(The following statement was released by the rating agency) Fitch Ratings-London-November 06: Fitch Ratings has affirmed global mining company Rio Tinto (LON:RIO) Plc/Ltd's (Rio Tinto) Long-Term Issuer Default Rating (IDR) and senior unsecured debt instrument rating at 'A'. The Outlook is Stable. A full list of rating actions is at the end of this commentary. The affirmation reflects Rio Tinto's large scale, first and second quartile business cost positions in iron ore and aluminium, strong cash flow generation supported by a deficit in the seaborne iron ore market in 2019 and 2020, the group's low debt levels and good operational performance compared with businesses across the mining sector. Rio Tinto maintains material financial flexibility as markets are facing decreasing global GDP growth and world trade. Management is pursuing a value-over-volume strategy and we expect earnings growth to mainly come from productivity improvements, technological innovation, cost control and development projects from Rio Tinto's own pipeline. Management emphasises disciplined capital allocation, which means the group's asset portfolio should evolve without a material shift in the underlying business risk. Fitch expects the group to maintain a conservative balance sheet with funds from operations (FFO) adjusted net leverage below 1.0x and broadly neutral free cash flow (FCF) after dividends over the medium term. Rio Tinto is one of the world's top-three mining companies with diversification of assets mostly across OECD countries and products across a number of bulk and base commodities. It also benefits from meaningful economies of scale and proximity of operations to important end-markets, particularly China and North America. Key Rating Drivers Market Leading Iron Ore Franchise: Rio Tinto markets a range of iron ore products that address specific end markets, fines and lump with consistent specifications (iron content, alumina, silica, phosphorus and other). The business has very competitive cash costs and sustaining capital expenditure. Currently the business cost curve shows Rio Tinto on average in the first quartile (according to data from CRU and their definition of business costs), but Rio Tinto's and Vale S.A.'s assets can be expected to have moving business cost positions within the first and second quartile, depending on the value in use adjustment linked to premiums for higher grade products and transportation costs. At the same time, costs are rising more quickly at Vale, reflecting that it has to spend more capital to address regulatory scrutiny linked to operating its assets in a safe and environmentally sustainable manner. Strong Aluminium Franchise: The group's Canadian smelters, with electricity from hydropower, are amongst the most competitive in the industry and Rio Tinto's bauxite production ranks on average in the second quartile of the global business cost curve (according to data from CRU Group). While the remaining smelters in Australia and New Zealand are efficient and well invested assets, high electricity prices and transmission costs in those countries render them unprofitable at prevailing aluminium prices. Rio Tinto has placed the smelter in New Zealand under strategic review and is evaluating alternative power supply options in both countries. Oyu Tolgoi Underground Project Delayed: In July, Rio Tinto announced that enhanced geotechnical information and data modelling suggests the approved mine design could potentially entail stability risks and as a result is exploring alternative mine design options. First sustainable production is expected between May 2022 and June 2023 (a delay of 16 to 30 months) with the preliminary cost estimates increasing by USD1.2 billion to USD1.9 billion. Rio Tinto owns 33.5% of the project (but fully consolidates Oyu Tolgoi due to having control). The group expensed a pre-tax impairment charge of USD2.2 billion in June 2019, of which USD1.5 billion is attributable to non-controlling shareholders. Fitch's rating case does not factor in any volumes from the underground development (same as last year). Cash Flow Generation Underpinned by Iron Ore Tightness: A lot of mining companies reported peak cash flow in 2018. After the tailings dam failure at Brumadinho, iron ore supply from Vale's operations was materially curtailed so that the seaborne iron ore market moved into deficit in 2019, with supply tightness expected to remain a feature in 2020. Iron ore prices spiked at USD119/tonne in July before moving back below USD100/tonne in August. As a result, Rio Tinto will report another record year of earnings in 2019. Broadly weaker commodity markets will only be fully reflected in earnings from 2021, given that iron ore prices will still reflect waning/decreasing supply disruptions and support EBITDA in 2020, while aluminium and copper prices already now reflect weaker growth and sentiment. Group Demonstrates Financial Flexibility: We expect FFO adjusted net leverage to remain below 1.0x over the next four years. Management wants to maintain a conservative balance sheet and emphasises disciplined capital allocation, with the option to invest countercyclical. The same is true for BHP and Anglo American (LON:AAL), although these companies have set debt targets that apply through the cycle. To date, Rio Tinto's management has chosen not to limit its scope to manoeuvre in times when asset prices are more affordable. Shareholder Returns Credit-Neutral: Dividends and shareholder returns expected to be paid in 2019 are high at USD12 billion, which includes return of capital from major asset disposals. The group has a dividend policy of distributing 40%-60% of underlying earnings. Therefore, Fitch expects dividends to moderate once earnings weaken. Fitch assumes dividends and share buybacks will be funded by cash flow, not debt. Derivation Summary Rio Tinto is one of the top-three global mining companies. Close peers include BHP Group Ltd (A/Stable) and Vale (BBB-/Stable). Rio Tinto derives an estimated 65% of EBITDA from iron ore (including the Canadian pellets business), 15-20% from the aluminium business, 10%-15% from copper and 5% from other minerals over the medium term (once the iron ore market moves back to balanced supply and demand/iron ore prices normalise after deficits created by reduced supply from Brazil in 2019 and 2020). BHP exhibits more balanced diversification with an estimated 40% of EBITDA from iron ore, 15% from coal (of which more than two-thirds come from metallurgical coal), 30% from copper and 15% from conventional