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Two days ago we posted an article about Sir Mervyn King and the Bank of England which described the inept management of the Bank with respect to forecasting the economy. Today we can show you an example of a company that understands the wisdom of getting it right by properly managing their business.
Instead of hoping, wishing, and praying that things will get better in the mining sector, Rio Tinto (LSE:RIO) has studied market conditions, the state of company operations and the corporate financials, and has decided to implement $5 billion in cost reductions and avoidance between now and the end of 2014. Do you realize that is more than most of us make in a lifetime? (Just checking to see if you are paying attention.) Fortunately, the management at Rio Tinto probably does not rely on the Bank of England’s forecasting as much as they do on their own research. And, apparently, the fellows and gals at Rio Tinto aren’t afraid to face the truth. They understand that their responsibility it to properly manage the company for its long-term success. That sure beats the methodology of Sir Mervyn and the boys who know that we are in the midst of a major sandstorm, but who believe that if they tell us that everything is hunky-dory, we won’t notice.
Enough about the effect of inbreeding at the Bank of England. Rio Tinto CEO Tom Albanese said, “The short-term macroeconomic outlook remains volatile with major uncertainties around future US and European economic growth. We are taking further tough action to roll back the unsustainable cost increases of the past few years, and are maintaining a relentless focus on improving productivity.” The entire board should be given awards for honesty and intelligence, but no one seems to be giving those out. Perhaps because the combination is so rare. The words “unsustainable cost increases” ring in my ears. In many companies the costs created during the good times are regarded as permanent. When viewed from the perspective of what is or is not sustainable, able to be funded with revenue in current and forecasted conditions, good managers stop protecting assets and costs that are or will be doing harm to the company.
The cuts start right in the conference rooms where strategic planning takes place, because this too is strategic planning. Over $1 billion of exploration and evaluation projects in the pipeline will be cut from the budget. While some old-school die-hards might say that is not the place to cut back, those are the guys who are still sipping tea in the dining room of the Titanic while the ship is headed straight for the iceberg. “Unsinkable, George. Nothing can stop us.” “Right you are Sir Mervyn.”
We know that another $1 billion will be cut from cap-ex. This is always a tough decision to make, but the fact is that engineers almost always ask for more than they really need. It’s not that they are unscrupulous, it’s that they want the very best to achieve their goals. It’s a matter of pride in the company and the work to be done. But the fact remains that the cap-ex faucet is only a valve. If their is nothing to flow through because the revenue reservoir is running dry, the cap-ex funds cannot flow. Albanese said that “I’ve been very concerned over the past few years that we’ve seen progressive escalation in our capital cost intensity. We’re just getting to a point now where we can’t run as many major capital projects around the world as we might have been a coupe of years ago with the same balance sheet.”
Investors should see Rio Tinto’s strategy as a very good thing for their investment. Whilst the first sound of cost-cutting is like fingernails on a blackboard (do they still have blackboards?), the reality is that, by making prudent cuts, the company can focus on fewer but more lucrative projects, which is exactly what Rio Tinto is doing.
The share price of RIO rose from 2,940 to 3,090 following the announcement yesterday. Trading of nearly 1.2 million shares today has been volatile jumping as high ans 3,105, showing sharp peaks and valleys until settling in around the 3,100 mark early this afternoon.
