Rio Tinto Margins Pressured

As a foreign supplier to the Asia-Pacific region, Rio Tinto (RTP - Analyst Report) should benefit from China’s status as a net importer of iron ore. The company is focused on boosting output to meet China’s increased consumption levels. Moreover, with a positive outlook on most metal prices, we expect solid long-term revenue growth.

The company’s primary focus remains on organic growth, exploration and opportunistic value acquisitions. In this respect, with the acquisition of Alcan Inc., Rio has become a global leader in the aluminium industry with large, long life, low-cost assets across the globe and a strong pipeline of attractive growth projects for the future.

However, cost pressures due to ongoing supply constraints are adversely impacting Rio’s margins and profitability. Also, significant capital spending on its expansion and development projects might put pressure on near-term free cash flow generation. We reiterate our Hold recommendation on the stock.

The management stated that on an average, global economic growth is expected to remain sufficiently high, thereby resulting in a strong overall demand growth. Together with relatively low stocks for many commodities and expectation of continuous production constraints, most metals and mineral prices are expected to remain well above their long run historical trend in 2008 and beyond.

In June, Rio Tinto approved funding of $667 million in infrastructure and studies for mine expansions as part of the company's program to increase Pilbara’s annual production capacity further to 320 million tonnes of iron ore by 2012. In July, Rio announced that it will invest $2.15 billion for the expansion of its iron ore mine in Brazil, boosting annual capacity of the mine from 2 million tonnes per annum to 12.8 million tonnes. The new production is expected to commence in the fourth quarter of 2010.

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