Rio Tinto Limited: $17.3bn reasons why BHP is a better bet

About Latest Posts Mike KingMike King is a Investment Analyst and Writer. He caught the investing bug more than …

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Rio Tinto Limited (ASX: RIO) management has presided over a sorry state of affairs. That, plus their over-reliance on iron-ore, makes BHP Billiton the better big mining bet.

Rio Tinto recently reported its full year results for 2011, and while underlying earnings are up 11% to US$15.5bn, net earnings have been hit by a $8.9bn write-down related to its aluminum business (Alcan). Thanks to the write-down, earnings per share have fallen 58% to US$3.03, despite a US$7bn buy-back program.

Capital expenditure (capex) increased almost three fold from US$4.6bn to US$12.3bn in 2011. Capex is expected to increase again in 2012 to $16bn. Much of this expenditure is aimed at increasing the company's iron ore production to 283 million tonnes per annum (Mt/a) by 2013, and further increasing capacity to 353 Mt/a by 2015.

In regards to the write-down, the CEO, Tom Albanese and CFO Guy Elliott have notified the company that they did not wish to be considered for an annual bonus, as they were involved in the acquisition of Alcan in 2007. How they have managed to keep their jobs is beyond me – more on that later.

Rio Tinto the company

Rio Tinto is a globally diversified miner engaged in mineral exploration, development, production and processing. Its major products include iron ore, aluminum, copper, diamonds and other minerals, and energy.

Higher commodity prices responsible for rise in earnings

Rio has taken advantage of higher prices for many of its commodity products. In fact US$6.7bn of net earnings came from higher prices in 2011 compared to 2012, with production only slightly up compared to 2010.

The company has also changed how it prices its iron ore contracts, making it much more susceptible to short term changes in commodity prices. While this is fine while there is booming demand for commodities, should prices fall dramatically, it will have a much larger effect on profits going forward.

The Alcan debacle

As I mentioned briefly above, the company has taken an impairment charge of US$8.9bn on its Alcan purchase. In 2007, Rio bought Canadian aluminum producer Alcan for US$38.1bn. At the time, it was considered an extremely high price. Shareholder activist and Crikey website contributor Stephen Mayne blasted the board at the time and labelled the Alcan deal "commercially reckless".

Mr Mayne has so far been proven right, with that purchase almost sending the company bankrupt. In 2008, just six months later, Rio took the first impairment charge on Alcan to the tune of US$8.4bn. Including the current US$8.9bn impairment, Rio has so far written off US$17.3bn against that US$38bn purchase. One wonders if that's going to be the last impairment charge or not.

In 2011, Rio also flagged that it was looking to sell $8bn of aluminum assets, making Alcan look like the world's most expensive lemon. Who would want these assets anyway, remains to be seen.

2007 to 2011 – A sorry tale

Since the Alcan purchase, the directors of Rio have presided over a sorry state of affairs:

  • $US17.3bn in write-downs on Alcan (so far)
  • In 2008 Rio announced that it was laying off 14,000 workers
  • A US$15.2bn rights issue used to pay off debts mostly accumulated with the Alcan acquisition
  • Knocked back a takeover offer by BHP Billiton Limited (ASX: BHP), in which BHP was offering 3.4 BHP shares for each Rio share. Tom Albanese said at the time that Rio was worth "much, much more". (Just for hypothetical purposes at current prices, BHP's offer would be worth A$124 or 77% higher than Rio's current price of around $70.) Maybe Mr Albanese got that one wrong.

How any directors from 2007 have survived, especially those directors intimately connected with the Alcan deal is beyond me.

The other issue is quite apparent from the charts below. Rio has increased its exposure to iron ore dramatically, leaving it critically exposed to any decrease in the price of iron ore.

Source: Company reports

Now more than three quarters of Rio's earnings comes from iron ore, and expect this proportion to increase dramatically over the next few years.

"Diversified, no longer is it" as Yoda would say.

The Foolish bottom line

If you are looking for a well-run, diversified resources company, Rio is not it. BHP is by far a much better managed, diversified miner with better defences against a downturn in commodity prices.

Rio on the other hand, is likely heading for more write-downs and future profit losses should iron ore prices or demand fall.

Attention: Are you are looking for investing ideas for 2012? Request our free reportThe Motley Fool's Top Stock For 2012Click here, whilst it's still free and available.

 More reading

Motley Fool contributor Mike King does not own shares in Rio or BHP. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Click here to be enlightened by The Motley Fool's disclosure policy.

More on ⏸️ Investing

A white and black robot in the form of a human being stands in front of a green graphic holding a laptop and discussing robotics and automation ASX shares
Technology Shares

Joining the revolution: How I'd invest in ASX AI shares right now

Advances in artificial intelligence (AI) could usher in a new industrial revolution. Here’s how you can invest in it.

Read more »

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

Two people in suits arm wrestle on a black and white chess board.
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »