The company envisions itself as having strong growth potential as global demand for minerals continues to increase, largely due to population increase and economic development around the world. The company sees China in particular as a strong source of future growth and has embarked on a number of joint ventures in the country to support this element of its strategy (Walsh, 2011).The company has also enjoyed good financial results recently due to increases in the price of base metals. Profits last year were £14 billion, fueled by a doubling of copper prices and a 50% increase in iron ore and aluminium prices. The company has also begun to recover financially from going into debt two years ago with its $40 billion purchase of Alcan, the Canadian aluminium giant (Wachman, 2011). In general, mining companies tend to benefit from increases in commodities prices, as they are able to earn higher margins on these products in the face of rapidly escalating demand. It is worth noting that over the long-run, the mining business tends to be cyclical in nature, as commodities prices are highly volatile (Bank of Montreal, 1997). The earnings of mining companies are highly exposed to fluctuations in commodities prices as a result. This is important to bear in mind over the course of this analysis because to some extent the relatively success or failure of Rio Tinto is based on commodities prices rather than internal competencies. Over the long run, Rio Tinto should be more successful than its peers as a result of its strategies, however.

Rio Tinto currently trades at 4243.5 p per share, on the lower side of its 52-week range. The company earns 7.26 p per share, giving it a multiple of 584.34, which is very high for a company its size, even if it is rapidly growing. Rio Tinto's market cap at this level is £83.26 billion. The company's high stock price implies a forward P/E of 4.44, so the expectation in the market is that earnings are going to increase significantly in the coming year over their current level.

According to Rio Tinto's 2010 Annual Report, the company has a relatively even geographic split: 21% of sales are in the Americas; 19% in Europe, the Middle East and Africa; 28% in China and 32% in Asia/Australia. The firm's dependence on the Chinese market is already high and is expected to continue to grow in the future as well. The contributions to earnings for the company's groups are as follows:

Group

Contribution to earnings

Aluminium

6%

Copper

18%

Diamonds & Minerals

2%

Energy

8%

Iron Ore

73%

This table illustrates that despite Rio Tinto offering a wide range of products, its business revolves around the health of the iron ore market. Iron ore prices have increased significantly of late. Since August 2010, iron ore prices have risen 28.7% from $145.34 per ton to $187.18 per ton in February 2011. The chart for the past year illustrates the strength in Rio Tinto's core business:

source: IndexMundi

Based on this understanding of Rio Tinto's business, the company should have enjoyed an improvement in its results over the course of the past year, roughly in line with the improvements in the price of iron ore and other key commodities. Rio Tinto's revenue from continuing operations for fiscal 2010 was $56.5 billion, compared with $41.8 billion in 2009 and $54.2 billion in 2008. The weakness in the global economy in 2009 resulted in depressed commodities prices. As those prices recovered in 2010 with the improvement of many economies including the key Chinese economy, Rio Tinto saw its revenues rebound. Net profit also improved significantly in 2010. Net profit for the year was $15.3 billion, compared with $5.3 billion in 2009 and $4.6 billion in 2008. These results derive primarily from the increase in commodities prices as evidenced by the sharp uptick in revenues that was unmatched by an equally sharp uptick in costs. Revenues from continuing operations increased 35% last year while net operating costs increased just 8.4%. There was also an element of cost containment in the profit improvement as operating costs as a percentage of revenues was 64.8% in 2010 compared with 69.3% in 2008, a year which saw similar revenue and cost figures. Thus, Rio Tinto improved its efficiency while enjoying the benefit of higher commodities prices.

A trend analysis on the statement of financial position shows that Rio Tinto has reduced its degree of gearing in the past year. While total assets increased 15.5% in 2010, total liabilities declined 8.1%. Along with the improvement in the net income figures, this reduction of debt is indicative of a company that is improving its financial position. A ratio analysis.....