With the stock market in the process of recovering from the 2022 correction, many dividend stocks continue to trade at depressed valuations. And one from the FTSE 100 that seems to be grabbing attention is Rio Tinto (LSE:RIO), thanks to its impressive 8% yield!
As one of the world’s largest mining enterprises, the group has been struggling to maintain earnings in the face of falling commodity prices. And that’s even after the tailwinds created by inflation. Yet, management appears confident about the long-term growth prospects of the firm.
So, is this secretly a buying opportunity?
The uncertainty of Rio Tinto shares
Rio Tinto’s revenue stream comes from selling extracted raw materials on the global markets. Of its portfolio of products, iron ore takes the lion’s share, with aluminium and copper providing the bulk of the rest. And this is where the problems start to emerge.
The supply chain disruptions caused by the pandemic sent commodity prices through the roof. And mining businesses like Rio Tinto enjoyed record-high profits, allowing the dividend stock to thrive. Since then, supply chains have been largely restored, allowing prices to normalise despite inflation.
But it seems that prolonged lockdowns in China – one of the world’s most iron-consuming countries – have caused demand to tumble even further. Consequently, the supply/demand balance has flipped on its head, and commodity prices have fallen drastically in recent months. This would certainly explain the 37% decline in Rio Tinto’s underlying earnings in 2022.
Since these earnings ultimately fund shareholder dividends, it’s not surprising to see investors get spooked. And in the rush to sell shares, the market capitalisation of this business has suffered, enabling the yield to rise up to 8%.
Should I buy this dividend stock?
Despite the adverse movement in commodity prices, management states they are “now seeing a modest shift to compelling growth”. As the Chinese economy reopens, the return of construction in the real estate and infrastructure sectors is likely to spark new demand for Rio’s products.
In the meantime, management has been busy allocating a larger amount of capital to new projects to increase the firm’s volume output. If the group’s expectations prove accurate, they’ll have more resources to sell, capitalising on an upward trend. And it may even pave the way for a higher shareholder payout in the future.
However, while the prospect of a rising yield certainly makes this dividend stock more attractive, there’s no guarantee. In fact, a recent report from Goldman Sachs predicts quite the opposite.
Analysts at the investment banking firm believe China currently has an oversupply of steel. As a result, 2023 is now the first year since 2018 when the world is in an iron ore surplus that may continue to grow well into 2024. As such, the price forecast for iron ore has been slashed from $110 per tonne to $90.
Rio Tinto is obviously more than just an iron mining business. But since this commodity represents the bulk of its revenue, such a forecast does not bode well for shareholder dividends. For reference, iron ore is currently priced at around $108 per tonne.
There seems to be a giant question mark surrounding this business with no easy answers. Therefore, I think income investors are better off searching for high yields in areas with less uncertainty.
