Rio Tinto's smaller than expected $5 billion share buyback and caution over the sustainability of a commodity boom overshadowed record profits from the mining giant.

The world's third-biggest miner by market value, flush with cash thanks to surging demand led by China, surprised investors by more than doubling its full-year dividend but a pledge to buy $5 billion worth of shares by the end of 2012 left some cold.

$5 billion isn't enough. It is ultra conservative, said Paul Galloway, analyst at Sanford Bernstein, adding that the two-year time period was also too long. He said the company had made a good start at returning cash but that it could afford to buy back $15 billion.

Shares in London fell 2.5 percent, underperforming a 1.8 percent decline in a British mining index and a 0.7 percent weaker London market.

Rio's Chief Financial Officer Guy Elliott told investors not to expect the company to come back with further increases to its buyback program.

The company raised its full-year dividend to 108 cents a share -- analysts had said anything more than 100 cents would be a big surprise - and plans to pay out 54 cents for the first half of 2011 as part of its progressive dividend policy.

Rio's move will raise expectations that top global miner BHP Billiton, with its nearly debt free balance sheet, will step up its dividend payout and add to its ongoing $4.2 billion share buyback when it reports results on February 16.

Smaller rival Xstrata set the pace earlier this week topping forecasts with an 86 percent jump in full-year profit and a dividend that was nearly double market expectations.

Rio and its peers are producing at full steam with copper prices at record highs, spot iron ore up nearly 50 percent from a year ago, and thermal coal prices up nearly 40 percent.

Chief Executive Tom Albanese said economic growth in emerging markets combined with supply constraints meant the market and pricing outlook for commodities remained positive, but warned that the risks were elevated.

In particular, the timing and speed at which post-global financial crisis stimulus packages are removed have the potential to generate both volatility and substantial swings in commodity prices, he told reporters.

Charles Kernot, an analyst at Evolution Securities, called the miner's outlook somewhat muted.

Albanese told analysts that he sees prices for iron ore, which accounts for almost 80 percent of Rio's core earnings, moving below $100 a ton. The Steel Index 62 percent iron ore benchmark is trading at $186.40.

EXPANSION

Rio said it was in strong shape to take advantage of any acquisition opportunities that might arise, even after returning cash to shareholders.

Burned by its top-of-the-market takeover of Alcan in 2007, Rio has said it is only looking for acquisitions worth less than about $5 billion and is currently chasing Mozambique-focused coal miner Riversdale Mining with a $3.9 billion bid.

Underlying earnings before one-offs rose to $8.22 billion for the six months to December, based on Reuters calculations, up from $3.73 billion a year earlier and in line with analysts' forecasts of around $8.29 billion.

Rio plans to further expand existing operations after approving $12 billion worth of projects in 2010.

Two key headwinds now face Rio in the form of a slow recovery of Australian coal production, after devastating floods shut mines and knocked out rail lines, and rising operating and project costs as labor and energy prices rocket.

But soaring coal prices are expected to more than offset the impact of lower production.

Rio extended its offer for Riversdale to March 4 on Thursday as it has yet to win support from top shareholders, India's Tata Steel and Brazil's CSN.

It is under pressure to raise its offer after CSN increased its stake this week to 19.9 percent, just below the threshold for making a full takeover offer.

CSN has not said what its intentions are and Albanese declined to comment on any talks with shareholders. Tata has said it intends to retain its strategic stake, at least for now.

Riversdale shares rose 0.6 percent to A$15.95, but remained below Rio's A$16 a share offer.

It's quite likely Tata and CSN will both stay and keep their exposure to coking coal, said Rakesh Arora, sector analyst at Macquarie Research in Mumbai.

(Editing by Anshuman Daga and Elaine Hardcastle)

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