BHP Billiton & Rio Tinto

Transcription

1 AUSTRALIA BHP s acquisitions and buybacks are more frequent in the good times and it s a similar story at RIO We have Outperform ratings on both BHP & RIO Stock CY2 CY4 CY6 CY8 CY1 CY12 Rating Price target Price BHP Outperform A$39/sh A$33.48 RIO Outperform A$76/sh A$.83 Prices as as 1/1/212 Source: Company data, Macquarie Research, October October 212 Buybacks Acquisitions/(divestments) Free cash flow (post capex and dividends) S&P GSCI Ind Metals (RHS) Buybacks Acquisitions/(divestments) Free cash flow (post capex and dividends) S&P GSCI Ind Metals (RHS) CY2 CY4 CY6 CY8 CY1 CY Buying high selling low Event We believe restrictive capital management policies are hurting the efficiency of BHP and RIO s spending plans. Specifically, we see onerous progressive dividends along with unwavering commitments to top tier credit ratings encouraging the diversified miners to become pro-cyclical investors (that is they acquire, invest and buyback shares at the top of the cycle as prices are high and sell assets or defer capex when prices are low at the cyclical bottom) Impact Counting the all-in cost of progression: Aside from growing accustomed to unsustainable dividend growth, investors are perhaps also overlooking the allin cost of these progressive dividends namely that the lack of financial flexibility they generate force BHP and RIO to buy high and sell low. At best this approach attracts a high opportunity cost from an inefficient allocation of capital and at worst, it simply destroys value. Despite both BHP and RIO having published capital management plans stating the opposite, recent evidence suggests the diversified miners investments are in fact made from residual cash flow after paying dividends and preserving credit ratings. Indeed, we note while commodity price softness is hitting current cash generation and therefore investment capacity, credit ratings and dividends have been maintained while capex plans are being curtailed. Progressive dividends at odds with cyclical earnings: With rising commodity prices, both BHP and RIO have established enviable track records of consistent dividend growth. However the legacy of these progressive dividends is a more onerous dividend obligation going forwards just as commodity prices (and therefore cash flow) fall, which limits funding flexibility. Credit metrics impair financial flexibility in a downturn: With S&P tracking the ratio of operating cash flow to debt, the diversified miners witness a swift deterioration in credit metrics as falling commodity prices hit cash flow. As a result, servicing the progressive dividend gets harder both from a cash flow, but also from a balance sheet perspective as the cycle turns. So what s the alternative? We appreciate the credibility that strong credit ratings and reliable dividends provide in uncertain times and do not expect management to soften their resolve on either front. That said, a target payout ratio rather than progressive dividend could perhaps provide both flexibility and transparency while also being better suited to more cyclical earnings. Ultimately, in such a cyclical industry there is also perhaps an argument for running more lazy balance sheets in order to better weather the peaks and troughs of the inevitable price cycles (just as many of the largest oil and gas companies do). This more conservative funding approach would better position the diversified miners to truly invest through the cycle which would ultimately improve shareholder returns. The issue here however is that it means management sits on surplus funds which would require investors to show faith in management s capital discipline rather than pressing for buybacks at the first sign of excess cash (challenging given their history of peak cycle acquisitions). Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website

2 Buying high selling low Despite BHP and RIO having the largest capital budgets in the Australian market, it increasingly appears that prescriptive capital management policies are impacting the efficiency of these investments. Specifically we believe onerous progressive dividend obligations along with unwavering commitments to top tier credit ratings are encouraging the diversified miners to become increasingly pro-cyclical investors in what is already one of the most cyclical of industries. We believe this tendency to invest at the top of the cycle and sell at the bottom is diluting the purchasing power of investment dollars, reducing ROIC metrics, and ultimately destroying value. Progressive dividends at odds with cyclical earnings streams Against the backdrop of rising commodity prices witnessed over much of the last decade, both BHP and RIO have established enviable track records of consistent dividend growth, courtesy of their respective progressive dividend policies: Since the merger in 21, BHP has grown its dividend per share by a compound annual rate of 24%, which is broadly in line with underlying EPS growth of 23%. This has nevertheless seen the payout ratio rise from 