Rio Tinto is ‘Primed’ for Another Buyback in Early 2016 — Deutsche Bank

Rio Tinto [ASX:RIO] is having the kind of flat year one might expect of an industry in freefall. But the Aussie giant may be readying itself for another buyback scheme in February 2016. Costs are coming down, and capital expenditures are decreasing. Rewarding investors again early next year might be just the ticket for Rio’s stock.

Rio’s earning report, due this week, should show a sharp decline in revenues. The company reported earnings of US$5 billion a year ago. This year, its expected earnings will be closer to US$2.4 billion.

Despite that, analysts still believe Rio should undertake a new buyback next year. Deutsche Bank says that Rio is primed to follow up on its recent $2 billion buyback scheme in February this year. That buyback is still ongoing today.

As mentioned, Rio is making real savings from its capex cutbacks. On top of that, it continues to cut back on other costs. Rio is currently on track to better its target of $750 million in spending cuts for 2015. Deustche Bank even says this target could increase, paving the way for a smoother transition to another buyback.

That, according to the bank, put it in a strong position to reward investors again.

Where do investors sit on this?

If the last buyback is anything to go by, they’ll be on board. Organic growth is hard to come by these days in the industry. Commodity prices, in both coal and iron ore, continue to fall. Meanwhile, market share driven strategies still dominate the market. That’s ensuring high global supply at the expense of falling prices.

From that perspective, investors understand Rio’s position. But that’s also why they expect investor-driven policies to ease their concerns.

Unfortunately, prices likely haven’t hit a floor yet this year. Beyond 2015, the outlook is even worse for iron ore. Prices could drop to US$40 a tonne according to Goldman Sachs.

Even with the February buyback, Rio’s stock is trading close to 5-year lows. Rio lost most of the gains in share price from that buyback by April.

At the same time, the buyback is adding to Rio’s growing net debt. Its debt is expected to rise to US$14.5 billion this year, amounting to US$2 billion increase since December. That’s partly down to infrastructure expenditures. But the buyback scheme is the primary reason why debt levels are mounting.

Rio Tinto’s dividend policy

Outside of buyback schemes, Rio is sticking with its progressive dividend policy.

The company is maintaining its US$1.08 yield per share. However this is still half of the total 2014 dividend.

Here’s Deutsche Bank’s Paul Young speaking about Rio’s future dividend strategy:

The declaration of the dividend will be an important confirmation of the returns policy. [It should] eliminate some market concerns that the dividend yield is not “real” and could be cut’.  

For Rio, and its investors, the trick is to keep dividends either rising, or level. Rising debt, cost-cuts and lower earnings mandate as much.

Mat Spasic,

Contributor, Markets and Money

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