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UPDATE: Brokers look on the bright side of Rio Tinto boss's shock exit

The departure of chief executive Tom Albanese at Rio Tinto after the company booked massive paper losses on its aluminium and coal assets may see an end to overpriced acquisitions, some analysts believe.
UPDATE: Brokers look on the bright side of Rio Tinto boss's shock exit

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Tom Albanese, chief executive officer of Rio Tinto (LON:RIO), has made an abrupt exit from the mining giant after the group announced US$14bn of impairments.

The bulk of the write-downs – some US$10-11bn – relate to Rio Tinto’s aluminium assets (Rio Tinto Alcan, and Pacific Aluminium), but around US$3bn relates to the acquisition of Rio Tinto Coal Mozambique, and this seems to have been the cause of Albanese’s downfall.

Rio Tinto chairman Jan du Plessis said: "The Rio Tinto board fully acknowledges that a write-down of this scale in relation to the relatively recent Mozambique acquisition is unacceptable. We are also deeply disappointed to have to take a further substantial write-down in our aluminium businesses, albeit in an industry that continues to experience significant adverse changes globally.”

Albanese has been succeeded as chief executive officer (CEO) by Sam Walsh, previously boss of Rio Tinto’s iron ore operations.

Rio Tinto said the non-cash impairments will be reflected in its full year results for 2012, and added that the underlying business and balance sheet remain in good health.

Rio Tinto’s acquisition of coal assets in Mozambique ran into trouble when the country’s infrastructure proved to be in need of more development than Rio Tinto anticipated.

Rio Tinto sought to transport coal by barge along the Zambezi River, but this option did not receive formal approvals.

Shares initially fell sharply on the news, hitting 3300p, before rallying to 3,405.5p by mid-morning, down 63p on the day, as brokers expressed their views on the ramifications of the change at the top.

“We believe the market will perceive today's write-downs and management changes negatively in the short term, but that these will be positive for the stock and the sector longer term,” is Citigroup’s view.

The US banking titan has upgraded the stock to ‘buy’ from ‘neutral’ after this morning’s announcement, as it believes the changes could significantly “realign Rio Tinto with shareholder interests” through reduced mergers & acquisitions (M&A) activity and reduced capital expenditure (capex).

“Due to today’s impairments, we have removed the large discount to net present value (NPV) we previously applied for poor capital allocation (we now apply a 15% discount vs. 40% previously). As a result of this, and a shift in our foreign exchange assumptions to reflect the current spot rate, we have increased our target price to £40.00 (previously £33).

Another US bank, Bank of America Merrill Lynch, said the paper losses on aluminium were expected, but the write-downs on the coal assets were an unpleasant surprise.

“The group is having trouble getting permission to barge coal. We are left wondering whether we need to factor in project delays and capex over-runs and expect more details with the full-year results. To the extent this is the case, this would end up being a downgrade to our NPV. As a sensitivity, a US$1bn capex overrun would negatively affect our discounted cash flow per share by roughly 33p/A$0.50,” BofA Merrill Lynch’s mining team write.

“Our base NPV for Rio is 3910p/A$61,” the broker added.

Colour Kate Craig at Liberum Capital unshocked by the write-downs.

“Our initial thoughts are the market already knew these acquisitions were overpriced and the write-downs are not incommensurate with ours and the market's valuation of these assets. Rio appears to be taking the front foot on write downs and appears to have been more proactive on culpability than Anglo – launching management changes and cost cutting before the market has asked for it. Sam Walsh is the logical replacement for Albanese and has a strong operational heritage and may be more focussed on iron ore growth, which the market will like,” the broker said.

Liberum remains bullish on Rio Tinto, and reckons the share price, up 11% since the beginning of December, has some catching up to do with iron ore prices – up 34% over the same period.

“Running our forecast 2013 iron ore price of $120/t, $30/t below spot, still leaves RIO at a 16% discount to the sector on 2013 PERs, a discount more consistent with historical averages,” Kate Craig calculates.

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