OREANDA-NEWS. February 12, 2016. Rio Tinto's (A-/Negative) decision to scrap its progressive dividend policy gives the group greater financial flexibility and should ease some of the near-term pressures on its credit rating, Fitch Ratings says. But market conditions will remain weak in 2016 and any improvement to the credit profile from a lower dividend pay-out and capital and operating expenditure cuts could be undercut if the group spends on acquisitions.

We see progressive dividends - where companies commit to increase, or at least maintain pay-outs - as particularly problematic in cyclical sectors such as mining because they can severely limit the ability to cut cash outgoings and maintain positive free cash flow during a commodity downturn. BHP Billiton (A+/Negative) is the only other major mining company that still operates a progressive dividend policy and we believe it is also likely to scrap the policy when it announces annual results on 23 February.

Rio Tinto's dividend will fall from USD2.15 a share in 2015 to a minimum of USD1.10 a share in 2016 and the company's intention is to pay out between 40% and 60% of its underlying earnings to shareholders in future years. The group is planning a further USD3bn of capital expenditure cuts over the next two years and hopes to reduce operating costs by USD1bn a year in 2016 and 2017.

These measures should reduce the company's relatively high FFO adjusted gross leverage, which is around 3.0x and is a key driver of the Negative Outlook on the rating. We see leverage at or below 2x across the cycle as compatible with an 'A-' rating. However, the impact of the changes will take time to become clear.

Rio Tinto said it will look at acquisitions, particularly for mines already in operation and copper assets. This could be positive in the long term as asset prices are low and we expect copper to be among the strongest performing commodities up to 2020 due to limited new discoveries. But in the short term, acquisitions could limit any improvement in leverage.

The operating environment is also unlikely to improve in the near term because of further weakening of Chinese commodity demand and the impact of investor sentiment about commodities, which is likely to remain deeply negative in 1H16 at least.