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Less of the hard stuff

17 October 2011 By John Foley

Rio Tinto has taken a bold step into aluminium rehab. The mining giant plans to sell off roughly a third of its business in the metal, most of which was acquired in a disastrously expensive merger with Canada’s Alcan in July 2007. The timing of the purchase was undoubtedly terrible. Now is probably as good a time as ever to make some amends.

The price of aluminium halved within two years of Rio buying Alcan, and, unlike copper and iron ore, has not fully recovered. Aluminium is not in short supply. Also, producers without good long-term electricity contracts have to deal with a margin squeeze. Power prices are high and, economically, aluminium is more like condensed electricity than refined bauxite. Longer term, the metal’s profit potential is limited by the ability of China, the biggest consumer and producer of aluminium, to use its abundant cheap energy to pursue self-sufficiency.

Rio has more attractive opportunities, most notably in iron ore. That business made up 68 percent of Rio’s earnings from 42 percent of revenues in 2010. Aluminium looks like iron ore’s evil twin: it provided 5 percent of earnings from 27 percent of revenues, and EBITDA margins overall are half the 40 percent Rio has targeted.

Rio is not selling enough to change its profile. Assume it disposes of assets which would otherwise have provided a third of Rio’s $21 billion of forecast aluminium revenues for 2012, based on Credit Suisse estimates which assume a slightly higher aluminium price than today’s. With an EBITDA margin of 20 percent and rival Alcoa’s 5.6 times multiple, Rio might take in $8 billion, 7 percent of the current market capitalisation.

Even that may be ambitious, since Rio is selling its costlier and dirtier plants, keeping those with captive and clean energy supply. Still, keeping its most competitive assets looks sensible, in case prices rise. And investors will welcome the nod towards financial discipline. Four years on, Alcan still looks like a mistake, but it is at least one that’s getting smaller.


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