32% in 22 to an expected 4% in FY13 (or 6% at spot commodity prices which would be a new record for the merged entity). Meanwhile at RIO, dividends were cut during the financial crisis meaning the growth rate has been lower at 9% and significantly below underlying earnings per share growth of 21%. This leaves RIO with a more manageable dividend payout ratio which we expect at ~3% in CY13 (however this also rises to a more significant 46% under spot commodity prices). The legacy of both companies unwavering commitment to progressive dividend policies is a more onerous dividend obligation going forwards just as commodity prices (and therefore cash flow) fall. What s more, faced with such macroeconomic uncertainty, investors are perhaps increasingly looking to the dividend as a sign of management confidence in the earnings outlook which could make it harder to tinker with the dividend policy during tough times. Fig 1: At 4%, BHP s expected 213 payout ratio is the highest its been for the merged entity Fig 2: RIO s progressive dividend has grown more slowly however its payout ratio is also creeping up USc ps DPS EPS Payout ratio (RHS) 7% 6% % USc ps DPS EPS Payout ratio (RHS) 7% 6% % 2 4% 4% 2 3% 4 3% 1 1 2% 1% % 1% CY CY CY1 CY1 % CY CY CY1 CY1 % Source: Company data, Macquarie Research, October 212 Source: Company data, Macquarie Research, October 212 Although expected to rise this year, with BHP and RIO s current payout ratios lower than they were 1 years ago, we are not suggesting these progressive dividend policies are at risk or that dividend cuts are likely any time soon. That said, with cash flow under pressure from falling commodity prices and with both companies guiding to their second highest capex budgets on record over coming months, we nevertheless expect the rate of dividend growth to slow significantly from here. If BHP maintains its historic average of 24% growth in dividends per share over the past 1 years, it could be paying out over 2% of earnings by the end of the decade. Meanwhile, RIO s slower rate of dividend growth would also see it comfortably paying out all of its earnings by 22. Indeed, even if the annual growth in BHP s dividend falls to only %, it would still be paying out ~6% of earnings by 22 which looks high for a cyclical company in the context of the local market s long-term historic payout ratio of 47%. 1 October 212 2

3 Macquarie Private Wealth What s more, should commodity prices reside at current levels for the next 12 months, even after its recent divestments we see a cash flow shortfall of U$.8bn at BHP while at RIO the deficit is U$6.1bn pointing to limited ability to significantly hike dividends in the near term. Fig 3: At BHP, current rates of dividend progression point to a ~2% payout ratio by 22 Fig 4: RIO s historic rate of dividend growth also looks unsustainable 2% % growth in dividend Flat dividend Historic growth rates continue 2% % growth in dividend Flat dividend Historic growth rates continue 1% 1% 1% 1% % % % CY2 CY4 CY6 CY8 CY1 CY12 CY14 CY16 CY18 % CY2 CY4 CY6 CY8 CY1 CY12 CY14 CY16 CY18 Source: Company data, Macquarie Research, October 212 Source: Company data, Macquarie Research, October 212 Credit metrics impair financial flexibility in a downturn With S&P essentially tracking the ratio of operating cash flow to debt, the diversified miners witness a swift deterioration in credit metrics as falling commodity prices hit cash flow which essentially impairs the ability to drawdown debt just as it is most needed. As a result, servicing the progressive dividend gets harder both from a cash flow, but also from a balance sheet perspective as the cycle turns. This lack of free cash flow curtails capex plans while encouraging divestments at the bottom of the cycle just as these companies should be investing and considering acquisitions. This lack of financial flexibility can be seen in Figs & 6 which show both BHP and RIO have little funding wiggle room if they are to hold on to their prized credit ratings with S&P (A+ for BHP and A- for RIO). Indeed under S&P commodity price assumptions and our production forecasts, both companies would already appear to be in breach of their current rating criteria over coming years highlighting the need either for a bounce in commodity prices or alternatively a further reduction in capex. Failing this, management is likely to take a more aggressive look at possible divestments. Fig : Under S&P s conservative commodity price assumptions, BHP already appears to be slightly in breach of it s A+ credit rating metrics but could increase debt capacity by dropping down to single A Fig 6: RIO also looks close to its credit rating limits however already being A-, it is unlikely to allow any significant deterioration in credit metrics from here 2. FFO/TD Macq base case S&P assumptions 2% FFO/TD Macq base case S&P assumptions 2 Spot prices required FFO/TD 2% Spot prices required FFO/TD 1. 1% 1 1%. A+ A % A- % Source: Macquarie Research, October 212 Source: Macquarie Research, October October 212 3

