RIO applying the brakes on capex

The release of Rio Tinto’s capex guidance is a perfect illustration of why mining services companies are experiencing such a major downturn.

Up until October this year, RIO withdrew $800 million in exploration and evaluation spending, $50 million more than forecast.

The company is also looking at cutting capex by almost 50% in two years; on current guidance the calendar year will see US$14 billion in capex falling to US$11 billion in CY14 and then US$8 billion in CY15 – that is a 20% reduction year-on-year.

The company is also looking at stripping out copper assets that do not meet its criteria, which would mean four low-cost, long-life operations will remain, with two greenfields to be developed; this is expected to see $1.8 billion being delivered back to the company.

The company has so far delivered $2.3 billion in asset divestments and I would suspect this will continue as the company looks to remove legacy issues from the acquisitions of Coal and Allied, Riversdale and Alcan.

It the Alcan assets that I believe will the heaviest hit. Aluminium prices are at four year lows, demand is waning and the cost of doing business at the Alcan plants is far from ideal. I would expect Sam Walsh to continue to wind these plays back and that point was summaries in the statement as the company looks to reduce operating cost through the sale suspension or curtailment of non-core assets.

The Trade

This news will be a net positive to RIO; margins should expand, and with the company firmly aligned to its iron ore division, expectations are growing for a solid second half of CY13. However in the short term this may have already been built-in, having seen the share price jump 5% in three days.

My view is RIO needs to see these structural changes appearing on the fundamentals, so come February I would expect margins and net profit to have benefited from the iron price and the lower cost environment. Until then I suspect RIO will drift with the cyclical space, and any changes to China’s import numbers or a crackdown on funding will see RIO heading back to $60 mark, which is the 50% retracement level of the year-to-date high and year-to-date low.

I also notice RIO is bouncing off its top Bollinger band and has returned to the 20 day moving average. If the down trend momentum holds I suspect RIO will hit 63.68; the 61.8% retracement level.

Until I see a clear change in the investment trends, RIO is likely to hold in a trading band of $60 to $66.

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