Over the last three months, shares in Rio Tinto Limited (ASX: RIO) have risen by 10%. For many investors, this could indicate that the company is at the start of a new era and that following the appointment of a new CEO, Rio Tinto will now move upwards.
However, there could be a degree of pain ahead. Although there is no definite plan for an asset disposal, Rio Tinto could follow a similar route to that taken by BHP Billiton Limited (ASX: BHP) over the medium term.
Rio Tinto could dispose of assets which are deemed to be non-core, with the company’s new CEO already planning a reorganisation of Rio Tinto’s operating divisions. The new ‘energy and minerals’ division contains segments such as coal, titanium dioxide and uranium, leaving assets such as iron ore, diamonds, aluminium and copper to potentially continue being part of Rio Tinto’s core operations.
In tandem with asset disposals, Rio Tinto may be gearing up for a shift in strategy towards cost reduction and efficiency, as opposed to further rises in iron ore production. That’s partly why the Simandou iron ore project in Guinea has been shelved, with Rio Tinto’s new CEO indicating that acquisitions and investment in coal may also fail to materialise over the medium term.
Of course, Rio Tinto already has a low cost base. In 2015 it achieved US$1.3bn in sustainable operating cash cost improvements and this took the reduction in operating costs to US$6.2bn since 2012. It also has excellent cash flow, with net operating cash flow standing at US$9.4bn in 2015 that allowed capex of US$4.7bn to be undertaken.
Although Rio Tinto’s new CEO appears to have taken a somewhat conservative stance regarding increased production and M&A activity, the company clearly has the financial firepower to invest heavily in new projects, with its net debt to equity ratio standing at a relatively modest 32%.
This compares favourably to mining sector peer Newcrest Mining Limited (ASX: NCM), which has a net debt to equity ratio of 42% and allows Rio Tinto to invest heavily for growth.
One area which could be a growth space for Rio Tinto is lithium, with demand for battery power from cars and for home energy use likely to rapidly rise over the long run.
Rio Tinto is already studying the potential of a lithium deposit in Europe and under a new CEO who seems less keen to invest in iron ore and coal, new segments could be the growth drivers of Rio Tinto.
That may be especially true for those segments with strong growth rates (such as lithium), which could offset the challenges in the iron ore market, where the price of the steel-making ingredient has fallen from US$187 per tonne in February 2011 to its current level of around US$55 per tonne.
Clearly, the future could be a lot different than the past for Rio Tinto. Although the company’s 10% gain of the last three months may not be repeated due to the uncertainty which persists in commodity markets, the company seems to have the financial strength and the opportunity to make the changes to improve upon its financial performance.
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Motley Fool contributor Robert Stephens has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
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