The announcement last night that Rio would return to shareholders a special dividend of US$4 billion caps off a remarkable company reporting season. While company profits and outlook statements have in the main been a touch disappointing, shareholders have been flooded with cash returns.
Increased ordinary dividends, special dividends, and share buybacks are the go as companies react to Bill Shorten’s proposed change to franking credits and generally favourable economic conditions. There is not a company board in Australia that isn’t looking at its franking credit balance and reviewing its capital needs to see whether it can increase short term returns to shareholders.
Franking credits are of no value to the company. Representing the tax the company has already paid, they are only valuable in the hands of shareholders. So with Bill Shorten looking like a shoo in come May, companies are acting before his 30 June deadline. This is why we have seen special dividends from BHP, Rio and Wesfarmers (amongst others), an “extraordinary” ordinary dividend from Woodside, and off-market share buybacks from Caltex and Woolworths. Next cab off the rank will be the three major banks (ANZ, NAB and Westpac) who will look at accelerating the payment of their interim dividend. These have typically been paid in early July, but watch for the dates to be moved to June or earlier.
All this money has to go somewhere and with the RBA now sounding “dovish” on the cash rate and some economists even predicting that the cash rate will be cut, income stocks are back in vogue. This is why the market has remained well supported above 6000, notwithstanding a fairly uninspiring company results season.
Back to Rio, it will pay a special dividend of US 243c per share or approximately A$3.39 per share. This is on top of a final dividend of US 180c per share (A$2.51), unchanged from 2017. The stock will trade ex-dividend on 7 March, with the dividend payment to be made on 18 April.
As good as it gets for Rio?
Rio’s underlying EBITDA for the full year of US$18.14bn was down US$0.44bn on 2017, a fall of 2.4%. This was a little short of broker forecasts. Improvements in the realised price of the commodities, a more favourable exchange rate and production increases added a combined US$1.4bn to earnings, while higher energy costs, raw material cost headwinds, inflation and other costs and one offs subtracted US$1.6bn from the result.
While cost pressures particularly impacted aluminium, Rio is struggling to make further headway in reducing costs with its Pilbara iron ore. Cash costs were US$13.30 per tonne, down very marginally from US$13.40 in 2017.
Since the end of the commodity boom in 2014, the major miners have been very focussed on improving shareholder returns. They have strengthened their balance sheets by selling underperforming assets, repaid debt, been very disciplined about capital investment and focussed on increasing productivity and efficiency, thereby lowering per unit production costs.
But the news from this report (and competitor BHP’s report) is that it is getting harder and harder to lower per unit costs. In fact, both miners reported “negative” productivity improvements.
Rio’s balance sheet is in fine form with adjusted net debt (after paying the special dividend and previously announced share buybacks) down to a proforma US$8.0b. This gives it a gearing ratio of less than 10%.
And while there is a development pipeline and a ramp-up of projects, with capital expenditure forecast to rise from US$5.4bn in FY18 to US$6.0bn in FY19, earnings growth is going to be largely dependent on higher commodity prices. There aren’t further assets to sell, and productivity and production increases will be challenging.
Interestingly, Rio began its investor presentation with a couple of slides describing 100 tailings storage facilities they operate, and their assurance processes for managing tailings and water storage. The fallout from Vale’s Brazilian mine tragedy is ringing alarm bells with investors and analysts.
What do the brokers say?
Going into the result, the major brokers were moderately positive on Rio with 3 buy recommendations and 4 neutral recommendations. The consensus target price (according to FN Arena) was $89.94, 5.5% below Wednesday’s pre-result closing price on the ASX of $95.12.
Broker target prices for resource companies are hugely dependent on forecasts for commodity prices, so a small uplift or downgrade to their commodity outlook can have quite a big impact on the target price. The company doesn’t have to do anything. But the history of broker forecasts shows that in the main, they aren’t any better than anyone else at forecasting commodity prices, so the target price is only of limited use. This all said, I expect that the brokers will be a tad disappointed with the result and over the next few days, there will minor downgrades to target prices.
The bottom line
If commodity prices continue to head higher, Rio’s share price will be well supported. The run up in the iron ore price following competitor Vale’s dam collapse could have further to go. But in terms of what the company can control, I reckon that this is as close to “as good as it gets”. Too late to buy. Use rallies to reduce weighting..
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