What you need to know about Rio Tinto Limited’s profit report and outlook

After the market closed yesterday, the world’s second-largest iron ore miner, Rio Tinto Limited (ASX: RIO), released its results for first six months of Financial Year 2016. Despite management’s focus on cash generation, investors are wearing the brunt of the collapse in commodity prices – although Rio shares rose marginally on the London stock exchange overnight.

Here’s what you need to know about Rio’s latest report (all figures are in US dollars/cents):

  • Sales slumped 14% to $15.5 billion
  • Net cash generated from operating activities fell 27% to $3.24 billion
  • Underlying earnings (management’s preferred measure of profitability) fell a whopping 47% to $1.56 billion
  • Dividends per share were cut by 58% to $0.45 per share
  • Gearing ratio (net debt divided by net debt plus total equity) fell 1% to 23%
  • Cash costs of US$14.30 per tonne of iron ore, down from US$16.20 in the prior corresponding period
  • Full-year dividend of not less than 110 US cents, equivalent to around A$1.45 per share (or a 2.9% yield) at today’s exchange rate

So What?

By cutting capital expenditure and investing in reducing production costs, Rio has been able to maintain a decent operation that generated $3.2 billion in operating cash, but only $700 million in free cash flow after reinvestment and dividends were accounted for.

Unfortunately, lower costs were not enough to offset the impact of weaker commodity markets, which caused all of Rio’s operating segments except Energy & Minerals (up 11%) to record big declines in their underlying earnings.

Management points to a ‘strong credit boost‘ in China at the start of 2016 as reviving the property market there and lifting commodity prices, which may make some investors optimistic. Despite this, management also reported that ‘more tonnes are expected to come onto the market in the near to medium term‘ suggesting that oversupply pressures will remain unless demand continues to grow apace.

Now What?

Rio’s strategy of focussing on cash flow and carefully selected developments like yesterday’s Silvergrass announcement is probably the best way forward in today’s market environment. BHP Billiton Limited (ASX: BHP) and Fortescue Metals Group Limited (ASX: FMG) are following a similar pattern of lifting productivity and cutting costs however, and competition is fierce. Should smaller players be forced out of the market, supply could stabilise, although if Chinese demand for steel were to sharply decline again, all three miners could get burned.

As the biggest miners in the market, Rio, BHP and Fortescue are in the best position to withstand a sustained downturn in the iron ore market. However, investors would be wise to remember that survival potential doesn’t equal a market-beating investment and, without a potential catalyst for higher resource prices, it’s tough to say that any of the three big miners are a market-beating idea today.

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Motley Fool contributor Sean O'Neill 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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