COLUMN-Rio Tinto's asset sales may show bearish commodity outlook: Clyde Russell

Mon Apr 8, 2013 2:09am EDT

--Clyde Russell is a Reuters market analyst. The views expressed are his own.--

By Clyde Russell

LAUNCESTON, Australia, April 8 (Reuters) - The lengthening list of assets being put up for sale by Rio Tinto shows the world's second-largest miner is serious about cutting costs and exiting non-core businesses, but what does it say about the state of commodity markets?

Coal and copper assets in Australia and iron ore in Canada have reportedly been added to the for-sale list, joining diamonds in Canada and aluminium smelters around the Pacific.

So far the company is winning praise from analysts for the focus of new Chief Executive Sam Walsh on increasing returns to shareholders through a relentless focus on containing costs, paring back capital expenditure and asset sales.

While the first two present challenges, they are likely to produce far more tangible results than the planned sale of a grab-bag of high-cost mines and aluminium smelters.

The logic here is simple: if Rio, with all its deep experience of developing and running such assets, can't make them work, why would anybody else take them on?

Also, it would be very unusual for a company to sell strongly performing assets in markets it thought held great long-term potential, even if they were high cost.

Among the assets said to be for sale is a chunk of Rio's 80-percent controlling stake in Coal & Allied, which produces mainly thermal coal in Australia.

While it may well be a high-cost miner compared to rivals, would Rio be keen to sell down its stake if it believed thermal coal was going to be a top performer in coming years?

Certainly thermal coal has been a poor performer in recent years, with the benchmark spot price at Australia's Newcastle port, at $87.01 a tonne, some 36 percent lower than the post-2008 recession peak of $136.30 reached in January 2011.

The price decline has come even as China and India import record amounts of the fuel and can mainly be attributed to a surge in exports from the United States and increasing supply from traditional producers such as Indonesia.

CHINA MODERATING

It would appear that Rio is taking a view that thermal coal isn't likely to be a strong performer over the longer term, which may be a reflection of the likelihood of slowing demand growth in China as its economic growth matures and pressure mounts for cleaner-burning fuels to combat pollution.

The potential sale of the majority stake in the Northparkes copper mine in Australia is probably more a reflection of that operation's high costs than the overall outlook for the copper market, although even here it's becoming apparent that the global balance is shifting to surplus after years of deficit.

Again, costs and strategic fit are probably behind the plan to divest Rio's 59-percent stake in Iron Ore Company of Canada, given Rio's overall dependence on the steel-making ingredient.

Last year about 90 percent of Rio's earnings came from the iron ore operations centred in Western Australia state, and much of the rest from copper in Chile and the United States.

The trick in both iron ore and copper is to be the lowest cost producer around, as both these commodities may suffer structural price declines in the next few years as supply increases at a time when China's demand growth is moderating.

This is why Rio, in common with rivals such as BHP Billiton , is focusing on cutting costs, capex and selling the high-cost operations.

The company wants to reap $5 billion in costs savings and asset sales could realise more than $10 billion.

But the difficulty is going to be translating planned asset sales into reality, as shown by the fact that the 13 aluminium assets hived off for sale under the Pacific Aluminium unit are still languishing unsold after more than a year on the market.

It would seem that commodity assets have gone from the market's darling during the boom years of the 2000s prior to the 2008 financial crisis to the runt of the investment litter.

It will be fascinating to see if any investor is brave enough to take a contrarian plunge on the assets up for sale.

After all, the big miners have shown that they generally time the buying of assets wrong, shelling out top dollar just as things are about to turn, as shown by Rio's $38 billion purchase of Alcan in 2007.

It's many of these Alcan assets that now can't find a buyer and are in danger of being shut down.

In the absence of contrarian commodity investors, it's likely that Rio will find selling assets an extremely slow and frustrating experience, and one unlikely to yield the anticipated returns.

Disclosure: At the time of publication Clyde Russell owned shares in Rio Tinto and BHP Billiton as an investor in a fund.

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