4 Counting the all-in cost of progression Aside from the market possibly growing accustomed to an unsustainable rate of dividend growth from the diversified miners, investors are perhaps also overlooking the true cost of these progressive dividend payments namely that they encourage BHP and RIO to adopt pro-cyclical investment strategies. At best we think this approach attracts a high opportunity cost from an inefficient allocation of capital and at worst, it simply destroys value. Although both BHP and RIO have stated capital management policies that put investment opportunities ahead of credit ratings and dividends, we note that the evidence over recent years perhaps suggests otherwise. Indeed, Figs 7 & 8 suggest both companies recent investments (including capex, exploration, acquisitions and share buybacks) appear to be made largely from residual cash flow after paying the dividend and maintaining sufficient balance sheet strength to preserve the credit rating (rather than vice versa). With the residual cash flow that drives investments being highest during periods of peak commodity prices, the investment outcomes for the diversified miners necessarily become pro-cyclical. Despite management assertions to the contrary, management s actions further support this view of pro-cyclical investing. For example despite BHP and RIO both recently reiterating bullish longer-term outlooks for the commodity markets, both also concede that medium-term price softness will hit cash generation which in turn limits investment capacity. As a result, while credit ratings and progressive dividends have been maintained, investment plans are being curtailed with both growth and sustaining capex budgets being cut. Fig 7: While credit ratings and dividends have been maintained through the cycle, BHP s acquisitions and buybacks are more frequent in the good times Fig 8: and it s a similar story at RIO where the Alcan deal appears particularly poorly timed which then forced ensuing divestments at the bottom of the cycle Buybacks Acquisitions/(divestments) Free cash flow (post capex and dividends) S&P GSCI Ind Metals (RHS) Buybacks Acquisitions/(divestments) Free cash flow (post capex and dividends) S&P GSCI Ind Metals (RHS) CY2 CY4 CY6 CY8 CY1 CY CY2 CY4 CY6 CY8 CY1 CY12 1 Source: Company data, Macquarie Research, October 212 Source: Company data, Macquarie Research, October 212 The net result of these pro-cyclical investments is that In the good times when commodity prices are high, there is simply more residual cash to invest. It is typically at these times when capex budgets rise across the sector (which drives cost inflation) while management also appear to chase acquisitions most aggressively just as asset prices are arguably elevated (such as Alcan and Petrohawk) and even consider buybacks just as their own share price is often peaking (if BHP conducted its 211 buyback programme at today s prices, it could have saved ~US$2.bn). Conversely, when commodity prices fall, capex budget are cut just as labour costs are typically falling (we note that at the first sign of commodity price weakness both BHP and RIO have flagged no near-term project sanctions), divestments are relied upon to bolster the balance sheet just as there are few interested buyers and prices are typically low (such as the diamonds, aluminium, nickel assets currently flagged for divestment) and buybacks dry up during periods of share price weakness. 1 October 212 4

5 Fig 9: If BHP conducted its 211 buyback programme today, it could have saved ~US$2.bn Fig 1: meanwhile RIO s 211 buyback looks similarly off-side 4 A$ps 12 1 A$ps Buybacks (RHS) Share price Buybacks Share price CY2 CY4 CY6 CY8 CY1 CY12 CY2 CY4 CY6 CY8 CY1 CY12 Source: Company data, Macquarie Research, October 212 Source: Company data, Macquarie Research, October 212 So what s the alternative? We appreciate the operational credibility that a strong credit rating provides in these uncertain times and do not expect management to soften their resolve for a strong balance sheet. What s more, it could be argued the commitment to a progressive dividend also takes on added meaning in a downturn, being seen as management s vote of confidence in the longer term outlook. That said, due to the ensuing pro-cyclical investment strategies that these capital management policies encourage, we are not convinced progressive dividend policies are necessarily in shareholder s best interests throughout the cycle. While there are also issues with many of the alternatives, we nevertheless believe a dividend policy governed by a targeted payout ratio could perhaps provide the necessary transparency and flexibility while also being better suited to the cyclical earnings streams of the diversified miners. What s more, as RIO s experience during the financial crisis demonstrates, although apparently held above all else in the good times, the current progressive dividends are only safe until they are not (although we note that BHP has cut its dividend only once in over 1 years). A dividend determined by a payout ratio would allow management to