Rio Tinto Limited posts $3.7 billion annual profit – here's what you need to know

Australia's second largest miner, Rio Tinto Limited (ASX: RIO), announced at 5pm yesterday a stellar annual report which will have long-term shareholders breathing a sigh of relief.

After years of massive write-downs, cost overruns and destruction of shareholder value, investors will be taking a second look at this potentially lucrative turnaround story. Despite posting underlying earnings of $10.2 billion – 10% higher than 2012 – and net profit of $3.7 billion – up from a $3 billion loss in 2012 – it wasn't all bells and whistles in the annual report.

The miner continued in its usual fashion and flagged impairments of $3.43 billion which were excluded from net profit, including impairments on its copper and gold project in Mongolia, Oyu Tolgoi, as well as $1.29 billion from the group's troubled aluminium business and $470 million related to Rio Tinto Coal Mozambique.

Despite its blemishes, swinging from a steep loss of $3.03 billion to a profit of greater weighting, will have both investors and management pleased. The strong cash flow, which increased 22% to $20.1 billion enabled the company to pay down debt and return a $1.92 interim dividend – ahead of expectations.

Net debt has reduced from $19.2 billion a year earlier to $18.1 billion at 31 December 2013. The group said: "Debt reduction to sustain a strong balance sheet will remain a priority in 2014." Cash cost improvements of $2.3 billion were achieved with a target for $3 billion set for 2014. Despite adding jobs in its iron ore division, a headcount reduction of 4,000 staff occurred, and over 3,300 left through divested assets.

The group's iron ore business produced 266 million tonnes and contributed the greatest amount to the company's underlying earnings (96%).

Resource prices drop while US dollar boosts earnings

In 2013, prices of major commodities decreased and had a negative effect on earnings, resulting in $1,289 million of lost profit compared to 2012. The average realised prices for major commodities were as follows:

Data sourced from Rio Tinto 2013 Full-Year report

The US dollar strengthened against the Australian dollar (6%), Canadian dollar (3%) and South African Rand (15%) to increase earnings by $1,008 million.

Growth areas

The miner's iron ore division continues to ramp-up production and expects to be operating at 290 million tonnes per annum by mid-2014. In 2013 Rio – through its 50.8% ownership of Turquoise Hill Resources – also completed the construction and first production of its huge Oyu Tolgoi gold and copper project in Mongolia. The company's Argyle diamond underground mine, Kestrel Coking coal mine extension and AP60 aluminium smelter all commenced production in 2013.

Divisional performance

Upon release of the results CEO Sam Walsh said: "These strong results reflect the progress we are making to transform our business and demonstrate how we are fulfilling our commitments to improve performance, strengthen the balance sheet and deliver greater value for shareholders."

Foolish takeaway

Shareholders in Rio Tinto can be, at last, content with the yearly progress of the company and its management. Since accepting the top job in February 2013, Mr Walsh has done a good job of rebuilding the mining giant. Despite the write-downs, it appears a majority of the damage from the company's disastrous acquisitions of Riversdale coal in Mozambique and Canadian aluminium business Alcan are now behind it.

From here on, management will continue to build free cash flow and returns to shareholders, whilst also paying down debt. It would be surprising to see Mr Walsh announce any new projects in 2014, other than what is currently in the pipeline – such as Simandou in Guinea.

For long-term shareholders, it's important to carefully scrutinise the price of any divestments the company makes from here on. We've already seen how difficult it has been for the company to sell assets, including its Mozambique coal business, Iron Ore of Canada and its diamond business. In my opinion, further reductions in assets outside of iron ore would be near-sighted and put the company in a very tricky position if the price of the steelmaking ingredient were to drop.

Keep an eye on Chinese growth and any major changes to government spending, particularly on key infrastructure projects. All-in-all shareholders can be happy with the company's progress in the past 12 months and its prospects for FY14.