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There was never any doubt that Rio's results would be stunning. Iron ore prices have been high and peers have already reported stellar numbers. Rio didn't disappoint, reporting one of the most profitable results in its history.
Earnings before interest, tax, depreciation and amortisation (EBITDA) of US$21bn came courtesy of high prices, with strength in iron ore adding US$4bn to the result.
· Dominated by iron ore
· Weak aluminium earnings
· Result driven by higher prices
As with BHP, cost savings and efficiency gains are harder to find and their impact is now more modest. This is now a relatively lean miner with less fat to trim.
The iron giant
It is increasingly difficult to pretend that Rio isn't an iron ore business, with a few other bits attached to it, rather than a diversified miner.
The iron ore business generated over US$16bn in EBITDA - 80% of the total - and margins of over 70%. Rio's iron ore business is the single best mining asset in the world and among the best businesses anywhere.
Table 1: Rio's 2019 result
Year to 31 Dec
Op. cash flow
The rest of the business looked less stellar. Lower aluminium and copper prices didn't help but there was more to fret than mere prices. Persistently low returns pose a problem.
Whereas iron ore generates return on assets of over 70% (that's after counting depreciation), the aluminium business generates returns of under 4%. We've been counting poor returns from aluminium for years.
Rio owns some of the lowest cost aluminium assets in the world so asset quality isn't the problem. This is simply not as attractive an industry as others and Rio may consider shedding some of the assets it operates.
There are high returning businesses within the aluminium segment - bauxite and alumina assets generate returns of over 14% - but those are diluted by poorer returning refining assets.
With aluminium production increasingly competitive, capital intensive and controlled by state-sponsored producers from Russia, the middle east and China, this may be a business in need of an introduction to an axe.
Mining aint enough
Copper assets have traditionally performed well but results in recent years have been disappointing, last year generating returns of just over 6%.
Copper prices have been lower and Rio's largest mine, Escondida in Chile, has demanded more capital, while the giant Oyu Tolgoi mine in Mongolia is struggling.
Despite being lavished with billions of dollars of expenditure, the mine generated just $25m in earnings for Rio. Politics, regulation and technical difficulties have all burdened the mine.
The orebody is too large and lucrative to lose, but the mine neatly illustrates that turning rocks into cash is about more than just mining.
With so much cash flowing from the Pilbara, however, these concerns don't matter too much. Last year Rio generated US$9.4bn in free cash flow, a free cash flow yield of about 14%. That is amazing considering only one of its three key businesses is firing.
Unlike BHP, Rio's non-iron ore businesses appear weak, particularly aluminium which may require attention.
Billions has already been written off the aluminium business yet returns remain miserable. There would be more pressure to raise returns if iron ore wasn't filling Rio's coffers.
As it is, Rio has more money that it knows what to do with. With just US$3.7bn in net debt, the balance sheet is rock solid and dividends remain affordable; Rio's payout ratio was just 70%.
Despite these excellent results, the dependence on iron ore, and a paucity of opportunity outside it, mean that BHP remains the better business. HOLD.