Company Overview

Rio Tinto is an Australian-British international and regarded as one of the largest metals and mining companies in the world. It was founded in the year 1962 and it aims to offer adequate returns to the shareholders through an effective portfolio. It operates through five groups namely Copper, Aluminium, Minerals, Diamonds, and Iron Ore. The prevalence of the company can be observed in forty countries through a massive workforce of 60,000 people. Rio Tinto was initially formed as a single entity but later it segregated its affairs by becoming a dual-listed entity (Rio Tinto Plc and Rio Tinto Ltd) and having distinct shareholding for both entities. The company has affairs on six continents but is majorly focused on Canada and Australia, and owns its affairs through a complicated web of partly and wholly owned subsidiaries (Rio Tinto, 2016). Moreover, the company being dually-listed is listed both on the London Stock Exchange and Australia Stock Exchange.

Substantial shareholders

Rio Tinto has a governance structure wherein it has framed committees that are liable for remuneration, audit, nomination, and sustainability issues. In relation to Rio’s ownership structure, it is more of an institutional nature that causes huge bear and bull trends if the perceived value of stock alters for big-ticket investors (Rio Tinto, 2016). The shareholder having more than twenty percent holding is HSBC Custody Nominees Ltd (28.72% holding). Based on this, Rio cannot be considered a family company. Further, shareholders with more than 5% holding are JP Morgan Nominees Australia Ltd (16.94%), Citicorp Nominees Pty Ltd (5.70%), Blackrock Holding (6.28%), and National Nominees Ltd (5.17%). 

Governance

The people involved in the company’s governance are the chairman (Jan Du Plessis), Chief Executive (Jean-Sebastien Jacques), CFO (Chris Lynch), and non-executive directors namely Robert Brown, David Constable, Megan Clark, Ann Godbehere, Anne Lauvergeon, Paul Tellier, Sam Laidlaw, Michael L’Estrange, Simon Thompson, and John Varley. Further, an executive board comprised of Bold Baatar, Vera Kirikova, Chris Salisbury, Stephen McIntosh, Alfredo Barrios, Joanne Farrell, Simone Niven, and Arnaud Soirat (Rio Tinto, 2016). It can be seen that Bold spend eleven years with JP Morgan that indicates his involvement in the firm governance as it specifies a relationship betwixt two employees.

Return on Assets

Return on equity

Debt Ratio

Equation 1

Equation 2

Equation 3

Multiplication of equation 1*equation 2* equation 3 provides ROE

The total asset divided by ordinary equity indicates the total assets of the firm to the segment that is owned by the shareholders. The ratio projects the leverage of the company (debt) that is utilized to finance the firm (Williams, 2012). A high ratio will stress that the company has undertaken a higher level of debt, on the contrary, a higher level of debt even indicates that the borrowed capital surpass the cost of capital. At a higher level, it is even indicated that financial position is in difficulty owing to the higher interest cost (Horngren, 2013).

Financial Analysis

iii.  In the case of Rio Tinto, the ROE is greater than ROA because the borrowing of the company is less than the assets of the company.  The equity of the company is not negative as the companies have more of assets in comparison to the liabilities (Northington, 2011).

Chart for movements

(Rio Tinto Ltd, 2016)

Comparison of Share price to the All Ords Index

From the chart projected above, it can be seen that the stock price of the company follows the All Ordinaries index. This is due to the fact that the beta of the company stands more than 1 at 1.64 hence when the market is up it moves up and when the market declined it falls. In short, the stock has high level of volatility and follows the All Ordinaries Index.

Mining buy back

The announcement of mining buy back was yet another new that led the movement of the share price. This led to the upside prices in the stock.

Iron ore prices

The prices of iron ore stabilized in the year 2016 after two years of decline. The decline that was present in the year till 2015 led came to a halt and the stock prices surged in account of strong iron ore prices (Trefis, 2016)

Lowering of average production costs

The new of lowering of average cost of production was yet another major announcement that helped the company to maintain the profits and took the business to a significant height. The low cost Pibara iron ore was one of the positive factor that led the dominance.

Copper prices outlook

The recovery in the prices of iron ore was a major boost to the recovery mechanism. The new of $1 trillion revamp of the infrastructure of U.S enhanced the global outlook for copper (Trefis, 2016). 

Coal rationalization

The company did a sale of Zululand coal mine in South Africa and the announcement of the rationalization led to a sharp decline in the coal shipment of the company in the upcoming future.

Rio Tinto has beta of 1.64 meaning that the volatility of Rio Tinto as per the measure stands higher in tune to the volatility of the market. When a stock contains a beta of more than 1 it indicates that the stock will move more in comparison to the market and decline in the same manner when the market fell (Parrino et. al, 2012).

