JIANAN YU
Rio Tinto's rehabilitation following its ill-timed acquisition of Alcan in 2007 is almost complete. The mining giant upped its dividend by 34 per cent on Feb. 9, at the same time as taking a $9-billion (U.S.) writedown on the overpriced deal. Chief executive Tom Albanese has also waived his bonus for the year. That gesture, twinned with the higher payout, can be seen as closing an unhappy chapter in the group's history.
The substantial dividend hike exceeded expectations and firmly signals Mr. Albanese's confidence in the future. Rio can afford the move right now, and shareholders will welcome the reliability of increased dividend income over the indirect and unpredictable benefits of ad hoc share buybacks – not that Rio has been a miserly purchaser of its stock in recent years.
The $2.2-billion of dividends paid in 2011 amounted to 18 per cent of underlying earnings. That was up from 15 per cent in the year-ago period. BHP Billiton, Rio's more diversified mining rival, pays out closer to 30 per cent of underlying earnings. Add in $5.5-billion of share buybacks, and Rio returned cash equivalent to half of last year's earnings before special items. While net debt doubled to $8.5-billion last year, a net-debt-to-EBITDA ratio of just 0.3 times means Rio could yet borrow more without losing its cherished single-A credit rating. BHP still has its single-A rating and its net debt is more than half of EBITDA (earnings before interest, taxes, depreciation and amortization).
The difficulty is that it's not hard to imagine a scenario where Rio's financial headroom narrows. Last year's earnings jump was mainly due to the rising price of iron ore, whose dominance within Rio's portfolio seems only to increase. Being so exposed to iron is fortuitous right now but the relative lack of diversification is a concern given that commodity prices can be volatile. Meanwhile, cost and capex pressures look stubborn and will help absorb cash saved by halting the existing buyback program. At least Rio is doing what it can to manage the impact of higher labour costs: By 2015 it hopes to ship half of its Pilbara iron ore production using driverless trucks.
For now, Rio is happily profiting from the commodities super-cycle. The raised dividend may limit Albanese's flexibility – but after the mistakes of the past, that isn't wholly a bad thing.