The Main Sources of Revenue for the Rio Tinto Company - Assignment Example

30 December Question No What were the main sources of revenue for the company? Rio Tinto is a UK-Australian based mining and metal producing company, which is engaged in the production of aluminium, iron ore, alumina, copper, uranium, diamonds, gold coal, bauxite, talc, titanium dioxide, gypsum, borates and salt. During the year 2012, Rio has made a record iron ore production and also high recovery in copper volumes. Despite the fact that Rio Tinto’s main focus is on mining of minerals, it has also poignant operations in refining activities, especially the refining of iron ore and bauxite. Rio Tinto’s group revenue chiefly organised into five main categories as per the details given below: Copper – extraction of copper, its by-products like silver, sulphuric acid, gold and molybdenum and future plans to diversify into nickel operations. Alcan- extraction and production of alumina, aluminium and bauxite Energy – extraction and mining of uranium and coal Diamonds & Minerals like talc , borax , titanium oxide and gypsum Iron ore- mining and extraction of iron ore and manufacturing of iron. The above operation divisions are supported by separate divisions’ thereby offering function and exploration support. Rio Tinto’s components of Sales Revenue for the years 2012, 2011&2011 31-12-2012 31-12-2012 31-12-2011 31-12-2011 31-12-2010 USD $ M USD $ M USD $ M USD $ M USD $ M Gross Income Net Income Gross Income Net Income Gross Income Iron Ore 24279 9242 29475 13267 24024 Aluminium 10105 3 12159 442 11313 Copper 6661 1092 7634 1932 7797 Energy 5783 283 7003 1074 5652 Diamonds & Minerals 4056 119 3654 -162 3035 Other Operation 6730 -528 8246 -120 10151 Consolidated sales revenue 50967 -2990 60537 5826 61972 As compared to 2010, Rio’s sales revenue fell by 21% in the year 2012 and this is mainly due to falling prices and increased overheads and it has also impacted its profitability. What were the main expenses of the company? In spite of record production of iron ore, the underlying revenues of company sharply fell down as the company is able to trade only on lower commodity prices that prevailed in the market. However, the diamond segment of the company is the only section which did not experience a fall in price. Rio Tinto wanted to minimise its losses at this falling commodity price mainly by engaging in the cost savings. To recoup the loss, the management is also planning to divest off its non-core assets. Further, its aluminium segment witnessed a tough time as it witnessed with high-energy costs and there was also over supply in the market. Rio Tinto also engaged in the processing of some of these minerals with dedicated plants to process smelting of iron ore into iron and the processing of bauxite into aluminium and alumina. It also derives many by-products from the processing of main minerals like molybdenum, gold, sulphuric acid, nickel, lead, potash and zinc. (www.telegraph.co.uk). Explain whether these have changed significantly over the three years. Provide examples of changes to revenues or expenses that have impacted on overall profitability. As per IAS 36, FVLCS method is mostly determined by employing market oriented methods; it is significant to note that the DCF method is also employed under FVLCS approach. In the Fair Value less Costs to Sell (FVLCS) method, it is more closely related with the market price or valued derived from a market for an asset. When evaluating the cash flows to be employed in the FVLCS, market participation presumptions shall be employed in estimating the cash flow projections and synergies which are not available to a market participant should be eliminated. In European research study carried over 2011 & 2012, about 13% of the South African respondents replied that they exclusively used FVLCS method. (Rowley). According to me, the following of FVLCS method has resulted in higher depreciation and impairment charges and it has impacted the profitability of the company. Component of income statement Yes. Rio Tinto financial reports have been prepared in accordance with the EU IFRS and IFRS (International Financial Reporting Standards), the format of income statement for minerals industry has been followed by the Rio Tinto as it considers recognition of sales revenue and currency translations in their revenue statement. Components of the balance sheet Yes, Rio Tinto has a strong balance sheet with investments of US$ 81759 m in plant, equipment, property and in tangible assets which are funded by borrowings $ 24591 m with reserves and surplus of US$ 36676 m. Rio Tinto has considered the exploration and evaluation of its mining activities, deferred striping, depreciation and impairment, estimation of iron ore reserves and other mining activities. RIO follows segment revenue reporting, which helps the lenders and investors in evaluating its various elements of its operations and information relating to its products like iron ore, aluminium, coal, diamond, etc. From the segment revenue reporting, Rio’s investors can be able to understand the opportunities, trends, risk elements, etc. Further, segment revenue reporting helps the Rio’s management to evaluate the performance of its each and every segment and also to make operational decisions. Thus, Rio’s segment revenue reporting helps to have consistent narration of its activities for both external and internal reporting and in particular, offers that external financial reporting closely adheres to its internal reporting.