Financial Analysis of Rio Tinto Plc - Case Study Example

Description

Rio Tinto is a global mining group based in the UK, with strong presences in Africa, Asia, America, and Australia. The company focuses on the discovery and mining of the Earth’s mineral resources. With their business spanning over 40 countries, the entity operates with more than 55,000 staff for the execution of their operations (Rio Tinto Group, 2016). The functionalities of the firm are executed as those of a conglomerate, comprising of Rio Tinto Plc., and Rio Tinto Limited, with the latter trading in the Australian stock exchange (Rio Tinto, 2015). Its ownership also extends to entities like Borax, Hamersley, Rio Tinto Iron & Titanium, and Kennecott (RioTinto Plc, 2016). There are also some partially owned subsidiaries including Palabora and Coal & Allied (Rio Tinto Group, 2016). The major products from this firm include aluminum, copper, gold, diamonds, thermal and metallurgical coal, industrial minerals including borates, titanium dioxide and salt, iron ore, and uranium (Rio Tinto, 2015).

Founded in 1873, the firm has been operational for over a century in the diversified Metals & Mining industry. The firm is the second largest producer of iron ore, closely following Australian entity BHP Billiton (Head, 2015). The total market share in the iron ore market held by Rio Tinto is about 17%, while its overall mineral output reaches 25% of the mining industry’s overall market share. Reports from the entity also record production of 33% of the world's zircon produce and 25% production in pig iron (RioTinto Plc, 2016). The rate of production has grown over the years, as has the level of revenue and profitability. Currently, the group revenue amounts to 24.56 billion pounds, while their profit in 2015 reached 1.21 billion pounds (Rio Tinto, 2015).

Due to the diversity of products, Rio Tinto benefits immensely from its global locations. Its markets and sources of raw materials differ, concentrating operations to places with easy sourcing of the minerals in question. As such, the main markets for this firm include industries making use of Titanium dioxide, which is the primary product of Rio Tinto (West, 2013). The industries are such as the motor industry, paints production, as well as in the manufacture of foods. Other markets for the products from Rio Tinto include hospital equipment manufacturers, as well as the producers of jewellery and electronic applications (Spiderbook, 2015). The ceramic industry also majorly purchases mineral from this group. Some of the major customers include the Mitsubishi Group, Hyundai, Wal-Mart, and the FTSE (Spiderbook, 2015).

The firm sources raw materials from various countries globally. For instance, its main copper sources are Chile through Minera Escondida, Kennecott Utah Copper for the USA, Australia, and Palabora in South Africa (Dixon, 2012). Further, the firm sources aluminium from its mines in West Africa, Brazil, and Australia; a venture spearheaded by Rio Tinto Alcan (West, 2013). Rio Tinto Energy sources coal and Uranium from Namibia, Mozambique, and Australia. Industrial minerals for this firm come from California and Argentina, while it prospects diamonds from India (Rio Tinto Group, 2016). Its Titanium is mostly from Australia, Guinea, Canada, India, and South America (Dixon, 2012). The application of diverse sources of raw material enhances its global presence, bringing it closer to the source while enabling it gain wider market share.

Financial Trends over Five Years

The performance of Rio Tinto over the past five years has been fluctuating. While some years have been marked by growth, others have had some decline in performance and resulting losses. Rio Tinto has, over the last five years, displayed periods of reduction in revenue and income. In fact, as of 2015, the company recorded a loss, even though it was not as big as it had predicted (Lannin, 2016).

Detail

2011

2012

2013

2014

2015

Gross Sales Revenue ($)

60,537

50,967

51,171

47,664

34,829

Profit Before Tax ($)

13,214

9,303

10,217

9,305

4,540

Net Earnings ($)

5,826

(2,990)

3,665

6,527

(866)

Cash Flow From Operations ($)

27,388

16,450

20,131

18,896

12,102

Operating Margin ($)

23%

18%

20%

20%

13%

Data from (Rio Tinto, 2015)

The strength of the balance sheet for Rio Tinto may not have fallen, but neither has it indicated any positive growth. Beginning 2012, its total assets have reduced to $91, 584 million from 118,437 million by 2015 (Rio Tinto, 2015). However, the total liabilities have also undergone a similar decline. The liquidity ratios of the firm show an increase in the cash ratio to 93% from 51%, while the quick ratio has gone up to 123% from 101% in 2012 (Rio Tinto, 2015). The current ratio has remained relatively even, only increasing to 8% in the last five years (Market Watch, 2016).

