Operations & financial report
Group financial performance
The Group uses a number of key performance indicators ('KPI's) to monitor financial performance. These are summarised below and discussed later in this report.
| KPI | Description | Results 2007 US$m |
2006 US$m |
2005 US$m |
| Underlying earnings | Underlying earnings is the key financial performance indicator which management use internally to assess performance. It is presented here as an additional measure of earnings to provide greater understanding of the underlying business performance of the Group's operations. Items excluded from net earnings to arrive at underlying earnings are explained in note 2 to the 2007 Full financial statements. The Group's underlying earnings for the past three years are discussed below. | 7,443 | 7,338 | 4,955 |
| Gearing (net debt to total capital) | The Group's total capital is defined as Rio Tinto's shareholders' funds plus net debt and outside equity shareholders' interests. The Group's approach to capital managementis discussed in the Liquidity and capital resources section in the Financial review of the Annual Report. | 63% | 11% | 8% |
| Capital investment | Continuing investment in value adding growth projects. | The Group's capital projects are listed in the Annual report | ||
| Total shareholder return ('TSR') | Total shareholder return measures the Group's performance in terms of generating shareholder wealth through dividends and the share price.The Group's TSR performance compared to the FTSE 100 index, the ASX All Ordinaries index and the HSBC Global Mining Index is shown in the Remuneration paid in 2007 area of the Remuneration report. The relationship between TSR and executive remuneration is also discussed in the Remuneration paid in 2007 area of the Remuneration report. | 91.8% | 7.6% | 78.4% |
Acquisition of Alcan
During 2007, the Rio Tinto Group acquired 100 per cent of the issued share capital of Alcan Inc. The total cost of acquisition amounted to US$38.7 billion, including fees. Alcan's results are included within the Group's results from 24 October 2007.
Alcan Inc. is the parent company of an international group of companies involved in bauxite mining, alumina refining, aluminium smelting, engineered products, flexible and specialty packaging, as well as related research and development.
The Group has decided to dispose of Alcan Packaging, which is presented in the balance sheet in the lines: 'Assets held for sale' and 'Liabilities of disposal groups held for sale'. Therefore, the income and cash flow statements for the year exclude amounts relating to Alcan Packaging. Following a company wide strategic review of the combined Rio Tinto and Alcan assets, on 26 November 2007 the intention to divest the Engineered Products business was also announced.
Net earnings and underlying earnings
Both net earnings and underlying earnings deal with amounts attributable to equity shareholders of Rio Tinto. However, EU IFRS requires that the profit for the period reported in the income statement should also include earnings attributable to outside shareholders in subsidiaries. The profit for the period is reconciled to net earnings and to underlying earnings as follows:
| 2007 US$m |
2006 US$m |
2005 US$m |
|
|---|---|---|---|
| Profit for the year | 7,746 | 7,867 | 5,498 |
| Less: attributable to outside equity shareholders | (434) | (429) | (283) |
| Attributable to equity shareholders of Rio Tinto (net earnings) | 7,312 | 7,438 | 5,215 |
| Less: exclusions from underlying earnings | 131 | (100) | (260) |
| Underlying earnings attributable to shareholders of Rio Tinto | 7,443 | 7,338 | 4,955 |
2007 financial performance compared with 2006
Net earnings of US$7,312 million in 2007 were US$126 million below 2006, a decrease of two per cent. Underlying earnings of US$7,443 million were US$105 million above 2006, an increase of one per cent. Underlying earnings per share increased by five per cent in 2007 reflecting the lower number of shares resulting from the share buyback programme in the first half of the year. The principal factors explaining the changes in underlying earnings are shown in the table below.
| US$m | |
|---|---|
| 2006 Underlying earnings | 7,338 |
| Effect of changes in: | |
| Prices | 1,364 |
| Exchange rates | (403) |
| Volumes | 516 |
| General inflation | (218) |
| Cash costs | (442) |
| Non-cash costs | (201) |
| Exploration, evaluation and technology costs | (309) |
| Tax/other | (202) |
| 2007 Underlying earnings | 7,443 |
The effect of price movements on all major commodities was to increase earnings by US$1,364 million. Prices for the major products remained strong throughout the year and were higher overall than those experienced in 2006: average copper prices were six per cent higher whilst average aluminium prices were three per cent higher. The strength of the global iron ore market was reflected in the 9.5 per cent increase in the benchmark price, mainly effective from 1 April 2007. The seaborne thermal and coking coal markets were also strong and strengthened further in the second half.
