Rio Tinto's (LON:RIO) increasing debt, which has already reached $33 billion, prompted Standard & Poor's to downgrade the giant miner’s credit rating outlook from stable to negative.
The rating agency’s announcement increases the pressure on Rio's new chief executive, Sam Walsh, to deliver on his promise of vast operating cost cuts, asset sales and reduced capital expenditure commitments ahead of a possible collapse in iron ore prices.
The negative outlook means there is a one-in-three chance Rio could lose its valued single-A credit rating in the next 12-18 months if it does not strengthen its balance sheet.
The current bumper iron ore price of more than $150 a tonne is good news for Rio, but only momentarily, said S&P, as the potential for the price of the key commodity to plummet would make Rio's deleveraging plan more of a challenge.
Rio’s gross debt increased to $26.7bn from $21.5bn in the year ending Dec. 2012 driven by extremely high capital expenditure, which reached a record $17bn. Add to this weaker commodity prices and you get limited cash flow.
Despite spending expected to fall to $13bn this year, S&P added Rio would not be able to cut debts because of its commitment to a “progressive” dividend policy.
“We see a risk that Rio Tinto’s debt may rise further in 2013-14 unless the company makes large disposals or iron ore prices stay well above US$120 a tonne,” the agency said.
However, Deutsche Bank analyst Paul Young told The Sydney Morning Herald that S&P took a conservative approach when analyzing Rio's future cash flows.
"It's not as though they don't have (funding) options," Young said.
He added that even if S&P was to downgrade Rio's credit rating, for instance, from A to BBB+, it would be temporary and would not have a material impact on the giant miner's funding costs.