Right now I’m looking at some of the most popular companies in the FTSE 100 to try and establish whether or not they have the potential to push profits up to levels not seen in the last few years.
Today I’m looking at Rio Tinto plc (LSE: RIO) (NYSE: RIO.US) to ascertain if it can make £9bn in profit.
Have we been here before?
A great place to start assessing whether or not Rio can make £9bn in profit is to look at the company’s historic performance. It would appear that Rio was able to make a profit of just under £9bn back during 2010, as the price of iron ore surged to an all-time high of around $170 per ton.
Unfortunately, even though the price of iron ore continued to surge during 2011, Rio’s net profit slumped as the company was forced to take £6bn worth of asset impairments.
However, as the price of iron ore stabilizes and Rio cuts capital spending while increasing output at its low-cost mines, it would appear that the company is well placed to hit my profit target in the near future.
But what about the future?
Rio’s management team has been working flat out during the past year to return the company to growth after two disastrous years for the company. Specifically, during 2011 and 2012 Rio was forced to write down the value of some assets by approximately £15bn and at the same time the company’s net debt jumped more than 80%.
Nevertheless, Rio returned to growth during 2013 and reported a net profit of £2.3bn along with a 10% reduction in net debt. What’s more, the global mining giant has the potential to drive profits much higher as management continues to divest non-core inefficient assets, cut operational costs and reduce exploration spending.
In particular, Rio’s management is seeking to cut operating costs by around $1bn during 2014 and reduce net debt by a further $3bn to $5bn, strengthening the company’s balance sheet and reducing interest costs.
And it would appear that the City has every confidence in Rio’s ability to meet these targets. Indeed, City analysts expect Rio to report a pre-tax profit of £10bn for 2014, well above my target. Still, this is pre-tax profit figure and Rio has paid a tax rate of 25% on average for the past five years. With this in mind I believe that Rio’s net income for 2014, according to current City estimates, will be in the region of £7.5bn, below my target but still double the figure reported for 2013.
Having said all of that, I should mention that Rio’s fortunes are tied somewhat to the state of the global economy as the company requires a high iron ore price to achieve high levels of profitability.
Foolish summary
So all in all, based Rio’s current initiatives designed to reduce debt, cut costs and increase the production of low cost, high quality iron ore, lead me to conclude that overall, the company can make £9 billion profit.