Molybdenum prices averaged US$30/lb throughout 2007, an increase of 20 per cent compared with the prior year.
There was significant movement in the US dollar in 2007 relative to the currencies in which Rio Tinto incurs the majority of its costs. The Australian dollar was 11 per cent stronger, the Canadian dollar was six per cent stronger and the South African rand four per cent weaker. The effect of all currency movements was to decrease underlying earnings relative to 2006 by US$403 million.
Higher sales volumes predominantly from growth projects increased underlying earnings by US$516 million compared with 2006. The ramp up of new projects in iron ore (including the Yandicoogina and brownfields expansions), higher volumes of copper in concentrate at Escondida from improved grades, higher refined copper sales from the Kennecott Utah Copper ('KUC') smelter operating at close to capacity and higher diamond grades at Diavik were the main contributors.
The Group continued to invest further in the future development of the business with an increased charge to underlying earnings of US$309 million from exploration, evaluation and technology costs. Higher freight and demurrage costs and increased energy costs reduced underlying earnings by US$163 million and US$82 million, respectively. Significant shipping congestion at the port of Newcastle affected coal sales with a resulting impact on costs at Rio Tinto Coal Australia, through higher demurrage and a higher unit cost of sale. General inflation and mining inflation increased costs by US$218 million and US$140 million respectively as higher contractor, maintenance and input costs were experienced throughout the Group, notably in the iron ore and copper operations, as industry supply constraints persisted.
An increase in non cash costs reduced 2007 earnings by US$201 million compared with 2006, following the completion of several large capital investment projects.
The effective tax rate on underlying earnings, excluding equity accounted units, was 25.7 per cent compared with 24.2 per cent in 2006. The tax charge in 2007 was reduced by US$392 million as a result of the impact of the reduction in the Canadian tax rate enacted in December 2007 on deferred tax provisions. The 2006 tax rate benefited from US$335 million of US Alternative Minimum Tax credits, which were recognised on the balance sheet as a result of improved prospects for recovery of these from future taxable earnings from the Group's US operations, as well as the utilisation of US$140 million of previously unrecognised tax assets.
Alcan's contribution to underlying earnings for the nine weeks to 31 December 2007 was US$424 million, including a benefit relating to the change in the Canadian tax rate as described above. Exploration divestments increased 2007 underlying earnings by US$139 million relative to 2006. A higher interest charge from an increase in net debt following the Alcan acquisition reduced earnings by US$248 million relative to 2006. These variances and the tax variances referred to above are included within the US$202 million adverse variance for 'Tax/other'.
2006 financial performance compared with 2005
Net earnings of US$7,438 million in 2006 were US$2,223 million above 2005, an increase of 43 per cent. Underlying earnings of US$7,338 million were US$2,383 million above 2005, an increase of 48 per cent. Underlying earnings per share, which increased by 52 per cent, also reflected the lower number of shares resulting from the share buyback programme. The principal factors explaining the changes in underlying earnings are shown in the table below.
| US$m | |
|---|---|
| 2005 Underlying earnings | 4,955 |
| Effect of changes in: | |
| Prices | 3,068 |
| Exchange rates | (35) |
| General inflation | (174) |
| Volumes | (135) |
| Cash costs | (629) |
| Non-cash costs | (66) |
| Exploration, evaluation and technology costs | (46) |
| Tax/other | 400 |
| 2006 Underlying earnings | 7,338 |
The effect of price movements on all major commodities was to increase earnings by US$3,068 million. Prices for the major products remained strong throughout the year and were considerably higher than those experienced in 2005: average copper prices were 84 per cent higher whilst average aluminium prices were 35 per cent higher. The strength of the global iron ore market was reflected in the 19 per cent increase in the benchmark price, mainly effective from 1 April 2006. The seaborne thermal coal market was also strong, although it weakened in the second half.
Molybdenum prices averaged US$25/lb throughout 2006, a decline of 20 per cent compared with the prior year.
