A look under the bonnet reveals all’s not well at Rio

Past performance is not necessarily a guide to future returns, and there is the sense that all is not well at Rio Tinto

Rio’s results were flattered by elevated iron ores prices. Picture: Bloomberg

Rio Tinto boss Jean-Sebastien Jacques has good cause to point proudly to the shareholder returns generated by the company under his watch.

On the back of cash generated by its operations, and a series of well-timed asset sales, the funds have been pouring into the company’s coffers and straight out the door again.

Mr Jacques says Rio has paid out $US36bn ($55bn) since 2016, the equivalent of 67 per cent of its market capitalisation at the beginning of that year.

It’s an extraordinary record.

But as the old market adage goes, past performance is not necessarily a guide to future returns, and there is the sense that all is not well at Rio.

This year’s results announcement is again headlined with another big cheque to shareholders on the back of its best profit in eight years.

But those results wouldn’t look nearly as pretty without the elevated iron ore prices caused by the tailings dam tragedy at Vale’s Brazilian operations a year ago.

A dive into Rio’s figures shows about $US5.5bn of the EBITDA gains in its dominant iron ore division came from higher prices, and another $US247m from the falling Australian dollar.

Lower volumes — 14 million tonnes of shipments were lost early in 2019 because of fires at Rio’s port and the impact of cyclones — and the need to strip additional dirt from the top of its Brockman mining hub, meant about $US986m was stripped out of the benefit of the iron ore price.

Nothing makes a shareholder happier than a big dividend cheque, particularly if it’s fully franked. But long-term investors would also do well to keep a close eye on the company’s operational performance.

Rio may have been delivering bumper returns to shareholders over the last three years, but at the same time costs, volumes and product quality at its flagship division have all gone backwards.

In 2019 WA iron ore sold 326 million tonnes, at unit cash costs of $US14.40 a tonne. In 2016 it produced 327.6mt at a unit cash cost of $US13.70.

And Rio has already downgraded its 2020 iron ore outlook by six to nine million tonnes, from initial guidance of 330-343mt to 324-334mt in the wake of Cyclone Damien this month, which flooded mines, caused minor pit-wall slippages, and damaged accommodation camps and port infrastructure.

It had problems at its other headline project in 2019 also, announcing a $US1.9bn blowout at its underground expansion at the Oyu Tolgoi copper and gold mine in Mongolia in July, along with a delay of 16 to 30 months on delivery due to the need to redesign sections of the underground workings. Rio now tips the Oyu Tolgoi underground development to cost $US6.5bn to $US7.2bn, up from an initial estimate of $US5.3bn.

Rio remains embroiled in arguments with sections of the Mongolian parliament over royalties and taxes at Oyu Tolgoi, which was intended to be the crown jewel of its copper division, forecast to produce up to 560,000 tonnes of copper a year when fully ramped up.

Today’s elevated iron ore price won’t last forever. And if Rio, BHP and the rest of the mining industry is right, and the big commodity of the next decade is copper, Oyu Tolgoi needs to be in position to deliver into it.