January 17, 2013 8:39 pm

Rio looks to build after writedowns

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Aluminium is the metal of choice for the automotive, aerospace and packaging industries thanks to its lightweight, malleable nature – as well as its ability to withstand corrosion.

For Rio Tinto, however, the commodity has proved anything but durable. After the latest writedown, impairments have now eaten away at some $20bn-$25bn of the $38bn the miner paid for Canada’s Alcan in 2007, analysts estimate. The deal – considered expensive at the time – proved disastrously timed, sealed as the global financial crisis hit and demand from industrial users slumped.

The transaction – pitched as a way for Rio to diversify away from its core iron ore operations in the Pilbara in Western Australia – was also a strategic flop. Rio still makes more than 80 per cent of its profits in iron ore, while the beleaguered aluminium operations barely contribute.

Yet the light metal was not the eventual downfall of Tom Albanese, who oversaw the fateful Alcan purchase after taking over as chief executive earlier that year. Nor was it the rejected £67bn approach by BHP Billiton in 2007, or the failed fundraising deal with Chinalco in 2009.

Instead, a $3bn writedown to a coal project in Mozambique, purchased only two years ago for $3.7bn, forced the unexpected departure of Mr Albanese and Doug Ritchie, the former head of energy who led the deal.

After swaths of red ink in aluminium, people familiar with the matter say the board saw the writedown in Mozambique as a bridge too far.

Rio had overestimated the quality and quantity of coal in the ground in Mozambique at the time of the 2011 deal, particularly for metallurgical coal, the pricier, low-sulphur form of the commodity used to make steel.

Moreover, the group’s initial plans to barge coal down the Zambezi river had proved impossible, blocked by the government. Instead, Rio faced building independent infrastructure, which became harder to justify given the lesser prospects for the resource.

For Rio, two attempts to branch out from Australian iron ore have now gone awry, leaving the miner among the least diversified of its peers.

But the message from Jan du Plessis, Rio’s chairman, is that the strategy remains unchanged. Putting it into action will now fall to Sam Walsh, the Australian head of iron ore who has been with Rio since 1991. At 63, Mr Walsh has only committed to three years at the helm, reinforcing the impression that his elevation to the top job was a sudden decision.

Mr du Plessis adds: “Sam Walsh is a hugely experienced operator who knows the industry inside and out and has been on the Rio board for four years. The transition will be swift and smooth.”

Interactive graphic

Timeline: Tom Albanese’s time at Rio Tinto

Tom Albanese

This interactive timeline tracks key events during his five years at the helm of the resources company.

The mining industry is struggling as weaker commodities prices and rising costs squeeze profitability, and Rio is forecast to report full-year underlying earnings of $9.3bn, down from a record $15.5bn in 2011, according to Bloomberg. But analysts hope the latest writedowns will give the new chief executive a solid base from which to tackle Rio’s challenges.

“It is a big cut to the aluminium business but brings the carrying value down to where we value the assets,” says Rob Clifford, analyst at Deutsche Bank. “We did not expect them to do that in one fell swoop.”

The writedowns, too, may help Rio offload its Pacific Aluminium operations, which have been tagged for a sale or a listing for nearly a year. Other loose ends for the new boss include the diamond business, which is earmarked to go.

In terms of the engine of Rio’s portfolio, where the miner is expanding iron ore capacity in the Pilbara from 239m tonnes last year to 290m tonnes in 2013, Mr Walsh is an old hand.

“With Sam’s years of experience in the iron ore business, I’m sure he can put the right person in place to manage the expansion programme and leave him time to focus on more troublesome business units,” says Peter Davey, analyst at Standard Bank.

Among his priorities will be ensuring that Rio’s big development project in copper, Oyu Tolgoi in Mongolia, reaches commercial production on schedule in the first half of this year and that political debate in the country about how to secure its fair share from mineral extraction does not endanger further progress.

“It’s a new country, a new mining jurisdiction and a new mine which is taking a big chunk of shareholders’ capital,” adds Mr Davey.

More fundamentally, according to Mr Clifford, shareholders will be looking for a new approach from Rio’s top managers after a series of spending blunders, for which the board too must take responsibility. “For a full re-rating of the mining sector, we need to see better capital allocation. The clear message from the Rio board to its team is that you had better not come asking for capital unless you are sure you can show returns,” he says.

Global miners last year pulled back on ambitious development plans, slashing capital expenditure budgets. Rio in November pledged to cut costs by $5bn over the next two years, arguing that expense control would become a new theme for the industry.

“They need to get into cost-cutting mode and that is a different mindset,” adds Mr Clifford. “The miners have been on a spending spree. Now is the time to trim.”

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