Rio Tinto Plc: Company Overview, Financial Ratios & Stock Performance

Introduction to Rio Tinto Plc

Rio Tinto Plc is the largest mining and metal company that was incorporated on 30^th March 1962. The main business of the company is to find and processing the mining and mineral resources. Various segments of the company include Aluminium, iron ore, diamonds, copper minerals, energy and other operations. The company carries out its activities all over the world and are widely represented in North America and Australia. Further, the company is strongly responded towards the increasing demand of the community under which it carries out its business for responding towards climatic chance and sustainability. It made the sustainable commitment to the sustainable development that includes social wellbeing, environmental stewardship, governance system and global transition (Rio Tinto 2018).  

1. Substantial shareholders

• More than 20% holding – HSBC Custody Nominees (Australia) Limited holds 121,820,095 shares that is 28.72%
• Greater than 5% of shares – J.P. Morgan Nominees Australia Limited hold 71,864,782 shares that is 16.94%, Citicorp Nominees Pty Ltd holds 24,176,758 shares that is 5.70% and National Nominees Limited holds 21,941,431 shares that is 5.17%.

1. Name of key persons

• Chairman – Jan du Plessis
• Board members – other key personnel included in the board of the company are –  
• Chris Lynch – Financial officer
• Robert Brown – Non-executive director
• Megan Clark – Non-executive director
• David Constable – Non-executive Director
• Ann Godbehere – Non-executive Director
• Sam Laidlaw – Non-executive director
• Anne Lauvergeon – Non-executive director
• Paul Tellier – Non-executive director
• Michael L’Estrange AO – Non-executive director
• Simon Thompson – Non-executive director
• John Verley – Non-executive director
• Simon Henry – Non-executive director
• CEO – Jean Sebastien Jacques

Any of the above mentioned key personnel does not hold substantial shares in the company.

1. Return on assets (ROA) = (NPAT / Total Assets)

           Return on Equity (ROE) = (Net profit after tax / Ordinary equity)

      Debt ratio = Total liabilities / Total assets

EBIT/TA * NPAT/EBIT * TA/OE = NPAT/OE

EBIT/TA * NPAT/EBIT * TA/OE = 6343/89,263 * 4776/6343 * 89,263/45,730 = 0.104

NPAT/OE = 4776 / 45,730 = 0.104

      Hence,

EBIT/TA * NPAT/EBIT * TA/OE = NPAT/OE (Proved)

This ratio is expressed in percentage form and is calculated through dividing the total assets of the company by the shareholder’s equity (Brigham and Ehrhardt 2013). It shows the relationship of total asset to the part owned by the shareholders. This ratio further indicates the leverage of the company that is used for financing the company. Though there is no specific ratio for TA to OE, it is valuable for comparing similar businesses under the same industry. Higher ratio represents that the company’s debt portion is considerably high to sustain in business. However, the high ratio can represent that the return on the borrowed capital is more than the capital cost of the company. Further, with the increase in the ratio the company may reach to the unsustainable level as additional cost will increase the interest cost which in turn will depreciate the value of the company.

ROE as well as ROA both are the metrics for analysing the profit. When the ROE is more as compared to the ROA, it states that the company’s total asset is more as compared to the owner’s equity of the company. With the increase of the equity the debt portion of the company reduces. However, if the ROE is more it represent that the company is earning on its borrowing. In other words, the interest rate on debt is lower that the return of the company. Therefore, if company raise additional debt only though debt it would earn more as compared to the situation where the additional fund is raised through debt and equity both.

Business Segments

1. Monthly stock movement for last 2 years

Rio Tinto –

All Ordinary Index –

Looking into the return and movement graph of both the stocks, it is concluded that the both the stocks are in increasing trend. However, the stock of Rio Tinto is sharply upward moving and the stock of All Ordinary Index is moderately upward moving. Further, though the stock of Rio Tinto is upward moving the stock is fluctuating and therefore will be considered volatile as compared to the stock of All Ordinary Index. Further, the highest and lowest return of Rio Tinto is 0.111 and -0.156 respectively (Serghiescu and V?idean 2014). On the other hand, the highest and lowest return of All Ordinary Index is 0.063 and -0.027 respectively. Moreover, the correlation among two stocks is computed as 0.981 and therefore, the stocks are uncorrelated.

• Rio Tinto has received the binding offer from the Liberty House fir acquiring the Aluminium Dunkerque of Rio Tinto under the Northern France for the cost of $ 500 million that is subject to the final adjustment. This is expected to secure the long-term sustainable position for the company with regard to its Aluminium Dunkerque.
• The company made the buy-back of shares that includes $ 500 million and $ 1 billion on market shares and completed A$ 750 million off-market buyback for the company’s share.
• The non-executive director Mr. Thompson will become the chairman of Rio Tinto after Jan du Plessis steps down from his post.
• Coal & allied Industries Limited that is known as Coal & Allied of Rio Tinto is acquired by Yancoal Australia Limited. 