Movement of Rio Tinto Plc. Shares

Source: Bloomberg

Notably, however, all the finances indicate the firm as having reported slightly better positive performance in 2014, only to decline again in 2015. For instance, 2014 had a current ratio of 179% and quick ratio of 137% (Market Watch, 2016). The net earnings this year also were much higher than the previous year and 2015, when the company recorded losses in the consolidated finances. The return on equity for the firm also reached 14% in 2014, from 2% in 2013 and falling back to 5% in 2015 (Lannin, 2016). The changes in Rio Tinto were attributed to a decline in commodity prices, which led to low growth globally and uncertainty in the global market (Lannin, 2016).

Corporate and Financial Actions

The recent years have held massive strategic decisions by Rio Tinto in its international activities. In 2008 and 2009, Rio Tinto engaged in merger and acquisitions activities targeting raising cash to refocus on core business. In 2008, the firm divested three major assets and raised $3 billion; and sold its interest in the Corumba mine and one coal mine (Dixon, 2012). The company also sold an aluminium smelter and its operations in potash. The company also staked Riversdale Mining in Australia in 2011, followed by a joint venture with Acron Group for potash development (Fitzgerald, 2016).

In 2012, Rio Tinto took more steps and gained control of Ivanhoe Mines in Mongolia (Head, 2015). These decisions have expanded the presence of the firm in Asia and Australia, giving it strategic geographic advantage. The company, however, rejected merger offers from Glencore in Australia (Head, 2015). This decision, despite the internal strategic reasons, could have beaten competitors as the merger would have produced the largest mining firm globally (Fitzgerald, 2016).

Rio Tinto has made several decisions regarding its financial expenditure in recent years. For instance, the company reduced its 2014 expenditure estimate to below $8.5 billion (Fitzgerald, 2016). This change was due to changes in global prices and the demand for iron. Further, 2015 saw the firm maintain its dividend rate as $US2.15, but with a replacement to its progressive dividend policy (Hoyle, 2016). The firm cut its capital spending by about $ 4.6 billion (Government Printing Office, 2015). The result was a decline in performance for 2015, resulting in a loss for the firm from the profits in 2014.

Management of Exchange Rate Risk

The geographic diversity of Rio Tinto influences the shareholders’ equity, cash flow, and earnings due to the difference in currency involved in the sales of the group products and operations. However, the firm denominates majority of the sales by the group using the US dollar (Rio Tinto Grp, 2010). The operating costs that the firm experiences are subjective to the currencies of the countries in which the mines of the Group and its processing plants are located. As the group is bound to import equipment and machinery, the costs are also influenced by the currencies in which they are made. Apart from the US dollar, the currencies considered the most critical in creating influence on costs are the Australian and Canadian dollars, and the Euro (Rio Tinto, 2015). This position means that, annually, the fluctuations in currency globally heavily influence the financial results of this entity. When the US dollar strengthens against other currencies like the Euro, it is usually considered a positive effect on the underlying earnings of the company (Rio Tinto Grp, 2010).

The presentation of financial results for the Group is made using the US dollar, further compounding its dominant role. Due to this position, borrowing and holding cash in surplus also makes use of the same currency (Rio Tinto, 2015). Nevertheless, the company makes a point of holding in other currencies especially the Aussie, Canadian Dollar, or the Euro (Rio Tinto, 2015). The cash holding is usually for short-term commitments for operational and capital commitments. The Australian Dollar, however, is used to hold excess cash used in dividend payments. The financing of operations relies on the US dollar. This financing takes place directly, or makes use of interest swaps cross currency (Rio Tinto Grp, 2010).

The financing activities of Rio Tinto employ different approaches, which creates some accounting exposures to exchange risk. For instance, some assets and liabilities like the US dollar debt are usually held in this form against in the currency functionally employed in the subsidiary (Rio Tinto, 2015). The outcome is that there are some exchange gains and losses for the group as the accounts of subsidiary assets and liabilities are translated from the US dollars to the functional currency (Rio Tinto Grp, 2010). In order to account for these gains and losses, they are recorded in the income statement, with the exception of the extent to which they can be taken to equity (Rio Tinto, 2015). However, in reporting the underlying earnings of the group, these losses or gains relating to the US dollar debt are excluded; while other exchange changes are included (Rio Tinto, 2015).

The hedging of exchange risk is executed by the use of cross-currency interest rate swaps. The interest rate swaps enable the conversion of fixed rate borrowing on foreign currency to floating rate borrowings in the US dollar (Rio Tinto, 2015). The application of various swap instruments ensures that the net debt of the Group is majorly held in US dollars. However, an equally high amount is usually held in the functional currency of the subsidiaries of this group (Rio Tinto, 2015). Using this approach, the company has the assurance to access borrowing in the host country while maintaining favourable rates of interest payment.

