The Rio Tinto Alcan smelter in Kitimat, B.C.John Lehmann/The Globe and Mail
Rio Tinto has taken a bold step into aluminum rehab. The mining giant plans to sell off roughly a third of its business in the metal, most of which was acquired in a disastrously expensive merger with Canada's Alcan in July 2007. The timing of the purchase was undoubtedly terrible. Now is probably as good a time as ever to make some amends.
The price of aluminum halved within two years of Rio buying Alcan, and, unlike copper and iron ore, has not fully recovered. Aluminum is not in short supply. Also, producers without good long-term electricity contracts have to deal with a margin squeeze. Power prices are high and, economically, aluminum is more like condensed electricity than refined bauxite. Longer term, the metal's profit potential is limited by the ability of China, the biggest consumer and producer of aluminum, to use its abundant cheap energy to pursue self-sufficiency.
Rio has more attractive opportunities, most notably in iron ore. That business made up 68 per cent of Rio's earnings from 42 per cent of revenues in 2010. Aluminum looks like iron ore's evil twin: it provided 5 per cent of earnings from 27 per cent of revenues, and EBITDA margins overall are half the 40 per cent Rio has targeted.
Rio is not selling enough to change its profile. Assume it disposes of assets that would otherwise have provided a third of Rio's $21 billion of forecast aluminum revenues for 2012, based on Credit Suisse estimates, which assume a slightly higher aluminum price than today's. With an EBITDA margin of 20 per cent and rival Alcoa's 5.6 times multiple, Rio might take in $8 billion, 7 per cent of the current market capitalization.
Even that may be ambitious, since Rio is selling its costlier and dirtier plants, keeping those with captive and clean energy supply. Still, keeping its most competitive assets looks sensible, in case prices rise. And investors will welcome the nod towards financial discipline. Four years on, Alcan still looks like a mistake, but it is at least one that's getting smaller.
John Foley