1. Calculated beta of the company is 1.66
2. Risk free rate = R_f= 4%, Market risk premium = R_m = 6%

Therefore, required rate of return of the company’s share =

R = R_f  + β ( R_m – R_f )

R = 4% + 1.66* (6% – 4%) = 7.32%

• Conservative investment

This is the investing strategy that increases the value of the portfolio through investing in lower risk associated stocks that provides fixed income. The risk tolerance level of the conservative investor are ranged low level to moderate level. The investors with low risk tolerance level are generally not comfortable with stock market and prefer to avoid it (Heikal, Khaddafi and Ummah 2014). However, the conservative strategy may protect the investor against inflation but at the same time it may not earn significant value over the time. As the beta of the company is considered quite high that is 1.66 and the required rate of return is 7.32% that is also quite high the stock of the company is not conservative investment (Hombert and Thesmar 2014).

1. Computation of WACC

WACC = E/V * R_e +D/V * R_d * (1-T_c), Where,

E/V = Equity percentage in the capital structure = 72%

D/V = Debt percentage in the capital structure = 28%

R_e = Cost of equity = 7.32%

R_d = Rate of debt = 4.2%

T_c = corporate tax rate = 30%

 The given information for computation of WACC is as follows –

Thus, WACC = 72*7.32% + 28*4.2% (1- 0.30)

= 5.27 + 0.82 = 6.09%

1. Impact of the higher WACC

WACC takes into consideration proportion of all the capital included under the capital structure. If the WACC of any company goes upward owing to increase of its beta and the ROE the valuation and risk of the company will also go up. Higher level of WACC also denotes that the company is associated with higher operation risk. Therefore, the investors will need additional return to cover up the risks (Krüger,  Landier and Thesmar 2015).

Sustainable Development

1. Optimal structure for capital

It is the financial measurement that the company uses for determining best mix of equity and debt financing for using in expansions and operations. The main objective of the optimum capital structure is to minimize the cost of the capital so that the company becomes less dependent on the creditors and finance the core operations of the company efficiently (Brusov, Filatova and Orekhova 2014). Though there is no ideal capital structure as it depends on various factors like type of the industry, company business and other economic factors. However, more or less 40% is considered as good for any company. It is recognized that the company’s debt ratio is 51.8% and 48.8% for 2015 and 2016 respectively. Therefore, the company shall pay-off the liabilities to improve the debt ratio (Morley 2013).

For adjusting the gearing ratio the company repaid its long-term borrowing amounting to $ 3670 million as the borrowings reduced from $ 21,140 to $ 17,470. Further the company increased its equity by $ 1,602 as the equity is increased from $ 44,128 to $ 45,730. Director’s report did not clarify anything regarding these adjustments (Streby et al. 2014).

The company has changed its dividend policy during the year. Earlier the company used to apply progressive dividend policy and changed to the policy under which the policy will be determined through taking into consideration the financial year’s result. Under the new policy, at the closing of each period the company will determine the appropriate level of dividend based on the financial result (Blitz, Falkenstein and Van Vliet 2013). The company adopted this policy to provide sufficient return to the investors.

It can be suggested to the client that if the above analysis is taken into consideration the sock of Rio Tinto shall be included in the portfolio of the investor. The main reason is that though the beta of the company is quite high, the return of the company is stable except for the year 2015. Further, the debt ratio of the company is quite stable. Therefore, the stock shall be included in the portfolio of the client. 

Reference 

Blitz, D., Falkenstein, E.G. and Van Vliet, P., 2013. Explanations for the Volatility Effect: An Overview Based on the CAPM Assumptions.

Brigham, E.F. and Ehrhardt, M.C., 2013. Financial management: Theory & practice. Cengage Learning.

Brusov, P., Filatova, T. and Orekhova, N., 2014. Mechanism of formation of the company optimal capital structure, different from suggested by trade off theory. Cogent Economics & Finance, 2(1), p.946150.

Heikal, M., Khaddafi, M. and Ummah, A., 2014. Influence analysis of return on assets (ROA), return on equity (ROE), net profit margin (NPM), debt to equity ratio (DER), and current ratio (CR), against corporate profit growth in automotive in Indonesia Stock Exchange. International Journal of Academic Research in Business and Social Sciences, 4(12), p.101.Cooray, A., Dzhumashev, R. and Schneider, F., 2017. How does corruption affect public debt? An empirical analysis. World development, 90, pp.115-127.

Hombert, J. and Thesmar, D., 2014. Overcoming limits of arbitrage: Theory and evidence. Journal of Financial Economics, 111(1), pp.26-44.

Krüger, P., Landier, A. and Thesmar, D., 2015. The WACC fallacy: The real effects of using a unique discount rate. The Journal of Finance, 70(3), pp.1253-1285.

Morley, J., 2013. The Separation of Funds and Managers: A Theory of Investment Fund Structure and Regulation. Yale LJ, 123, p.1228.

Rio Tinto., 2018. Home – Rio Tinto. [online] Available at: https://riotinto.com.au/ [Accessed 31 Jan. 2018].

Serghiescu, L. and V?idean, V.L., 2014. Determinant factors of the capital structure of a firm-an empirical analysis. Procedia Economics and Finance, 15, pp.1447-1457.

Streby, H.M., Refsnider, J.M., Peterson, S.M. and Andersen, D.E., 2014. Retirement investment theory explains patterns in songbird nest-site choice. Proceedings of the Royal Society of London B: Biological Sciences, 281(1777), p.20131834.

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