Nevertheless, the group emphasizes its belief against hedging during normal market conditions. It is the belief of Rio Tinto that such transactional behaviour will not offer any long-term benefits to its owners (Rio Tinto Grp, 2010). Consequently, there are constant reviews to assess the degree of exposure and determine the appropriate time to adopt hedges in the maintenance of financial stability. The hedging of capital expenditure and tax usually requires approval by the board, subject to previously stipulated conditions (Rio Tinto, 2015). For instance, by 2010, the group has a notable series of forward contracts hedging against currency exposure from transactions with the north (Rio Tinto Grp, 2010). These instruments were implemented in a bid to refinance on of the acquisitions in South Africa, Palabora, and prevent exposure to the movement in copper pricing (Rio Tinto, 2015).

Management of Country and Political Risk

The diversity of the Group’s operation exposes it to a set of country and political risks, often unique to the country in question. Rio Tinto relies heavily on the Chinese market, implying that should China experience an adverse event or an economic downturn, or in case of Chinese customers opting for an alternative product source, it will affect demand immensely for this group (Reed, 2014). The outcome will be a consequent decline in pricing, as demonstrated by the global behaviour in 2015. Currently, the Group notes the basis for iron ore pricing evolution in Asia and its influence on pricing and associated mechanisms would influence the eventual cash flow and earnings of the group. Nevertheless, the country risk in China currently remains low as China pledged earlier in the year to facilitate the activities of the iron industry (Hoyle, 2016).

The business cultures of some countries pose some risk to the operations of Rio Tinto internationally. These forms of risk often are instigated by different factors, ranging from corrupt economies and operations to the need for specific acts with governments in order to commence activities. As such, countries with bribery and corruption deeply instilled within their business pose difficulties for the honest operation of the Group (Rio Tinto, 2015). The legislative bodies in some countries also impose some conditions, as well as adherence to regulations and associated acts in different countries. The law surrounding the exchange and exploitation of land resources, as well as ownership being individual or public also tends to be unclear in some of the countries where the group operates (Cotterill, 2015). The possibility remains that, with any changes to the law, the rights and assets of the group are at risk of exposure and possible loss (Rio Tinto, 2015).

As Rio Tinto continues its operations, it faces the possibility of political instability, or changes to the government terms applicable to the operations of the Group. These changes could result in an increase in internal costs, or even prevent the continuation of activities in which the group participates (Rio Tinto, 2015). Further, the operations of the group currently and in the future take place close to communities that may consider them damaging (Rio Tinto, 2015). Communities present complex expectations, which differ according to their surroundings and cultures. Disputes with the communities could disrupt the operations of the group, which would result in the increase of costs and consequently lower their profitability (Rio Tinto Grp, 2010). The disputes may escalate to criminal activity, which not only affects the reputation of the firm, but also increases the losses (Seitanidi, 2010).

In order to minimize political risk, Rio Tinto attempts to conduct suitable risk assessment before venturing into a new country. Political risk experts offer adequate analysis and information, enabling advice for the entity regarding a prospective investment. However, it is impossible to accurately predict the occurrence of such risks. In this regard, the Group makes deliberate steps to mitigate the effect such risks could have on their operations (Rio Tinto, 2015). Notably, most of the subsidiaries owned by Rio Tinto are only partially owned. Local investors often hold the rest of the ownership, which implies the Group, can efficiently pull out in case local regulation limits the conduct of international investors (Fitzgerald, 2016).

Rio Tinto also emphasizes agreements with local governments and local communities. In countries like Australia, the Native Titles align the activities of Rio Tinto with those of the local community (Rio Tinto, 2015). The agreements put the firm in a favourable position, possibly preventing disputes with local communities. Like other firms, it is also possible for Rio Tinto to purchase political risk insurance. This has been especially useful in politically volatile nations that are subject to internal disputes (Fitzgerald, 2016).

Conclusion

Rio Tinto demonstrates a long-standing image of international success. Evidently, the international business scene is subject to fluctuations, which then result in fluctuations in the performance of the firm. In this regard, the pricing and demand of the products in Rio Tinto has changed in the last five years, displaying trends of increased income and a decline in 2015. Nevertheless, the Group has maintained a strong balance sheet, matching its decline in assets with a decrease in liabilities both in the short and long term. The strategic activities of Rio Tinto display strong inclinations towards avoiding risks and adopting solidified cash positions. The use of forward contracts and hedging is meticulously applied in this Group. In good financial times, there is a strong regulation against their use. Coping with political risk relies on political insurance, research, and mass exploitation of agreements with both governments and specific communities.