As regular readers of my articles will know, I’m usually very keen to buy stocks with high dividend yields that are supported by surplus cash flow.
So why aren’t I buying FTSE 100 mining giant Rio Tinto (LSE: RIO)?
After all, the Anglo-Australian firm has just announced a surprise $1bn special dividend, in addition to a record ordinary interim dividend of $2.5bn.
Indeed, I estimate that Rio’s shareholder payout could now reach $8.5bn this year, giving a total dividend of about $5.25 (435p) per share. That’s equivalent to a yield of 10% at the last seen share price of 4,555p.
The company has very little debt and is funding these shareholder payouts from its free cash flow. What’s not to like?
Red metal hangover
The RIO share price is down by 3% at the time of writing, despite the firm’s latest dividend giveaway.
I think there are two reasons for this. The first is that the company has benefited from a spike in iron ore prices, which have risen by 60% to more than $120 over the last six months.
The red stuff generated 83% of the group’s underlying profits during the first half, hiding weak contributions from aluminium, copper and coal. However, most analysts believe that iron ore prices have now peaked and are likely to fall, as supply improves and demand stabilises.
Ahead of today’s results, City analysts were predicting a 12% fall in profits for 2020, with a similar reduction in the dividend.
Problem #2
In previous articles, I’ve discussed Rio’s potential to generate more income from copper and aluminium. But I have to admit I keep on being disappointed.
Although aluminium and copper prices were relatively weak during the first half, I think the real problem is that Rio’s operations in these areas don’t have the combination of ultra-low costs and giant scale that make the firm’s Australian iron ore mines so special.
Efforts to expand the copper business are also facing headwinds. The Oyu Tolgoi mine in Mongolia has the potential to be one of the largest copper mines in the world, when a planned extension underground is completed.
The problem is that this is taking longer and costing much more than Rio expected, due to problems with the mine design and ground conditions. In today’s half-year results, the firm admitted that production isn’t expected to start until some time between May 2022 and June 2023. That’s 16-30 months later than originally planned.
These delays are coming at a hefty cost too. The firm has added $1.2bn-$1.9bn to its budget for the mine. This has increased the planned spending from $5.3bn to between $6.5bn and $7.2bn.
Good company, wrong time?
I remain a fan of Rio Tinto, but with a weaker outlook for iron ore and delays to copper expansion, I don’t think now is the right time to be buying the stock.
The shares are trading at twice their net asset value and look fully priced to me, given that earnings are expected to fall next year. I expect better buying opportunities to be available in the future. For now, I see the stock as no more than a hold.
