The group is an industry leader in most of the major commodities markets, including aluminum, coking and thermal coal, copper, manganese, iron ore, uranium, nickel, silver and titanium.
On top of this, Rio has sizable interests in oil, gas and natural gas.
China slowdown impacts iron ore prices
Since the February 2013 high of US$159.9 per tonne, the price of iron ore has decreased around 27%. The main contributor to the weakness in iron ore markets has been the slowing growth in China.
China, which accounts for approximately 60% of global iron ore demand, is facing slowing growth as evidenced by recent economic data. The HSBC Flash Manufacturing PMI revealed the Chinese manufacturing sector entered contraction territory in May for the first time in seven months.
Weekend data showed Chinese export growth of just 1% in the year to May, down sharply from the 14.7% expansion in the year to April. Economists were expecting export growth of 7.4%, but a combination of a deteriorating trade environment and a weaker Chinese economy suggests conditions are much worse than currently estimated.
While demand for iron ore is expected to remain weak due to economic growth concerns, an influx of supply is likely to heap further pressure on prices.
Earlier last month, China Iron and Steel Association (CISA) and Brazilian iron ore miner, Vale, warned of an impending supply glut that may see an extra 30 to 40 million tonnes or ore hit the market this year.
Asset sales need to repair balance sheet
RIO’s FY12 gearing ratio (net debt to equity) stood at 34%, a significant jump from the 20% ratio a year earlier.
This was largely due to a 53% slide in operating cash flow from FY11. Unfortunately for RIO, its global iron ore shipments slid 14% between 4Q12 and 1Q13, and its coal shipments fell 15% in the same period.
As mentioned, iron ore prices have come under severe pressure in the year to date, all of which implies the group’s operating cash flow has continued to dry up in FY13.
Whilst a gearing ratio of 34% isn’t exactly a reason for panic, the negative trend in this metric lowers the likelihood of initiatives like a strong dividend increase or another share buyback.
When taking into account the company’s diminished growth potential, the prospect of higher dividends may become a crucial a reason for holding the stock.
Amid these concerns, RIO has flagged asset sales including its diamonds assets, its 80% stake in the NSW-based Northparkes copper mine and 59% its stake in Iron Ore Company of Canada, as well as its Australian-based Pacific Aluminium business.
However there are questions on how long it will take to offload these assets and the price RIO can achieve from any sale.
The deterioration of China’s economy comes at a bad time for RIO. Operating cash flow is under pressure amid declining output and a sharp fall in iron ore prices.
The group is sensibly considering asset sales to strengthen its balance sheet. However, timing uncertainty and the prospect of weaker iron ore prices is expected to result in further share price declines.