pay more in the good times at the cost of greater dividend volatility in the future. However, with yields as low as they are (3.3% for BHP and 3% for RIO) the diversified miners progressive dividend streams do little to protect investors from the inherent cyclicality of these businesses. Indeed, it is arguably exactly this exposure to the underlying commodity price cycle that investors are looking for when holding BHP and RIO. Ultimately, in such a cyclical industry there is perhaps an argument for running a more lazy balance sheet in order to better weather the peaks and troughs of the inevitable price cycles. Certainly this is a policy frequently witnessed among the global oil and gas majors where we note Exxon s net cash balance has averaged U$8bn over the last seven years while Chevron has averaged net cash of U$2.2bn over this period (this compares to BHP with average net debt of U$11.2bn and RIO at U$2.3bn). What s more, we note that the argument that BHP and RIO can survive with more aggressive funding positions due to their more diversified businesses across a larger suit of commodities is not borne out by the relative volatilities of underlying earnings data. This more conservative funding approach would better position the diversified miners to truly invest through the cycle which should ultimately improve shareholder returns, in our view. The issue here is that such an approach requires investors to show faith in management s capital discipline rather than pressing for buybacks at the first sign of excess cash (challenging given their history of peak cycle acquisitions). 1 October 212

6 Much of the evidence suggests that within each division, the diversified miners spend more and buy more at the top of the cycle Fig 11: BHP - Aluminium Fig 12: RIO - Aluminium Aluminium capex Aluminium price (RHS) USc/lb CY2 CY4 CY6 CY8 CY1 CY , 1, 8, 6, 4, 2, -2, -4, USc/lb CY2 CY4 CY6 CY8 CY1 CY12 Aluminium capex Aluminium price (RHS) Fig 13: BHP - Copper Fig 14: RIO - Copper 4, 3, 3, 2, 2, 1, 1, - USc/lb Copper capex Copper price (RHS) CY2 CY4 CY6 CY8 CY1 CY ,, 4, 3, 2, 1, Copper capex Copper price (RHS) USc/lb CY2 CY4 CY6 CY8 CY1 CY , -1, Fig 1: BHP Iron ore Fig 16: RIO Iron ore Iron ore capex Iron ore price US$/t 62% Fe (fob) Iron ore capex Iron ore price US$/t 62% Fe (fob) CY CY2 CY4 CY6 CY8 CY1 CY12-1 CY CY2 CY4 CY6 CY8 CY1 CY12 Source: Company data, Macquarie Research, October 212 Source: Company data, Macquarie Research, October October 212 6

7 How are the companies reacting to the current downturn? Fig 17: Over the past 6 years, BHP has spent ~U$14bn of which over 3% has been returned to shareholders. Meanwhile RIO has spent less at ~U$1bn but has also returned less to shareholders having acquired more aggressively over the period BHP Billiton Rio Tinto Investments over the past 6 years % % Dividends 27,41 19% 11,323 11% Buybacks 18,929 13% 8,611 9% Capex 69,3 48% 37,768 38% Acquisitions/(divestments) 18,3 13% 36,63 37% Exploration 9,37 7%,244 % Total spent 143,27 1% 99,9 1% Source: Company data, Macquarie Research, October 212 BHP investing through the cycle (but apparently more in the good times) While BHP s more diversified earnings streams are arguably better suited to servicing a progressive dividend, management nevertheless concede that investment budgets necessarily reflect the capital available. By extension therefore, the commitment to a progressive dividend would appear to increase capex volatility and make investments increasingly pro-cyclical. BHP argue that divestments, cost reductions and debt draw downs can be used to reduce this inevitable capex volatility and investment pro-cyclicality. Here we note BHP s stated commitment to a Stable A rating appears to mean either A+ or A. As a result, BHP could let its current rating drop a notch which we estimate would release an additional ~U$4.bn of debt capacity which would go along way to covering this year s apparent cash flow shortfall. With less cash available in a downturn, management has stressed that there will be no major project sanctions this year as these long term investments (which will produce over many cycles) are nevertheless influenced by the current point in the commodity price cycle (perhaps suggesting that management s and investor s investment horizons are not as vastly different as is sometimes suggested). RIO investing within dividend and balance sheet boundary conditions At its recent investor seminar, RIO again reiterated its commitment to both to its A credit rating (RIO is currently 'A-' with S&P) and also its progressive dividend, and as a result acknowledged that investments are necessarily becoming increasingly pro-cyclical as commodity prices fall. Indeed, under S&P metrics, we see limited funding wiggle room by 214, meaning that with iron ore remaining the priority, capital is being restricted to several divisions (including Aluminium, Diamonds and Titanium Dioxide). What s more, in terms of divestments, RIO could raise between U$1-3bn from the planned sales of Pacific Aluminium (rather than an in-specie