Iron Ore Gravy Trains

Once upon a time mining companies were making a lot of money by extracting ore from Australia’s crust.

Soon after, the government needed some money to pay for the debts they incurred as a result of the spending promises they made to the Australian public, in their attempt to remain elected to power.

They thought that they could invent a tax which charged mining companies for how much resources that they dig up and sell.

The tax was created. Some were happy and others weren’t. They was lobbying, protests, crying and demanding. The tax had a short life. The new government had mates in the mining sector. The tax was no longer alive.

It was OK ’cause the government still earned some sort of money from whatever businesses the large mining companies conducted, providing that they didn’t cleverly use their offshore subsidiaries to move around and book profits into.

The price of coal had already fallen, but nobody likes them anyway ’cause their industry is a visibly polluting one.

But oh oh – recently the price of Iron Ore has fallen.

This is how I see it,

Government let off the iron ore miners off the hook with the mining tax, less money for the government, then global demand slowed, the giants continued to increase supply, the price of iron ore fell, the companies made less profit but them increasing supply (coupled with falling commodity prices) also pressured the smaller miners, thus the giants are growing their market share, but government still needs more cash, there is no capital gains tax being paid of share profits because the stock prices of the major iron ore companies are the same as 5 years ago, thus shareholder return is poor, but hundreds of employees are making more than $400,000 per year.

It’s important to keep the gravy train going by any means you can, whether you manage to dupe government, the economy or shareholders.

Yet they still are on the look out for federal government help to assist them with their plight of iron ore prices being below their cost of production.


Rio Tinto’s writedown is an example of Management Risk

I appreciate the operational leverage and potential returns that a company can provide its shareholders but last week’s news of Rio Tinto $14 billion writedown on its assets illustrates the handicaps that a company’s management can provide.

The result of such an announcement is that the CEO merely resigns.

Two years ago, bets were made in acquiring a coal business for $4 billion and today its value has been written down by $3 billion. Three-quarters of this coal business has been lost in 2 years, which is yet another example of company executives making large acquisitions in order to grow their business, with shareholders money.

When playing with large sums of company money, there is no downside for these executives other than losing their jobs, but their reward is large, financially and for their own personal career and resume improvement.

For these poor operational and investment decisions, management is paid very well. In Rio’s outgoing CEO’s case he also provided shareholders with a total share performance return of 2.5% during his 6 year tenure.

In Rio Tinto’s case, financial analysts are now speculating that it may embark on a $2-$4 billion share buyback to “make up for the losses”.

Rather than investing in its existing businesses, increasing its dividend payout or sheepishly attempt another equity destroying takeover, Rio Tinto could buyback its own shares, which in turn will improve the “Earnings Per Share” metric which hopefully is a benchmark that executives have their compensation incentives tied to.

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