Rio Tinto’s dividend bonanza
Cast your mind back to 2015, the bottom of the most recent resources bust. In November 2015, BHP (ASX: BHP) experienced the Samarco dam disaster in Brazil and iron ore prices had plummeted to US$39 per tonne, down from around US$190 per tonne in 2011.
BHP’s share price was below A$15 and Rio Tinto’s (ASX: RIO) share price was around A$32.
One of the main reasons iron ore prices had plummeted was that the big four iron ore miners – Rio, BHP, Vale (NYSE: VALE) and Fortescue (ASX: FMG) – had responded to the previous mining boom a decade ago by massively ramping up production.
From 2011 the big four iron ore miners increased production (on a 100% basis) from 703Mt to 1,065Mt, a rise of some 52%.
The cure for high prices…
But as they say in finance, the cure for high prices is high prices.
Once all this new supply came online without a corresponding increase in demand, prices plummeted.
Anyone who understands basic economics could have foreseen this, and many did.
While it didn’t include the people running the big iron ore miners, it did include former Glencore (LSE: GLEN) CEO Ivan Glasenberg, who not-to-subtly criticised BHP, Rio and Vale for their lack of foresight.
As he pointed out during the iron ore price rout in 2014-2015, demand (especially from China) hadn’t fallen. As such, the only cause of the bust could be, and was, the big four iron ore miners acting like fools and mindlessly adding more supply.
There’s a reason Glasenberg is a billionaire!
The cure for low prices…
Ultimately, however, the CEOs of the big miners eventually came to their senses, helped by iron ore plummeting to under US$40 per tonne at the end of 2015.
The cure for low prices…is low prices!
And so Rio in particular moved to a “value over volume” strategy.
In the five years since the iron ore price bottomed in 2015, the big four miners have increased their production by a much more respectable 5%.
Some might quibble that with this figure, arguing that it is understated due to Vale being forced to take production offline due to the Brumadinho mine disaster. However, even if we include this lost production of some 80Mt or so, the increase is only 13%.
Interesting things can happen in commodity markets if the market leaders act sensibly and manage supply, especially if there is a positive demand shock.
And this is precisely what has happened over the past year.
In response to the COVID-19 pandemic spread by the Chinese Communist Party, western governments led by the US have cranked up fiscal and monetary policy to stimulate their economies.
China is also stimulating and so demand for iron ore and many other commodities has increased.
And so here we are, with iron ore prices now above US$200 per tonne.
Rio has increased revenue by 71%, to US$33.1bn, in the six months to 30 Jun 21. Underlying EBITDA is up a cool 118%, to US$21bn and Aussie shareholders will receive a total half year dividend of A$7.60, comprising a A$5.09 interim dividend and $2.51 special dividend, both fully franked.
This compares very favourably to Rio’s share price of A$32 at the end of 2015!
Tough to make predictions
How long with it last?
As Yogi Berra said, “It’s tough to make predictions, especially about the future”.
So I have no idea where iron prices will be in 1 year, 2 years or 10 years.
Yet new mines don’t come online quickly – it often takes a decade or longer for newly-discovered deposits to become new mines.
As for iron ore, the Aussie miners don’t have any material increases in production planned in the medium term.
However, Vale is likely to get its act together and will probably be the biggest culprit in increasing production in coming years. It has a target capacity – which doesn’t necessarily equate to production – of 400Mt in 2022 and a “future target” of 450Mt. For comparison, Vale produced 300Mt in 2020.
And then there is the never-ending saga of the giant, high quality Simandou iron ore deposit in Guinea. Simandou has been talked about for at least six decades but it still hasn’t been developed.
Yet today’s iron ore prices provide every incentive to finally develop it.
China is particularly keen to develop Simandou to reduce its reliance on Aussie iron ore producers.
But it wont come cheap. A consortium planning to develop just 2 of the four blocks at Simandou estimates it will cost US14bn to ultimately produce between 60 and 80Mt per year.
Production is planned within 5 to 7 years.
I, however, am sceptical that production will occur this quickly given the complexity of the logistics involved, including a 650km railway that the government wants to carry other traffic and also a 2km wharf at the port to actually get the ore onto ships for export.
So for now at least, Rio and the other big iron ore miners are reaping the benefits of their value over volume strategies.
Whether this lasts – and how long it lasts – is anyone’s guess, though.