petroleum assets (over the medium term). Earnings from petroleum assets add diversification benefits, given that oil prices exhibit weaker correlation with prices of BHP's other mining products. Most of the iron ore for BHP and Rio Tinto comes from Australia, with Rio Tinto producing more lump. A large proportion of copper for both players comes from the Escondida mine in Chile (BHP: 57.5% ownership; Rio Tinto: 30%). Rio Tinto and BHP have similar financial profile characteristics with FFO adjusted gross leverage at or below 1.5x and FFO adjusted net leverage below 1.0x over the medium term. We expect both companies to maintain a disciplined approach towards capital allocation for growth, while returning significant amounts of funds to shareholders through dividends and share buybacks, as long as commodity prices remain supportive. Equally, we expect both companies to scale back shareholder returns and safeguard neutral or positive FCF when commodity prices fall. BHP and Rio Tinto derive a large majority of earnings from assets in OECD countries. In comparison, Vale has historically derived more than 85% of EBITDA from iron ore (including pellets) with the remainder coming from nickel, copper and other minerals. Until the tailings dam failure at Brumadinho its rating was lower than its peers at 'BBB+' due to i) concentrated exposure to one commodity - iron ore; ii) the majority of operations being located in Brazil, which has a less developed economic environment and systemic governance; and iii) higher transportation costs to important markets like China, which may be offset by the premium achieved for its higher grade product. We downgraded the company this year to 'BBB-' linked to the tailings dam failure at Brumadinho due to uncertainties from unquantifiable contingent liabilities related to fines, remediation and reparations as well as scrutiny from regulators and government that may influence future output and increase capex requirements. Key Assumptions Fitch's Key Assumptions Within Our Rating Case for the Issuer - Price assumptions for selected commodities: iron ore at USD90/t CFR in 2019, USD75/t in 2020 and USD60/t in 2021 and 2022; aluminium at USD1,780/t in 2019, USD1,750/t in 2020, USD1,800/t in 2021 and USD1,900/t in 2022; copper at USD6,000/t in 2019, USD5,900/t in 2020, USD6,200/t in 2021 and USD6,300/t in 2022. - Dividend payout ratio of 50% from 2020 (Fitch assumption). - Capex in line with company guidance: USD5.5 billion in 2019, USD7 billion in 2020 and USD6.5 billion for 2021 and 2022. - Net debt to increase to mid to high single digit billion levels (as calculated by Fitch, applying adjustments to cash and cash equivalents referenced in the Summary Financial Adjustments section below). - No large-scale debt-funded acquisitions. RATING SENSITIVITIES Developments That May, Individually or Collectively, Lead to Positive Rating Action An upgrade is unlikely unless Rio Tinto diversifies into other sectors with lower business risk and correlation to its mining operations. Developments That May, Individually or Collectively, Lead to Negative Rating Action - FFO adjusted gross leverage remaining above 1.5x for a sustained period (2018: 1.3x) - FFO adjusted net leverage remaining above 1.0x for a sustained period (2018: 0.4x) - Net debt / (cash flow from operations minus capex) above 2.0x for more than two consecutive years (2018: 0.24x) - Debt-funded dividends or share buybacks - Iron ore proven and probable reserves falling below 2,000mt on a sustained basis Liquidity and Debt Structure Solid Liquidity: At 30 June 2019 Rio Tinto held around USD7.5 billion in unrestricted cash (as calculated by Fitch; cash and cash equivalents less an estimate of restricted cash plus 40% of a separately managed portfolio of fixed income instruments), had available USD 7.5 billion under its revolving credit facilities (USD1.9 billion maturing in November 2021 and USD5.6 billion maturing in November 2022) and continues to generate strong cash flow. We do not expect the group to issue new debt in the near future. Existing debt is likely to be repaid with internally generated cash flow and existing liquidity. Summary of Financial Adjustments - Fitch has adjusted the balance sheet debt by capitalising operating leases using the standard 8x multiple. The lease expense disclosed in the accounts was USD787 million in 2018, following USD555 million in 2017 and USD541 million in 2016. The aggregate amounts of minimum lease payments under non-cancellable operating leases have been broadly steady over the last three years. The increase to USD787 million is related to additional short-term commitments, which we decided to exclude from the adjustment of the financial spreads. We have used a normalised operating lease expense of USD550 million for capitalisation using the 8x multiple. - Fitch has adjusted available cash to reflect USD270 million restricted cash as these funds are not available to apply against debt repayment or are held in jurisdictions which do not allow foreign currency remittances. - 40% of USD2,522 million of a separately managed portfolio of fixed income instruments were moved to cash equivalents; this is a conservative approach, given that Rio Tinto does not disclose more detail on the risk parameters established for administration of this portfolio. - USD288 million of debt-related derivatives were added to the debt in line with disclosure in note 24 of the financial accounts. ESG Considerations Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of 3 - ESG issues are credit neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Rio Tinto Finance (USA) Plc ----senior unsecured; Long Term Rating; Affirmed; A Rio Tinto Finance Plc ----senior unsecured; Long Term Rating; Affirmed; A Rio Tinto Alcan Inc. ----senior unsecured; Long Term Rating; Affirmed; A Rio Tinto Ltd; Long Term Issuer Default Rating; Affirmed; A; RO:Sta ; Short Term Issuer Default Rating; Affirmed; F1 ----senior unsecured; Long Term Rating; Affirmed; A Rio Tinto Plc; Long Term Issuer Default Rating; Affirmed; A; RO:Sta ; Short Term Issuer Default Rating; Affirmed; F1 Rio Tinto Finance (USA) Ltd ----senior unsecured; Long Term Rating; Affirmed; A Contacts: Primary Rating Analyst Oliver Schuh, CFA, CAIA, FRM Senior Director +44 20 3530 1263 Fitch Ratings Ltd 30 North Colonnade, Canary Wharf London E14 5GN Secondary Rating Analyst Maria Yakushina, Director +44 20 3530 1315 Committee Chairperson Peter Archbold, CFA Senior Director +44 20 3530 1172
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