distribution), and additional funds from the sale of its stake in Palabora and the Diamonds division. Apparently supporting this view, management suggested that RIO began running into capital constraints back in 4Q11 and is consequently trimming capital budgets accordingly. In part this appears to be driven by a deferral of the mine spend associated with the 33mtpa expansion in the Pilbara (which presumably will still be needed, but is now more likely to occur in a subsequent higher commodity price, higher cost environment in the future). Similarly, another target for cost reductions is sustaining capital which ultimately is non-discretionary, meaning any current capex savings may end up being significantly more expensive in the future. Like BHP, RIO also recognises some of the labour cost pressures are showing signs of abating yet is not willing to capitalise on this as instead is also deferring any near-term project sanctions. Indeed, RIO sees the industry s pro-cyclical investments as ultimately playing into its hands as it slows the supply response which ultimately could support prices when demand returns. 1 October 212 7

8 BHP Billiton Summary BHP Billiton Share price: A$ Target price: A$ Profit & Loss 21A 211A 212E 213E 214E Divisional EBIT 21A 211A 212E 213E 214E Turnover 2,798 71,739 72,226 7,9 77,46 Petroleum 4,73 6,33 6,348 4,63 6,611 Consolidated revenue 2,798 71,739 72,226 7,9 77,46 Aluminium Operating Costs 28,813 3,177 39,386 42,693 4,11 Base Metals 4,632 6,79 3,96,1 4,949 EBITDA 23,98 36,62 32,84 27,816 32,44 Carbon steel materials 8,766 16,69 16,6 11,387 12,917 - Depreciation & amortisation 4,794,113 6,8 7,19 7,14 Iron ore 6,1 13,328 14,21 1,17 1,84 + Share of JCE profit Manganese Other income Met coal 2,3 2,67 1, ,611 EBIT 19,719 31,98 27,238 21,36 2,74 Diamonds & Specials Net interest payable ,694 2,274 Energy Coal 73 1,129 1,227 1,47 1,18 + Exceptionals ,486 Stainless Steel Materials Pre-tax profit 19,72 31,2 23,22 19,666 23,471 G & A (plus other income) Tax expense 6,63 7,39 7,49 7,6 8,666 Underlying EBIT 19,719 31,98 27,238 21,36 2,74 - Minorities Reported Net Profit 12,722 23,648 1,417 11,923 14,68 Production 21A 211A 212E 213E 214E - Exceptional items (post tax) 23 1,964-1,7 Aluminium kt 1,241 1,246 1,13 1,2 1,282 Adjusted Net Profit 12,469 21,684 17,117 11,923 14,68 Alumina kt 3,841 4,1 4,12 4,776,28 Profit growth % 16.3% 73.9% -21.1% -3.3% 22.2% Copper kt 1,7 1,139 1,94 1,246 1,334 Effective tax rate % 31% 32% 34% 3% 3% Nickel kt Iron Ore (incl. Samarco pellets) mt EPS adjusted US ps Coking Coal mt EPS growth (adjusted) % 16% 7% -18% -3% 22% Thermal Coal mt DPS US ps Oil & Gas mboe Diamonds mct Underlying EBITDA 24,13 37,93 33,746 28,2 33,29 Uranium t 2,279 4,4 3,88 4,144 4,16 Underlying EBIT 19,719 31,98 27,238 21,36 2,74 Key Assumptions 21A 211A 212E 213E 214E Cash Flow 21A 211A 212E 213E 214E AUD/USD exchange rate A$/US$ Net cashflow from operations 23,276 38,62 34,876 29,686 34,11 Aluminium US /lb Dividends from JV & Associates Copper US /lb Net interest ,96-2,474 Nickel US /lb Tax paid -4,9-6,8-8,327 -,87-8,38 Fine iron ore US /mtu Operating Cashflow 17,92 31,61 2,986 22,134 23,98 Lump iron ore US /mtu Asset sales / (purchases) -39 -,8-12,81 2,11 Coking coal US$/t Capital expenditure -9,323-11,147-18,38-19,27-16,68 Thermal coal US$/t Exploration & other -1,333-1,24-2,42-2, -2, WTI oil US$/t Investing Cash Flow -11,1-17,44-33,638-19,417-19,18 Uranium (received) US$/t Dividends paid -4,618 -,4 -,877-6,173-6,99 Debt drawdown / (repayment) ,827 3, Equity financing & other -24-1, Financing Cash Flow -,37-16,18 2,9-6,173-3,99 Cash Flow Pre-Funding 2,287 8,62-13,29-3,47-2,68 Net Cash Flow 1,98-2,42 -,143-3, Free Cash Flow 6,9 13,616-7,62 2,716 3,94 Balance Sheet 21A 211A 212E 213E 214E Cash 12,46 1,84 4,781 1,324 1,666 Current assets 12,678 1,196 1,67 1,67 1,67 Fixed assets,76 68,468 9,247 16, ,73 Other assets 8,142 9,143 13,7 13,7 13,7 Total assets 88,82 12, , , ,646 Current liabilities 13,42 19,733 22,34 22,34 22,34 Total liabilities 39,23 4,136 62,188 63,948 66,841 Minority interests ,21 1,21 1,21 Shareholder equity 48,2 6,762 6,87 71,62 79,9 Total debt 1,764 1,97 28,33 28,326 31,324 Net debt 3,38,823 23,49 27,2 29,68 Working capital 12,92,47-1,83 -,4-4,698 Average diluted shares m,6,16,322,322,322 Ratio analysis 21A 211A 212E 213E 214E Net Debt / Equity % 7% 1% 3% 37% 37% Net Debt / (Net debt + Equity) % 6% 9% 26% 27% 27% EBIT Net Interest Cover x Net interest cover x Payout Ratio % 39% 26% 3% 4% 47% Diamonds & Specialty Energy Products Coal 2% 6% % EBITDA Margin % 4% 1% 4% 39% 42% -2% Underlying EBITDA Margin % 46% 2% 47% 4% 43% 211A 212E EBIT Margin % 37% 4% 38% 3% 33% EV/EBITDA (fixed debt) x % Nominal $USm $US/sh $A/sh /sh EV/EBITDA (prospective) x Petroleum 9, Aluminium, GCFPS US ps Base Metals 32, PGCFPS x Iron ore 76, FCF Yield % 3.9% 7.8% -4.4% 1.6% 2.3% Metcoal 12, ROE (NPAT / Equity) % 26% 38% 26% 17% 18% Manganese 1, ROCE (EBIT / Debt + Equity) % 3% 43% 29% 21% 23% Diamonds & Specialty Products 3, EVM x Energy Coal 11, Stainless Steel Materials 4, PE x Group & Unallocated -3, Adjusted AUD PE x Net Debt (incl Assoc Net Debt) -2, Adjusted GBP PE x BHP Billiton NPV 182, Dividend yield AUD % 2.9% 3.1% 3.3% 3.4% 3.7% BHP Billiton NPV (spot fx conversion) Dividend yield GBP % 3.