CAPM

E(R) = RFR + β_stock (R_market – RFR)

= 0.04 + 1.64 ( 6-4 )

= 0.04 + 3.28

=3.32

Rio Tinto cannot be considered as a conservative investment because the beta of the stock is more than 1 and stands at 1.64. Hence, stock with more than beta of 1 is volatile and behave in a volatile manner.

Weight of equity = E/ (E+D)

= 101006.30/ (101006.300 + 20346)

Return on Assets

=0.8323

Weight of debt = D/(E+D)

=20346.5/ (101006.300 +20346.5)

=0.1677

Cost of equity = 1.33000000% + 1.26 + 6% = 8.89%

Cost of debt = 787/ 20346.5 = 3.868%

WAC = E(E + D) * Cost of equity + D/ (E+D)* Cot of debt* (1- tax rate)

= 0.8323 * 8.89% + 0.1677* 3.868% * (1- 56.04%)

=8.41%

Implications of a high WACC

A higher WACC is basically a sign of higher risk related to the operations of a company. Investors tend to require more return by assuming additional risks. Moreover, in relation to investment projects, a higher WACC can have extreme implications upon the management’s evaluation process. The reason behind this can be attributed to the fact that a company’s WACC can be utilized to forecast the anticipated expenses for all its financing sources. This consists of payments being made on debt obligations, the required rate of return ordered by ownership, and cost of debt or equity financing (Melville, 2013). Moreover, companies often look for attempts to decrease their weighted average cost of capital through cheaper sources of finance. This is because WACC intends to balance out relative expenses of different sources to generate a single cost of the capital figure. Issuance of bonds can be more attractive than the issuance of stocks if the interest rates are lesser than the demanded return rate on the stock. Therefore, a higher WACC depicts higher risks and higher costs for the company in relation to prospective investment projects. Nevertheless, the costs for proposed company investments will be clearly more than forecasted or evaluated by the management, thereby resulting in higher risks for the company as well. 

Debt ratio

Debt ratio should be less than 0.50 as that indicates a stable structure meaning low level of debt. As per the debt ratio of Rio Tinto it can be observed that the company has low level of debt as indicated by the ratio and stand near to 0.50 hence, it has a stable structure that will benefit the company in its management (Brealey et. al, 2011).

The debt ratio is optimum and going by the balance sheet it is indicated that the company has repaid the debts. When the borrowings are repaid it leads to lower pressure on the management of the company. The same has been indicated in the notes to the financial statements (Brealey et. al, 2011). 

Based on the dividend policy of the company, the Board will ascertain a sufficient level of total ordinary dividend per share after considering the outcomes for the financial year, board’s perspective of long-term growth perspectives of the business, the outlook for its significant commodities, and company’s intention of maintaining an effective balance sheet. The reason behind the formulation of such dividend policy can be attributed to the fact that the balance betwixt the final and interim dividend is weighted to the final dividend respectively (Albrecht et. al, 2011). This process is decided to be implemented by the Board at the end of every financial period so that the commitment of the Board to maintain an effective balance betwixt investment in the businesses and cash returns to the shareholders, with the objective of enhancing or maximizing value for the shareholders as a whole (Rio Tinto, 2016). Another reason of adoption of such dividend policy can be attributed to the fact that the company has to undergo various examinations owing to the cyclical nature of the industry and in the period of cash generation and strong earnings, such dividend policy can assist the company in supplementing ordinary dividends with extra returns to the shareholders (Gibson, 2010).

Rio Tinto has provided a good performance in 2016 and that can be attributed to the strong fundamentals. Apart from that the company rests on the concept of an optimal debt ratio and the return on equity stands tall. Further, it is seen that the governance and the mechanism is into proper movement. Going by the overall, analysis it can be recommended that the company can reach to further heights if the company can tame the external factors with ease and flexibility. The external factors and the iron ore conditions must be meet with precision to have a better view and understanding. 

References

Albrecht, W, Stice, E & Stice, J 2011, Financial accounting, Mason, OH: Thomson/South-Western.

Brealey, R, Myers, S & Allen, F 2011, Principles of corporate finance,  New York: McGraw-Hill/Irwin.

Gibson, C 2010, Financial Reporting and Analysis: Using Financial Accounting Information, Cengage Learning.

Horngren, C 2013, Financial accounting, Frenchs Forest, N.S.W: Pearson Australia Group.

Melville, A 2013, International Financial Reporting – A Practical Guide, Pearson, Education Limited, UK

Northington, S 2011,  Finance. New York, NY: Ferguson’s.

Parrino, R., Kidwell, D. & Bates, T 2012, Fundamentals of corporate finance, Hoboken, NJ: Wiley

Rio Tinto 2016, Rio Tinto Annual Report and accounts 2016, viewed 1 February 2018 https://www.riotinto.com/documents/RT_2016_Annual_report.pdf

Rio Tinto Ltd 2016, Market Index, viewed 1 February 2018 https://www.marketindex.com.au/asx/rio 

Williams, J 2012,  Financial accounting, New York: McGraw-Hill/Irwin.