Rio confident of beating off BHP

RIO Tinto chief Tom Albanese remains serenely confident that he can beat back the BHP Billiton barbarians at his gate. Now those are my words not his. Also, my characterisation of his confidence, which I have very deliberaterly described as serene not supreme. For there are two critical aspects to the position that Rio and Albanese in particular have taken on the BHP offer. First and this is explicit, that the proferred 3.4 BHP shares for every Rio share is way inadequate. What is implicit is that any feasible - my word - increase would also be inadequate. Second and explicitly, that he and the rest of Rio will just get on with the job of running the company and maximising value for shareholders. The serenity implicitly suggests that shareholders will agree with them. And so, when and if the offer goes "live", it will be beaten back. Talking to Albanese yesterday, he repeats the core argument that all the synergies in any union of the two companies come from Rio. Specifically, in the Pilbara where such benefits are concentrated, that he could not see an additional tonne of Rio ore going through BHP infrastructure. But not so with the reverse. It was very easy to contemplate BHP ore going through Rio infrastructure. It would merely require expansion of the wharves at Cape Lambert. From Rio's perspective this is one of two critical points of differentiation in their two growth stories. Rio will have annual iron ore production in the Pilbara up to 220 million tonnes by the end of the year. On the way to 320 million tonnes by 2013. BHP simply cannot match that. By 2013 it might be in the low 200s. At current iron ore prices the difference equates to - and these are my back of the envelope numbers - perhaps $US12 billion ($A14.5 billion) in revenue terms and half that in gross profit terms. Now all of this flows from the decision in 2000 to take over North and Robe River, and in 2003 to dramatically expand iron ore in anticipation of China. BHP is playing catch-up The second is aluminium, which Albanese clearly sees as a positive not a negative. Even in the takeover context, not just as a long-term growth and - cheap - energy story. Well, the immediate thought prompted is of Mandy Rice-Davies. He would say that. Both because Rio Tinto has $45 billion invested in that answer; and one way or another has to sell the aluminium numbers in its profit report. What Albanese does say is that aluminium is both a demand and a supply story. Chinese demand growth at 18 per cent is even topping steel growth at 16 per cent. More broadly, with per capita income levels in the $USS5000-$US12,000 range, aluminium had the same intensity of use as other materials. But over $US12,000, it was higher. In short, demand for aluminium would grow at the same pace as copper and steel in the short run in China, and accelerate in the longer run. Then bring in supply. Compared to a year ago, there is the increased possibility of a supply deficit, he says. Whereas the copper price is well above the marginal cost of production - short-hand for saying supply can and will be increased. The aluminium price is LOWER than the marginal cost of production. Short-hand again, for saying that prices will go higher AND supply will NOT rise significantly, quickly. Even abstracting from possible REDUCTIONS in domestic Chinese supply. Something that would further imbalance demand and supply. Now the proof of all this will play out in their respective profit reports. For the current December half - the "last" ones before the offer goes live and has to be resolved. And what can be projected into the future, and then discounted back to present-day values. Which brings us to the share prices. Rio at $111 is some $15 below the BHP offer price of $126 based on BHP's share price yesterday. It is now consistently trading at that sort of discount. The conventional wisdom is that reflects the expectation that the offer will fail and/or just the general time and uncertainty factor given the process. Now obviously Rio could not, nor should it, urge shareholders to accept an offer simply because it is higher than current market. But it would become increasingly difficult to resist swapping one bit of paper for another, which still contained all the Rio upside claimed. Certainly, if diluted. But starting higher. Especially as presumably the BHP share price would go higher if it became clear that the offer would succeed. Logically, it must also be trading at a discount on the upside that BHP would reap with the takeover. The combination means it is critical for the defence that aluminium does not stumble in the short run. Especially when set against the high prices BHP will reap in energy - oil and gas and coal. Lost in the wash RELAX. The Senate hasn't destroyed the Budget and condemned you to RISING interest rates as a consequence. And the trade balance hasn't plunged back into the red. The Senate's rejection of the luxury car tax and the increase in the Medicare surcharge will cut the budget surplus by - wait for it, I hope you're sitting down - $130 million this year. The surplus, instead of being $21,700 million, will be slashed, SLASHED I say, to $21,600 million. Sarcasm aside, whatever might be the merits or demerits of what the Senate has done, it is completely irrelevent to the Budget and the economy. Apart from the fact that the normal ups and down as the year unfolds could give us a surplus of, say, $24 billion. Or $14 billion. Talk about getting lost in the wash. These measures aren't even the proverbial pesky sock. More of an invisible piece of lint. So to the extent we need a big budget surplus to put - and I quote somebody whose name I've just forgotten - "downward pressure on inflation and downward pressure on interest rates", nothing has changed. As for the trade picture, all you need to do is pick up the RIGHT message. That is, in April, our trade bottom line took a giant leap up, as those lush prices for what we are selling to China finally started to kick in. In March our total trade was in deficit to the tune of $2.4 billion. Pretty much where it had been every month going back into 2007. In April, it went $630 million into the black - a positive turnaround of $3 billion in a single month. Our trade deficit was actually trending worse, before this sudden extraordinary, quite vertical, improvement. Yes, it went back into deficit in the latest month. That's entirely because of the timing of shipments. You have to look at the trend. Rising. The key message is that the trade balance is bouncing around that zero line. That's to say, in any month it could be south of the line, in another north of the line. For the moment. Until it takes another lurch HIGHER. Why will it do that? Because so far only higher PRICES have kicked into export earnings. And then only part of those higher prices. Both coal and iron ore in particular have scored respectively price rises of 100 and 200 per cent, which will apply for the entire 2008-09 year. And they will apply on higher VOLUMES shipped. As increased production finally kicks into gear. See Rio's projections of what will happen to iron ore sales out of the Pilbara. Then on the IMPORT side, we are likely to see those numbers slip a bit as consumer demand slows. It's too complicated to try to predict imports. It's not just demand, but price - take the oil price; and the value of our dollar. But I WILL predict a big trade surplus for the 2008-09 year in total. Even though the first month has kicked off with a $700 million deficit. Source: Courier Mail