Rio Tinto Eyes China, Maintains $16 Billion in Capital Expenditures for 2012

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Written by Richard Finlayson, Senior International Editor for Industrial Info Resources (Sugar Land, Texas)--Despite the fact that profit was down 22% for the first half of 2012, Rio Tinto (NYSE:RIO) (London, England), the third-largest global mining company, will maintain its capital expenditure target for the full 2012 year at $16 billion. Profits were negatively affected by reduced prices for iron ore, copper and aluminum, and rising costs for operations.

Net income for the six-month period fell to $5.9 billion compared to the $7.6 billion for the same period in 2011. Net income received a $1 billion addition from the "deferred tax benefit" following the introduction of Australia's mineral resource rent tax on July 1.

"We have taken a considered approach to investment, committing capital only to projects that will deliver value to shareholders under any probable macroeconomic conditions," said Rio's Chairman Jan de Plessis.

The company reported capital expenditures of $7.6 billion in the first half of 2012. Projects covered by this capital investment, which is up year-on-year (YoY) by $2.4 billion, include an expansion of the Pilbara iron ore mines and infrastructure to a capacity of 283 million tons annually; the development of the Oyu Tolgoi copper-gold project in Mongolia; the modernization of the Kitimat aluminum smelter in British Columbia; the extension and expansion of the Kestrel coking coal mine in Queensland; and the underground development of the argyle diamond mine in Western Australia.

A $4.2 billion expansion plan for the iron ore operation was approved in June at a time when ore prices were moving downward. "We have been signaling for some time that markets would remain volatile, and we have seen challenging conditions in the first half," de Plessis said. "We continue to generate strong margin despite falling prices."

The major continued investment in Western Australia's iron ore mines could still see an operating profit of $70 a ton on a price of $120 a ton, although prices have been down as much as 21% YoY.

While Rio executives are looking for upward signs in the crucial Chinese market to start appearing by the end of this year, other sector watchers have expressed concerns about the company's faith in iron ore, which is contributing 80% of its profit and lopsided diversification. Rio anticipates that Chinese steel production could grow to nearly 1 billion tons annually by 2020 from the 700 million-ton level in 2011.

But Citi analysts say that China has arguably gone through its most rapid phase of investment growth, with steel consumption moving at about 8% of gross domestic product (GDP) annually since 2004. If China replicates Japan's steel consumption, now settled at about 2% of GDP, steel demand could drop to 480 million tons in 2020. Citi estimates Rio's Pilbara expansion will come on stream in 2015.

But if iron ore prices remain high, Rio should keep generating a decent return on investment due to low-cost operations, according to Deutsche Bank. The investment in Pilbara mines should increase output 60% to 353 million tons through 2015. If iron ore prices remain above $80 after 2018, the Pilbara expansion could generate a 24.8% internal rate of return, significantly higher than Rio's cost of capital.

For related information, see June 29, 2012, article - BHP Billiton and Rio Tinto Send Conflicting Sign on Investments.

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