% 3.3% 3.7% 3.8% 4.% Premium/(Discount) to NPV (@ long run AUD:USD): -2.% -7.2% Franking % 1% 1% 1% 1% 1% Market Capitalisation ($USm): 174,92 4, 3, 2, 1, Manganes e 1% Metcoal 6% Iron ore 37% Underlying EBITDA ROCE (EBIT / Debt + Equity) 21A 211A 212E 213E 214E NPV Breakdown Stainless Steel Materials 2% Petroleum 29% % 4% 4% 3% 3% 2% 2% 1% 1% % % Aluminium 2% Base Metals 1% A 211A 212E 213E 214E Met coal Iron ore Energy Coal Base Metals Petroleum 1% 8% 6% 4% 2% PE x PGCFPS x EBIT Contribution () Manganese Stainless Steel Materials Diamonds & Specials Aluminium Prices as at 1 October, 9:pm AEST Source: BHP Billiton, IRESSS, Macquarie Research, October October 212 8

9 Rio Tinto Summary Rio Tinto Share price: A$ Target price: A$ Profit & Loss 21A 211A 212E 213E 214E Divisional EBITDA 21A 211A 212E 213E 214E Gross sales revenue 6,323 6,678 6,48 64,342 67,7 Iron Ore 16,6 2,93 14,2 14,13 13,162 Consolidated revenue 6,76 6,37 1,36 8,64 6,99 Energy 2,374 2,232 1,24 1,4 1,728 - Operating Costs 33,274 33,84 3,969 4,866 43,12 Diamonds & Minerals ,841 2,722 2,639 EBITDA 23,32 26,733 1,66 17,77 17,87 Aluminium 2,418 1, ,33 1,931 - Depreciation & amortisation 3,437 3,817 4,293 4,3 4,81 Copper 4,3 3,394 1,67 3,483 4,223 Share of JCE NPAT 1, ,224 1,63 1,913 Other operations EBIT 21,128 23,62 12,498 14,874 14,973 Intersegmental adj Net interest payable ,26 Sub-total 26,62 29,491 19,22 22,88 23,632 - Amortisation of discount Other items ,133-1,22 Pre-tax profit pre-exceptionals 2,219 22,88 11,931 13,923 13,6 Exploration & other Exceptional charges 261-9, Underlying EBITDA 2,978 28,21 18,121 2,943 21,472 - Tax expense,296 6,439 2,143 4,2 4,1 - Minorities Production 21A 211A 212E 213E 214E Reported Net Profit 14,324,826 9,16 9,291 9,86 Aluminium kt 3,79 3,826 3,36 3,786 3,9 - Exceptional items (post tax) 337-9, Alumina mt Macquarie Adjusted Profit 13,987 1,49 8,434 9,291 9,86 Borates kt Adjusted Net Profit 13,987 1,49 8,434 9,291 9,86 Coking coal mt Profit growth % 17.9% 11.2% -4.8% 1.2% -2.2% Other Coal (Australia) mt Effective tax rate % 3% 31% 3% 37% 37% Copper kt Diamonds mct EPS adjusted US ps Gold koz EPS growth (adjusted) % 111% 13% -43% 1% -2% Iron Ore mt DPS US ps Titanium feedstock kt 1,392 1,442 1,94 1,8 1,8 Underlying EBITDA 2,978 28,21 18,118 2,943 21,472 Key Assumptions 21A 211A 212E 213E 214E AUD/USD exchange rate A$/US$ Cash Flow 21A 211A 212E 213E 214E Aluminium US /lb Net cashflow from operations 22,126 26,89 1,283 19,77 19,72 Copper US /lb Dividends from JV & Associates 1, ,18 2,216 2,8 Gold US$/oz Net interest ,26 Lump iron ore US /mtu Minority dividends paid Fine iron ore US /mtu Tax paid -4,1-6,197-4,49-3,63-4,92 Coking coal US$/t Operating Cashflow 18,277 2,3 11,76 17,37 16,76 Thermal Coal US$/t Asset sales / (purchases) 2,97 -,7-716 Capital expenditure -4,3-12,298-16,974-18,998-12,736 Exploration & other ,111-1,982-1,882 Investing Cash Flow -1,711-18,81-19,81-2,98-14,618 Dividends paid -1,74-2,236-3,17-2,833-3, Debt drawdown / (repayment) -9,36 4,28,44, Equity financing & other 4-3,421 Financing Cash Flow -1,61-1,449 2,492 2,167-3, Cash Flow Pre-Funding 14,812-1,21-11,741-6, Net Cash Flow, ,232-1, Free Cash Flow 16,66 1,21-8,72-3,66 2,138 Balance Sheet 21A 211A 212E 213E 214E Cash 9,948 9,67 3,63 2,19 1,333 Current assets 13,217 12,316 12,236 12,236 12,236 Fixed assets 6,24 64,967 79,62 93,61 1,677 Other assets 33,213 32,92 32,222 32,1 31,744 Total assets 112,42 119,4 127,1 139,97 14,989 Current liabilities 13,62 14,999 12,972 13,34 13,742 Total liabilities 47,128 6,337 9,71 6,828 66,28 Minority interests 6,941 6,669 9,892 9,892 9,892 Shareholder equity 6,274 9,28 67,44 73,769 79,781 Total debt 14,341 21,84 24,178 29,178 29,178 Net debt 4,621 12,134 2,43 26,983 27, Average diluted shares m 1,972 1,936 1,82 1,82 1,82 Ratio Analysis 21A 211A 212E 213E 214E Net Debt / Equity % 7% 2% 3% 37% 3% Net Debt / (Net debt + Equity) % 7% 17% 23% 27% 26% EBIT Net Interest Cover x Net interest cover x Payout Ratio % 1% 18% 33% 31% 34% EBITDA Margin % 41% 44% 3% 3% 29% 9.33% Nominal $USm $US/sh $A/sh /sh Underlying EBITDA Margin % 43% 43% 32% 33% 32% Iron Ore 81, EBIT Margin % 39% 4% 26% 27% 26% Energy 1, EV/EBITDA (fixed debt) x Copper 27, EV/EBITDA (prospective) x Industrial Minerals 8, GCFPS US ps 927 1, Aluminium 13, PGCFPS x Diamonds Other Operations & Investment 2, ROE (NPAT / Equity) % 27% 28% 1% 1% 14% Net Debt -13, ROCE (EBIT / Debt + Equity) % 31% 33% 3% 3% 29% RIO TINTO NPV 136, RIO TINTO NPV (spot fx conversion) PE x Premium/(Discount) to NPV (@ long run AUD:USD): -37.9% -32.3% Adjusted AUD PE x Market Capitalisation ($USm): 96,826 Adjusted GBP PE x Dividend yield % 2.1% 2.9% 3.% 3.1% 3.3% Franking % 1% 1% 73% 1% 1% 3, 2, 2, 1, 1,, Energy 1.4% Underlying EBITDA ROCE (EBIT / Debt + Equity) NPV Breakdown Aluminium 9.% Diamonds.% Industrial Minerals.6% Copper 18.6% Iron Ore.4% 3% 34% 33% 32% 31% 3% 29% 28% 27% 26% PGCFPS x PE x. 21A 211A 212E 213E 214E 3, 3, 2, 2, 1, 1,, -, Divisional EBITDA contribution () 21A 211A 212E 213E 214E Prices as at 1 October, 9:pm AEST Source: Rio Tinto, IRESSS, Macquarie Research, October October 212 9

