Rio battles to save 'A' rating

The spotlight was once again on the mining sector after Rio Tinto released its results and trade data from China shaped sentiment.

Rio Tinto's underlying earnings for the first-half of the year came in at $4.23bn, down from $5.15bn a year earlier, but in line with estimates. Lower metal and coal prices accounted for the profit drawdown.

Earnings are undeniably important, but credit investors were more focused on the balance sheet. Net debt increased to $22.1bn from $19.2bn, mainly due to capital expenditure and higher dividends.

Rio raised its dividend by 15%, a move that might placate shareholders, but is detrimental to the company's credit standing, as it leaves less room for debt reduction. The miner also raised its 2013 guidance for capex, though it will still be lower than last year.

Rio has made progress on its goal of cutting operational costs by $2bn this year - it achieved nearly half of this by the end of June. A sharp increase in cash flow from operating activities was also welcome.

The firm's leverage, though, is still high for an 'A' rated credit, and Rio faces considerable challenges to sell non-core assets, as was reflected today in its decision to cancel the disposal of its loss-making Pacific Aluminium business.

Rio's CDS spreads currently trade around 107bps, a level consistent with a 'BBB' rating, according to Markit data. This suggests that the market is sceptical that the company can hold on to its current rating.

However, Rio's spreads did tighten 2bps today, and that was probably due to the strong data from China. Exports rose 5.1% year-on-year in July, while imports increased by 10.9%. The data were well ahead of expectations and a vast improvement from the previous month.

Concerns about a slowdown in China have weighed on the mining sector and beyond, so today's news should boost risk assets. But it is only one month's worth of data, and a slew of data tomorrow will give a clearer picture on the health of the Chinese economy.

Elsewhere, the Markit iTraxx Europe was slightly tighter at 96bps in what has been a typically quiet August week. Earnings were mixed, with Commerzbank beating expectations and Nestle missing consensus estimates. Several other firms also reported, though there was little impact on credit spreads.

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