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Rio Tinto may be down, but its iron heart is still beating

The commodity price whacked Rio Tinto but its massive iron ore business is still profitable

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Rio Tinto's underlying earnings halved to $US4.5 billion last year and the mining group says its policy of maintaining or boosting its annual dividend is to be scrapped, but even that understates how far the big miners have fallen.

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Rio Tinto flinches amid commodities pain

Global miner Rio Tinto has posted its worst underlying earnings in 11 years and scrapped a generous payout policy in the face of a bleak outlook for the global economy.

One starting point is to work out what Rio actually is: an extremely efficient iron ore miner, that also mines and processes other minerals.

That sends you back to 2011, the peak of the extraordinary boom that China's construction splurge precipitated.

In 2011, the iron ore price peaked at almost $US192 a tonne, and averaged about $US167 a tonne.

Rio's iron ore mines shipped 239 million tonnes of ore, and lifted their earnings before interest, tax, amortisation and depreciation (EBITDA) by 29 per cent or $US4.8 billion to $US21.4 billion.


They booked revenue of $US29.8 billion, putting them on an astonishing EBITDA margin 72 per cent.

Iron ore revenue represented 49.2 per cent of the Rio Tinto group's underlying revenue of $60.5 billion in 2011. Iron ore EBITDA was 75 per cent of Rio's total EBITDA of $US28.5 billion, and the business carried the group's underlying net profit 11 per cent higher to $US15.5 billion.

Rio's average iron ore price last year was $US48.40 a tonne – 71 below what it got in the peak year. The iron ore division's EBITDA fell by 45 per cent, to $US7.9 billion.

That is 63 per cent below what it earned in 2011, a slightly less steep decline that the 71 per cent fall in the iron ore price because Rio has cut its production costs, and boosted mining volumes.

The $US7.9 billion gross EBITDA iron ore result is still a return of 23 per cent on iron ore revenue, however, and it equals 63 per cent of the group's EBITDA. The iron ore division's underlying profit of $US3.95 billion also equates to 87 per cent of the group's $US4.5 billion underlying profit.

Rio is hunkering down for a commodity price siege as it continues to aim at conservative balance sheet gearing of between 20 per cent to 30 per cent.

For 2015 it has hung on to its progressive dividend policy of either maintaining or boosting dividend by making an unchanged annual payout of $US2.15 a share. It is only guaranteeing dividends of $US1.10 a share this year, however, a little more half the 2015 payout.

Capital expenditure budgets have also been cut, from $US5 billion to $US4 billion in 2016, and from $US7 billion to $US5 billion in 2017.

In each year, the first $US2 billion will be maintenance spending, so Rio's "capex" is being cut close to the bone: to put it into perspective again, capex was $US12.3 billion in 2011, and $US17.4 billion in 2012.

It's very important that the Pilbara iron business is still making money, however. The iron ore price slide has been steeper than both Rio and BHP expected when they were investing to boost their production in the boom, but the Pilbara twins are still the world's low-cost producers, and still able to make a reasonable return.

In Rio's case, it means a balance sheet-boosting share issue is unlikely. A share issue to fund opportunistic acquisitions is also not on the cards: Rio chief executive Sam Walsh says he sees no compelling acquisition prospects in the resources sector, despite the ferocious fall in market values.