10 Important disclosures: Recommendation definitions Macquarie - Australia/New Zealand Outperform return >3% in excess of benchmark return Neutral return within 3% of benchmark return Underperform return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield Macquarie Asia/Europe Outperform expected return >+1% Neutral expected return from -1% to +1% Underperform expected return <-1% Macquarie First South - South Africa Outperform expected return >+1% Neutral expected return from -1% to +1% Underperform expected return <-1% Macquarie - Canada Outperform return >% in excess of benchmark return Neutral return within % of benchmark return Underperform return >% below benchmark return Macquarie - USA Outperform (Buy) return >% in excess of Russell 3 index return Neutral (Hold) return within % of Russell 3 index return Underperform (Sell) return >% below Russell 3 index return Volatility index definition* This is calculated from the volatility of historical price movements. Very high highest risk Stock should be expected to move up or down 6 1% in a year investors should be aware this stock is highly speculative. High stock should be expected to move up or down at least 4 6% in a year investors should be aware this stock could be speculative. Medium stock should be expected to move up or down at least 3 4% in a year. Low medium stock should be expected to move up or down at least 2 3% in a year. Low stock should be expected to move up or down at least 1 2% in a year. * Applicable to Australian/NZ/Canada stocks only Recommendations 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations Financial definitions All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards). Recommendation proportions For quarter ending 3 Sept 212 AU/NZ Asia RSA USA CA EUR Outperform.% 6.8% 61.4% 41.38% 63.19% 44.1% (for US coverage by MCUSA, 7.3% of stocks covered are investment banking clients) Neutral 36.62% 2.14% 27.69% 2.13% 3.77% 3.7% (for US coverage by MCUSA, 9.31% of stocks covered are investment banking clients) Underperform 13.38% 18.2% 1.77% 6.49% 6.4% 2.28% (for US coverage by MCUSA,.% of stocks covered are investment banking clients) Company Specific Disclosures: Macquarie Bank Limited makes a market in the securities in respect of BHP Billiton Limited. The Macquarie Group advised Leighton Holdings on the sale of HWE Mining Iron Ore to BHP Billiton as announced on 9 August 211. Within the last 12 months, Macquarie Group has received compensation for investment advisory services from Leighton Holdings. Macquarie and its affiliates collectively and beneficially own or control 1% or more of any class of BHP Billiton Limited's equity securities. The analyst and/or associated parties own or have other interests in securities issued by BHP. Macquarie Bank Limited makes a market in the securities in respect of BHP Limited. The Macquarie Group is acting as adviser to Rio Tinto Plc in relation to the proposed acquisition of Rio Tinto Plc by BHP Billiton Plc as announced on 8 November 27. The analyst and/or associated parties own or have other interests in securities issued by BHP. Macquarie Bank Limited makes a market in the securities in respect of Rio Tinto Limited. Macquarie and its affiliates collectively and beneficially own or control 1% or more of any class of Rio Tinto Limited's equity securities. The analyst and/or associated parties own or have other interests in securities issued by Rio Tinto Limited. The Macquarie Group acted as financial advisor to RIO on a recommended off-market takeover bid of Riversdale Mining Ltd as announced on 23 December 21. Within the last 12 months, Macquarie Group has received compensation for investment advisory services from Rio Tinto Limited. The Macquarie Group acted as financial advisor to Rio Tinto Limited and Mitsubishi Development Pty Ltd in relation to the potential acquisition proposal made to Coal & Allied Industries Limited as announced on 8 August 211. Within the last 12 months, Macquarie Group has received compensation for investment advisory services from Rio Tinto Limited. The Macquarie Group will or expect to receive compensation for investment advisory services from Rio Tinto Limited and Mitsubishi Development Pty Ltd. The Macquarie Group acted as Sole Financial Adviser to Rio Tinto, Mitsubishi Development and Hunter Valley Resources in a Scheme of Arrangment to acquire all of the shares in Coal & Allied Industries Limited which they do not already own as announced on 26 August 211. Within the last 12 months, Macquarie Group has received compensation for investment advisory services from Rio Tinto Limited. The Macquarie Group will or expect to receive compensation for investment advisory services from Rio Tinto Limited, Mitsubishi Development Pty Ltd and Hunter Valley Resources. The Macquarie Group acted as Joint