(Delaney & Whittington 691). 2. Answer to Question 2 RIO Tinto’s revenue statement recognises the point of sale and the revenue which is regarded to be earned during the specific period. Revenue generated means products have sold, which connotes that products adhered to the customer’s specification. Further, interest is accounted in the Rio Tinto’s books on accrual basis. Further ¸dividend income is acknowledged when the right to receive the payment is demonstrated. (Rio Tinto’s Annual Report 2012:217) Rio Tinto’s balance sheet is a statement which lists out its liabilities and assets at a particular point of time i.e. for example, as on 31st December 2012. Rio Tinto’s group financial position contains non-current assets, current assets, total assets, current liabilities, non-current liabilities, total liabilities, net assets, and capital reserves. Rio Tinto’s cash flow statement reports the effect of company’s operating, financing and investing activities on cash flows during the accounting period. Rio’s cash flow statement lists all major cash receipts and cash outflows during the particular financial period and lists out the changes happened from investing, operating and financing activities. 3. Answer to Question 3 30-06-2012 30-06-2011 30-06-2010 30-06-2012 30-06-2011 30-06-2010 USD $ M USD $ M USD $ M USD $ M USD $ M USD $ M RIO TINTO BHP Billiton Operating Profit Margin 32.89% 44.35% 37.94% 0.35 0.47 0.47 Net Profit Margin 21.35% 32.96% 24.10% 0.22 0.35 0.26 Return on Equity (ROE) 23.41% 41.66% 26.22% 22.98% 40.95% 25.79% Debt / equity 4.14 3.50 2.35 0.95 0.3995 0.2845 Current ratio 1.39 1.46 1.67 2.29 2.73 3.38 If we go through the above table, we can find that Rio Tinto’s profitability ratios are good as compared to BHP. However, Rio Tinto has having high debt component and this will reduce its profitability due to higher finance costs. As regards current ratio, BHP is having high current assets as compared to Rio Tinto. From the profitability ratios, we can understand both Rio, and BHP are witnessing a decline in their margins, and this is mainly due to high volatility of commodity prices and the dampening impact of the Australian dollars. (AUD). Thus, there is a need for both Rio and BHP to indulge in cost cutting initiatives to restore their margin percentage to their 2010 year level. In the case of BHP, gross profit grows steadily due to its annual copper volume growth even in the falling commodity prices. However, in case of RIO, its gross profit is badly impacted as it is having great exposure to the declining iron ore price. However, the fall in gross profit is being counterbalanced by the diversified activities of RIO as diversified miners seems to be well placed to keep up their margins even during the period of declining iron ore prices. Normally, a prudent management exhibits higher capital discipline, particularly in weaker commodity price scenarios by engaging in downsizing its capex budgets and by postponing their spending budgets. However, in case of RIO, high debt –equity ratio symbolises even in the falling commodity price scenario suggests that RIO management is engaged in the capex budgets in the best long run interest of its shareholders. Both Rio and BHP are able to preserve their net operating margin as the both companies engaged in the merger and acquisition activities continuously even in the bearish market. Thus, merger and acquisition activity helped both the companies to attain higher production and resulted in maintaining their operating profit margin even in the falling commodity price circumstances. Though RIO’s operating margin was impacted by the ever increasing iron ore prices, but this was counterbalanced by its higher exposure of Aluminium segment. Both Rio and BHP are able to remain as leaders in the industry due to the mixture of strategies like increase in volume due to new projects that nearing its completion , enhancing free cash generation mainly because of higher capital restraint and new production facilities , the market propensity to pay back higher valuation multiples particularly in weaker commodity price scenarios and continuously engaging in cost cutting initiatives, which will maintain the margins even in the falling commodity prices. Rio’s energy segment revenue also witnessed a decline trend due to lower prices for uranium and coal, ever increasing input costs and with a strong Australian dollar. (Rio Annual Report 2012 28). Rio’s underlying revenues have declined by US$ 6246 m of 2012 as contrasted to 2011 revenues. This indicates about the lower average market prices for the RIOs commodities during the period, and an aggregate decline in sales volume and industry based cost inflation tendencies. (Rio Annual Report 2012 8). RIO performance somewhat excels the performance of BHP as it has attained poignant volume growth over the past period and it also need less exposure in ongoing projects, which means it can generate high volume of cash flow, which will add more strength to its balance sheet. However, RIO has the risk of higher exposure to iron ore price, which will pull down its long-term performance due to lesser profitability