The net effect of changes in average levels of exchange rates against the US dollar for those currencies influencing the Group's costs was to reduce underlying earnings relative to 2005 by US$35 million.
Lower sales volumes decreased underlying earnings by US$135 million compared with 2005. As anticipated, significantly reduced volumes from lower grades at Grasberg impacted earnings by US$355 million year on year. This more than offset higher volumes at other operations. The ramp up of new projects in iron ore (including the Yandicoogina and brownfields expansions), higher copper in concentrate volumes from improved grades and throughput at Northparkes, higher ore grades and the commencement of sulphide leach production at Escondida, along with higher molybdenum and gold production at KUC, were the main contributors. Record volumes of thermal coal sales at Rio Tinto Energy America and alumina at Yarwun, also contributed to higher volumes. Lower sales volumes were recorded at Argyle with a build up of diamond inventories due to softer market conditions, at Kennecott Minerals from lower grades at Cortez, and at Hail Creek from lower coking coal volumes in response to lower customer demand.
Excluding the effects of general inflation, higher costs reduced earnings by US$741 million, of which US$77 million was the result of higher energy costs. Ongoing acute shortages in the mining industry, in particular in the Pilbara, continued to put pressure on costs. Costs at KUC were affected by an extended, scheduled smelter maintenance shutdown whilst Escondida experienced higher wages, following the strike in August. Significant shipping congestion at the port of Newcastle affected coal sales in the second half of the year with a resulting impact on costs at Rio Tinto Coal Australia, through higher demurrage and a higher unit cost of sale.
The effective tax rate on underlying earnings, excluding equity accounted units, was 24.2 per cent compared with 29.2 per cent in 2005, following the recognition of US$335 million of US Alternative Minimum Tax (AMT) credits expected to be utilised in future years. This reflected improved projections of long term taxable earnings from the Group's US operations. Additionally, the high levels of profit generated by the Group's US operations in 2006 resulted in the realisation of US$140 million of previously unrecognised deferred tax assets in the year. Deferred tax provisions decreased by US$46 million as a result of a reduction in Canadian tax rates. These favourable tax variances are included within the favourable variance of US$400 million for 'Tax/other'.
Exclusions in arriving at underlying earnings 2005-2007
Earnings contributions from Group businesses and business segments are based on underlying earnings. Amounts excluded from net earnings in arriving at underlying earnings are summarised in the discussion of year on year results below.
| 2007 US$m |
2006 US$m |
2005 US$m |
|
|---|---|---|---|
| Profit less losses on disposal of interests in businesses | 1 | 3 | 311 |
| Impairment reversals less (charges) | (113) | 44 | 4 |
| Exchange gains/(losses) on US$ net debt and intragroup balances (including those relating to equity accounted units) | 156 | (14) | (99) |
| Gains/(losses) on currency and interest rate derivatives not qualifying for hedge accounting (including those relating to equity accounted units) | 34 | 30 | (40) |
| Other exclusions | (209) | 37 | 84 |
| Total excluded in arriving at underlying earnings | (131) | 100 | 260 |
In 2007 an impairment charge of US$328 million after tax was recognised at Argyle following a decline in value as a result of large increases in the estimated capital costs of the underground project. This was partly offset by the reversal of the residues of the impairments of Tarong Coal and Palabora.
Other exclusions from underlying earnings in 2007, a charge of US$209 million, mainly comprised non-recurring consequences of the Alcan acquisition, including integration costs. Of this total, US$146 million resulted from the sale of Alcan inventories that were revalued based on selling prices at the date of acquisition.
Net earnings in 2006 included net impairment reversals totalling US$44 million. Impairments were reversed at KUC and IOC which more than offset impairment charges at Argyle and Tarong Coal.
Exchange gains and losses on US dollar net debt and intragroup balances that are recorded in the Group's income statement, together with gains and losses on currency and interest rate derivative contracts that do not qualify as hedges under EU IFRS, are excluded from underlying earnings. In 2007, these items produced a gain of US$190 million (2006: a gain of US$16 million) reflecting the weakening of the US dollar against the Australian and Canadian dollars.
In 2005, gains from disposals of interests in businesses amounted to US$311 million, relating mainly to the sale of Rio Tinto's interests in the Labrador Iron Ore Royalty Income Fund and in Lihir Gold.