Global Coordinator in relation to the Rights Issues by Rio Tinto PLC and Rio Tinto Limited as announced June 29. The Macquarie Group acted as Advisor to Rio Tinto Ltd. and Rio Tinto PLC in relation to its strategic partnership with Chinalco as announced 12 February 29. The Macquarie Group is acting as adviser to Rio Tinto Plc in relation to the proposed acquisition of Rio Tinto Plc by BHP Billiton Plc as announced on 8 November 27. Macquarie Bank Limited makes a market in the securities in respect of Rio Tinto Limited. Macquarie Bank Limited makes a market in the securities in respect of BHP Limited. On the front page of research:the Macquarie Group is acting as adviser to Rio Tinto Plc in relation to the proposed acquisition of Rio Tinto Plc by BHP Billiton Plc as announced on 8 November 27. Important disclosure information regarding the subject companies covered in this report is available at Analyst Certification: The views expressed in this research reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research. The analyst principally responsible for the preparation of this research receives compensation based on overall revenues of Macquarie Group Ltd (ABN , AFSL No ) ( MGL ) and its related entities (the Macquarie Group ) and has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. General Disclosure: This research has been issued by Macquarie Securities (Australia) Limited (ABN , AFSL No ) a Participant of the Australian Securities Exchange (ASX) and Chi-X Australia Pty Limited. This research is distributed in Australia by Macquarie Equities Limited (ABN , AFSL No. 2374) ("MEL"), a Participant of the ASX, and in New Zealand by Macquarie Equities New Zealand Limited ( MENZ ) an NZX Firm. Macquarie Private Wealth s services in New Zealand are provided by MENZ. Macquarie Bank Limited (ABN , AFSL No. 2372) ( MBL ) is a company incorporated in Australia and authorised under the Banking Act 199 (Australia) to conduct banking business in Australia. None of MBL, MGL or MENZ is registered as a bank in New Zealand by the Reserve Bank of New Zealand under the Reserve Bank of New Zealand Act Any MGL subsidiary noted in this research, apart from MBL, is not an authorised deposit-taking institution for the purposes of the Banking Act 199 (Australia) and that subsidiary s obligations do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of that subsidiary, unless noted otherwise. This research is general advice and does not take account of your objectives, financial situation or needs. Before acting on this general advice, you should consider the appropriateness of the advice having regard to your situation. We recommend you obtain financial, legal and taxation advice before making any financial investment decision. This research has been prepared for the use of the clients of the Macquarie Group and must not be copied, either in whole or in part, or distributed to any other person. If you are not the intended recipient, you must not use or disclose this research in any way. If you received it in error, please tell us immediately by return and delete the document. We do not guarantee the integrity of any s or attached files and are not responsible for any changes made to them by any other person. Nothing in this research shall be construed as a solicitation to buy or sell any security or product, or to engage in or refrain from engaging in any transaction. This research is based on information obtained from sources believed to be reliable, but the Macquarie Group does not make any representation or warranty that it is accurate, complete or up to date. We accept no obligation to correct or update the information or opinions in it. Opinions expressed are subject to change without notice. The Macquarie 1 October 212 1

11 Group accepts no liability whatsoever for any direct, indirect, consequential or other loss arising from any use of this research and/or further communication in relation to this research. The Macquarie Group produces a variety of research products, recommendations contained in one type of research product may differ from recommendations contained in other types of research. The Macquarie Group has established and implemented a conflicts policy at group level, which may be revised and updated from time to time, pursuant to regulatory requirements; which sets out how we must seek to identify and manage all material conflicts of interest. The Macquarie Group, its officers and employees may have conflicting roles in the financial products referred to in this research and, as such, may effect transactions which are not consistent with the recommendations (if any) in this research. The Macquarie Group may receive fees, brokerage or commissions for acting in those capacities and the reader should assume that this is the case. The Macquarie Group s employees or officers may provide oral or written opinions to its clients which are contrary to the opinions expressed in this research. Important disclosure information regarding the subject companies covered in this report is available at 1 October