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J-S and the reshaping of Rio Tinto

Miningnews net

July 5,2017

IT took all of 21 minutes across meetings in London and Sydney last week for Rio Tinto shareholders to approve the group's historic exit from thermal coal in NSW's Hunter Valley in a sweetened US$2.69 billion deal to sell Coal & Allied to China's Yancoal. By Barry FitzGerald While much of the commentary on the sale - first put in train back in January - was focussed on the eleventh hour attempts of fellow Hunter Valley coal producer Glencore to snare C & A for itself with a $2.67 billion bid, the discussion has now moved on to what's next on Rio's chopping block? As a matter of policy Rio does not comment on what assets are for sale or not. But in all of its conversations with investors on road shows in the last 12 months it has made very clear that it would only be investing in what it sees as the most attractive industries - iron ore in the Pilbara, bauxite, copper, and Canadian (hydro-electric) aluminium. That leaves a long list of non-core and secondary assets - maybe as much as $15 billion worth - that could be pushed off by newish chief executive Jean-Sebastien Jacques (J-S) in the years ahead under his mantra of capital discipline to protect the balance sheet, improving shareholder returns, and careful selective investment. Among the list of assets that could well go the way of C & A is the Australian and New Zealand aluminium assets Rio tried to offload through a trade sale or float of Pacific Aluminium in 2011. But as much as ongoing strong aluminium demand and a recent price recovery will help revive a PacAl exit, the disarray in Australia's energy markets looms as a major obstacle. A more likely near-term exit is Rio's production interest in Freeport's controversial Grasberg copper-gold giant in Indonesia. Changes in government policy and the delay in the production interest delivering Rio benefits have most assuming J-S will want out before long. Rio's coking coal interests seem safe from the knife because of the tighter supply channels for the steelmaking raw material. But they are nevertheless considered sub-scale and could be let go at the right price. Diamonds fall in to the same category but the Argyle mine in Western Australia and the Canadian operations will have mined themselves long before becoming an issue. That is even more so the case with Rio's listed uranium subsidiary Energy Resources of Australia at its Ranger mine inside Kakadu, while the mineral sands business is a quality one but one with obvious buyers. Back in the more obvious likely sale category is Rio's IOC iron ore pellets business in Canada, its uranium exploration/development portfolio in the same country, and its WA salt business. What is known is that J-S has proved to be a dab hand in asset sales to date by Rio. His fingerprints are on most of the $8 billion in sales since 2013, either as CEO or in his previous divisional roles. Last year's sale of the Lochaber aluminium smelter in Scotland for $410 million was a prime example of what can be delivered from a reshaping of the Rio Tinto portfolio. It wasn't valued by the market at all yet pulled in $410 million. And it has to remembered the market valued C & A at about $2 billion compared with the eventual sale price to Yancoal of $2.69 billion. A great believer that the diversified model of the big miners is over stated - it is China demand and China demand alone that matters most - J-S can't see the point of holding on to assets where a case for more investment cannot be made. Without investment, value can be destroyed. It's best then to move the assets on to others who find them more attractive, as was the case with Lochaber and C & A. But as the sale of those two demonstrated, there is no fire sale element to J-S's streamlining of the portfolio to the assets that matter. And given that will continue to be the case, the roll out of additional asset sales will come in increments, with the sale of another $5 billion or so of non-investable assets - from Rio's point of view - over the next three or four years considered highly likely. Cash freed from such additional sales will not be needed for more balance sheet repair. Rio is already well under its 20-30% gearing target. And with a relatively modest capex program over the next three years of $5.5 billion on Silvergrass (Pilbara), Amrun bauxite (Cape York), and copper (Oyu Tolgoi) there is going to be a big chunk of free cash flow available for increased returns through increased dividends and buybacks, with a $500 million buyback of the dual-listed company's London shares already underway. The potential for a substantial increase in dividends (an increase in the size of the London buyback, or a new buyback in the locally listed shares, is already factored in by the market) is now on the cards. So much so that a yield on the current share price approaching a remarkable 9% is not out of the question. And to be honest, it will take such a remarkable yield outcome for Rio to win back the share premium it used to command in the days before the massive value destruction caused by the Alcan and Riversdale forays.