in this sector. Further , it is the practice of RIO to identify and invest in and to operate giant , long-run , low-cost business and mines and this strategy helped to perform well not only in the past but also in the near future .Further , RIO is the global leader in processing and mining technologies. Further, it owns and operates driverless trucks, which are controlled about 1500 km away. RIO is also the industry leader in innovation and technology to drive safety and to introduce productivity enhancements across all of its business segments. This has given RIO an edge over its competitors. RIO’s is able keep to its operating margin intact which demonstrates that it has strong fundamental strength in its business activities as its iron ore business attained record production and also shipments and its copper segment also witnessed a recovery in the past years as regards to copper volumes. Further, RIO also witnessed an increase in production in segments like alumina, bauxite, titanium dioxide and thermal coal. To strengthen its financial ratios, RIO has to take the following initiatives viz. to focus its capex on the value-added projects and should enhance the style in which it manages its capital. Further, it should engage in a more belligerent portfolio approach to hive off nonperforming assets. Thus, both Rio and BHP should give immediate priority in the improvement of their performance by introducing productivity innovations, vibrantly to minimise their support and operating costs, to control the capital spending and leveraging their management expertise across all segments of their business activities. (Rio Annual Report 2012 6). Though, ratios and comparative analysis may not give the full picture, I find that the above ratios are giving warning to these companies to introduce adequate preventive steps to avoid any pitfall in the near future. 4. Answer to question no 4 (1) 2012 (US$ million) 2011(US$ million) Change Cash flow from operations 16,450 27,388 -40% The operating cash flows will offer an insight how to manage costs and to have an improved productivity and efficiency across the business. As compared to the year 2011, in the year 2012, there was 40% decline in cash flow activities and this is mainly due to lower commodity prices that existed in the global market and higher cost of production. However, even in the falling market ¸Rio Tinto is able to generate strong cash flows and has posted earnings of 9.3 billion. Answer to question 4. (ii) RIO TINTO CASH FLOW STATEMENTS – ANALYSIS Cash flow from investing activities 2012 (US$ million) 2011(US$ million) Acquisition of JVs , Associates and subsidiaries (1336) (4156) Disposals of JVs , associates and subsidiaries 251 387 Purchase of associates , plant and property (17458) (12335) Divestment of financial assets 693 104 Acquisition of financial assets (50) (146) Other activities (361) (931) Cash employed in investing activities (18174) (16838) (Rio Tinto Annual Report 2012 141). As compared to the year 2011, in the year 2012, Rio Tinto spent more on the purchase of properties, associates and plants. As compared to the year 2011, Rio Acquisition activity becomes less vibrant in the year 2012. Further, it is the practice of the mining companies like Rio to indulge in disposing of non-core assets (sale of financial assets of $693 million in 2012) particularly in the slump period to beef up their balance sheet and to keep their dividend payout. Thus, this kind of activity helped RIO to preserve the aggregate margins, especially in declining commodity prices. Answer to question 4 (iii) Cash flow from financing activities 2012 (US$ million) 2011(US$ million) Payment of dividend to equity shareholders (3038) (2236) Buy back of shares (1471) (5504) Additional borrowings to meet shortfall 8569 4704 Unit funded balances –cash movement on equity -- 1683 Loan Repayment (681) (496) Other activities (361) (931) Raising of fresh capital 2945 424 Buy back of non-controlling interest (76) (2243) Cash flows from other financing activities 77 242 Cash flow from financing activities 6325 (3426) (Rio Tinto Annual Report 2012 141). As compared to the year 2011 , in the year 2012 , Rio Tinton raised fresh capital and gone for additional borrowings mainly to fund the payment of dividend , and to buy back the shares from the existing shareholders and to fund the investments in plant and machinery. As the RIO management exhibits higher capital restraint normally displayed at the bottom of the cycle, even though earnings are falling, still cash flow yields can increase while increasing dividend payouts also turned to be gradually more encouraging. Works Cited BHP billiton.com 7 September 2012 .Annual Report 2012 .30 December 2013 < www.bhpbilliton.com/.../reports/.../2012/BHPBillitonAnnualReport2012> Rio Tinto.com. Annual Report 2012. 30 December 2013 < www.riotinto.com/reportingcentre2012/.../rio_tinto_2012_annual_report.> Delaney P R & Whittington O R. Wiley CPA Exam Review 2011. New York: John Wiley & Sons, 2011. Rowley, E. 8 August 2013 .Rinto focuses on Cost Savings as Falling Prices hit Earnings. 30 December 2013 http://www.telegraph.co.uk/finance/newsbysector/industry/mining/10181704/Rio-Tinto-focuses-on-cost-savings-as-falling-prices-hit-earnings.html www.kpmg.co.za. Cost of Capital and Impairment Test Study .30 December 2013 Read More