* New mine deferred amid "challenging" near-term outlook
* Expects to announce capital return plans in February
* Sees iron ore margins at 56 pct even at weaker prices (Adds CEO comments, iron ore margins)
MELBOURNE, Nov 28 (Reuters) - Global miner Rio Tinto has deferred plans to build a $1 billion iron ore mine in Australia and said that, despite volatile commodity prices, it would be able to sharply step up returns to shareholders.
The move to delay an investment decision on its proposed Silvergrass mine until the third quarter of 2015 at the earliest follows a 50 percent slide in iron ore prices this year as Rio and BHP Billiton have flooded the market with new supply.
"While the long-term outlook remains sound, the near term is undoubtedly more challenging," Rio Chief Executive Sam Walsh said.
Rio is focusing on cutting spending to preserve cash so it can meet shareholders' demands for higher returns following a spending binge on bad acquisitions and huge mine expansions over the last seven years.
"Looking out over the next five years, we expect to generate strong free cash flow and we remain committed to materially increase cash returns to shareholders in a sustainable way," Walsh said in a statement ahead of an investor briefing.
"I look forward to announcing this at our annual results in February next year."
Walsh wants to set Rio apart from its arch rival BHP, which has been more cautious about the timing of returning cash to shareholders amid a commodity price slump, and satisfy shareholders to fend off rebuffed suitor Glencore Plc.
Rio said total capital spending this year would be below $8.5 billion, compared with a previous forecast of around $9 billion and said its operating and exploration costs would be cut by $5.4 billion by the end of 2015 from 2012.
Those cost cuts will make it able to deliver iron ore to China for $35 a tonne by 2020, down from $47 a tonne in 2012.
Deflecting criticism from the Western Australian premier and Glencore CEO Ivan Glasenberg for depressing iron ore prices, Rio said - even against analysts' weak outlooks for iron ore prices over the next five years - its profit margin would be around 56 percent.
"But against this background, Rio Tinto thrives. It's when our competitive advantages come into their own," Walsh told investors.
Despite deferring development of a new mine, Rio still expects to reach its iron ore expansion target of 350 million tonnes a year by 2017. (Reporting by Sonali Paul; editing by Gunna Dickson)