With the stock market trending downward over the last couple of months, double-digit dividend yields seem to be everywhere, including in the FTSE 100 index. That’s not too surprising since a firm’s yield is strongly influenced by its share price.
In my experience, seeing a high payout ratio is usually a warning to steer clear since it’s typically an indicator of fundamental problems with the underlying business. But when stocks are in freefall during a correction, not every high-yielding stock is an income trap. And when looking at Rio Tinto (LSE:RIO), a buying opportunity may have emerged.
Let’s take a closer look.
What’s going on with Rio Tinto shares?
As a quick reminder, Rio Tinto is one of the largest mining companies in the world with a diverse portfolio of products, including iron ore, aluminium, copper and salts, among others.
Over the last 12 months, the stock has taken a 14% hit as fears of a recession continue to mount. And looking at the latest interim results, those fears aren’t entirely unfounded.
With the Covid-related disruptions to China’s steel industry, the global demand for iron ore has suffered along with its price. Given iron is Rio Tinto’s biggest source of income, that’s obviously not good news. Consequently, the interim shareholder dividend payment was cut by 29%.
Needless to say, this doesn’t exactly paint the best picture for this FTSE 100 stock. However, while the world is focused on the short-term hurdles every business in this cyclical sector is facing, I’m more interested in the long-term potential.
A top FTSE 100 dividend share?
After a stellar 2021 of soaring metal prices, management was able to further strengthen the balance sheet. The group currently has around $13.9bn in cash at its disposal, which is more than enough to wipe out its remaining debt, if needed. Seeing a strong level of liquidity, especially in a rising interest rate environment, is encouraging.
However, what I’m watching closely is the capital investment plan. By the end of 2022, management expects to have invested $7.5bn into expanding its current projects and accelerating the development of new prospects. These investments are expected to rise to $9bn and $10bn in 2023 and 2024 respectively.
That’s obviously a lot of money being dedicated to improving both operational efficiency as well as growth for the future. And it includes the introduction of lithium into the portfolio. Demand for this is already skyrocketing, courtesy of electric vehicle battery manufacturers.
It’s too soon to tell whether these investments will deliver long-term value to shareholders. And it’s possible that metal prices, especially iron ore, may continue to decline within the next few months.
Yet I remain cautiously optimistic given the firm’s successful track record. And at a P/E ratio of just 5.6, this FTSE 100 business, in my opinion, is looking like a potential bargain for my income portfolio.
