Rio’s First-Half Profit Drops 22% on Weaker Iron-Ore Prices

Rio Tinto Group (RIO), the world’s third- largest mining company, said first-half profit dropped 22 percent after prices for iron ore, copper and aluminum fell and costs at its operations gained.

Net income declined to $5.9 billion from $7.6 billion a year earlier, London-based Rio said today in a statement. That compares with the $5.04 billion average of 11 analyst estimates compiled by Bloomberg. Net income was boosted by a $1 billion so-called deferred tax benefit after Australia introduced its Mineral Resource Rent Tax on July 1.

Rio, like BHP Billiton Ltd. (BHP) and Xstrata Plc (XTA), is confronting the dual headwinds of rising costs and lower prices as waning global growth saps raw material demand. Xstrata reported a 33 percent drop in first-half profit yesterday. Iron ore is expected to generate about 86 percent of underlying earnings this year, Credit Suisse Group AG said Aug. 2.

The “result was slightly better than expected; however, it has not bucked the trend of diversified miners showing lower year-on-year earnings,” Tony Robson, an analyst at BMO Capital Markets, said in a report today. Rio “continues to generate large profits on its high-margin iron ore business and through further growth in both iron ore and copper, profits from Rio Tinto are forecast to grow significantly in 2013.”

Rio Tinto, the biggest ore-exporter behind Rio de Janeiro- based Vale SA (VALE), advanced 2.9 percent to 3,220 pence by the close of trading in London, the highest since May 3.

Volatile Markets

The company increased its interim dividend 34 percent to 72.5 cents a share, even as underlying profit slumped by 34 percent to $5.2 billion.

Rio posted a “strong set of first-half results,” Barclays Plc analysts David Butler and Ian Rossouw wrote in a note today, adding that underlying profit beat its estimates by 8 percent. Earnings from iron ore were an “impressive effort driven by better-than-expected realized prices,” Barclays said.

A reliance on iron ore is Rio’s “Achilles’ heel,” Credit Suisse said in a July 12 report. The price of the raw material for immediate delivery to the Chinese port of Tianjin, a benchmark for Asia, averaged about $141 a ton in the half, 21 percent lower than a year earlier. It has dropped a further 14 percent since June 29.

“We have been signaling for some time that markets would remain volatile and we have seen challenging conditions in the first half,” Rio Chief Executive Officer Tom Albanese, 54, said in today’s statement. “We continue to generate strong margins despite falling prices.”

Western Australia

Rio is expanding iron ore operations, including a $4.2 billion spending plan approved in June, even as prices drop. An expansion at its Pilbara business in Western Australia to increase capacity to 283 million tons a year is on schedule to be completed by the end of 2013, Rio said today.

The market for the steel ingredient is starting to find a “floor” near current levels, Credit Suisse said Aug. 2, a view shared by Albanese today on call with analysts. The price declined 1.1 percent to $114.9 a dry metric ton today, the lowest since Dec. 29, 2009.

“Whilst we are mindful of short-term uncertainties we remain convinced of the strength of the long-term demand outlook,” Chairman Jan du Plessis said in the statement. “We have taken a considered approach to investment, committing capital only to projects that will deliver value for shareholders under any probable macroeconomic conditions.

Bonuses Waived

Albanese and Chief Financial Officer Guy Elliott waived their annual bonuses in February after the company reported a loss for the second-half of 2011 following an $8.9 billion one- time charge on the value of its aluminum business that contributed to a 59 percent drop in full-year profit.

Last week, BHP said it would take $3.3 billion in charges on gas and nickel assets this year. The Melbourne-based company, scheduled to report fiscal 2012 profit on Aug. 22, cut the value of its Fayetteville shale gas assets in Arkansas by $2.84 billion and its nickel business in Western Australia by $450 million.

Rio today maintained its estimate for 2012 spending of $16 billion to expand mines and build new operations. That includes a project to boost annual iron-ore output in Australia’s Pilbara region to 353 million tons by mid-2015 from current capacity of 230 million tons.

Spending in 2013 may be lower and the company will ‘‘pause for breath’’ on any further expansion in the Pilbara beyond 353 million tons, Albanese said on a conference all today.

China’s Growth

BHP and Xstrata are among other mining companies reining in spending plans for expansions and new projects as rising costs for construction materials and labor coupled with lower commodity prices curb the outlook for future returns.

BHP, the biggest mining company, said in May it won’t meet its five-year $80 billion spending target on new mines and expansions. Xstrata said yesterday it had trimmed its spending plan for this year by $1 billion to $7.2 billion.

Rio Chief Economist Vivek Tulpule said June 29 he sees economic growth in China accelerating this half even as the European economic crisis escalates. The world’s fastest-growing major economy accounted for 31 percent of Rio’s $61 billion in sales last year, and imports more iron ore than all other nations combined.

China’s economy grew 7.6 percent in the second quarter, the slowest pace since 2009. The nation’s non-manufacturing industries expanded at a slower pace in July as new orders and the outlook for business slipped, an official survey indicated Aug. 3, showing the slowdown in exports and industrial output may be spreading to services.

Fragile Recovery

‘‘Although sentiment remains negative in Europe and the US recovery is still fragile, our order books are full and we expect Chinese GDP growth to be around 8 percent in 2012,” Albanese said. “We expect to see signs of improvements in Chinese economic activity by the end of the year.”

The price of aluminum has declined 20 percent in the past year, hurting producers such as United Co. Rusal and Alcoa Inc. (AA), which last month posted $2 million net loss for the second quarter. Rio’s February writedown related to the $38 billion acquisition in 2007 of Alcan Inc., the biggest completed mining takeover.

Rio could report additional impairment charges on the assets, JPMorgan Chase & Co. analyst Lyndon Fagan wrote in a July 31 report, adding that Rio values its aluminum assets at $26 billion, nearly double the bank’s $13 billion estimate.

“There could still be several billion dollars worth of impairments still to be reported,” Fagan wrote.

To contact the reporters on this story: Jesse Riseborough in London at jriseborough@bloomberg.net; Elisabeth Behrmann in Sydney at ebehrmann1@bloomberg.net

To contact the editor responsible for this story: John Viljoen at jviljoen@bloomberg.net

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