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Rio Tinto Writedowns and Lessons for Creditors

January 23, 2013

In Stories in Credit Analysis and elsewhere we had highlighted avoiding companies whose competitors can take practically unlimited losses in pursuit of various goals.  The biggest example of such a competitor, we had said, were Chinese state-owned steel companies, which in pursuit of the Chinese state’s goals to keep employment high, would continue to produce steel even if it did not make economic sense.  Plant shutdowns to bring supply in line with demand did not happen and the weaker players in the steel industry across the world have suffered immensely on account of this.

This thesis extends beyond the steel sector.  In 2007, when metals giant Rio Tinto acquired aluminium major Alcan, it had not factored in the potential intervention of the Chinese state.  Rio Tinto, at the time of the acquisition, drew excessive comfort from the superior cost structure (translating into lower production costs) of Alcan versus Chinese state-owned aluminium producers.  It did not factor in potential state subsidies to keep the uneconomic Chinese aluminium producers going through cheap loans and cheap energy.  The Chinese continued to produce despite the sales price not being adequate to cover the full cost of production.  This has proved to be disastrous for Alcan and by extension Rio Tinto.  Things will only get worse for Rio Tinto because the Chinese now produce 43% of the world’s Aluminium, up 10% from 5 years ago.  Last week Rio Tinto took a $14 billion write-down of its Alcan assets.  This should be a valuable lesson to creditors who plan to lend to companies whose competitors can take unlimited losses.

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From → Credit Analysis

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