So what should investors make of BHP Group (LSE: BHP) and Rio Tinto (LSE: RIO), two FTSE 100 stocks whose monster dividend yields make them look great on paper?
One cannot discuss the prospects for these two businesses without reflecting on the state of the iron ore segment, a commodity from which both firms source the majority of their profits. This is how those on both sides of the divide currently see things.
The bulls would point towards heavy infrastructure spending in China, coupled with rounds of heavy monetary stimulus from Beijing, as reasons to expect demand for the steelmaking ingredient to remain robust. Indeed, production of crude steel in the Asian economic powerhouse galloped to record highs of 89.09m tonnes in May.
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It’s quite likely iron ore demand will continue to soar in the near-term at least, though some argue the outlook beyond then is looking a little less convincing. Why? The Sino-American trade spat which severely threatens to exacerbate economic cooling in China, a country which sucks up around two-thirds of the world’s seaborne iron ore, and in some people’s eyes tip the US into recession also.
Shipments soaring again
Now iron ore prices have soared in recent months on a couple of major supply disruptions in key producing regions which have slaughtered imports into China and pushed stocks at the country’s ports to multi-year lows.
First came the Brumadinho tailings dam disaster in Brazil in January, which caused wisepread environmental devastation and prompted regional heavyweight Vale to halt output. Then came tropical cyclones in Western Australia in April which harmed shipments from local heavyweights BHP, Rio and Fortescue Metals Group.
However, it’s quite probable that prices will crumble as exports from major producing levels rebound sharply. Latest data from UBS shows that total ore shipments from Australia, Brazil and South Africa leapt 24% month-on-month in May. And the bank’s tipping prices will fall back below the $100 per tonne marker in the second half of the year (and to keep on falling until 2020 at least, when values will average $80).
Big worries
I’ve long made my own outlook on the iron ore market known. And, unfortunately for BHP and Rio investors, I can’t say that I’m particularly enthused.
The threat of unwanted material swamping the market and depressing iron ore prices, reflecting a ramping up of output across those three major producing nations, is extremely real. UBS, for one, thinks the iron ore market will slip back into surplus next year as more than 60m tonnes of new ore comes out of the ground. Though surely this disparity could exceed expectations should those trade wars really begin to bite demand.
So it doesn’t move me that BHP and Rio sport big dividend yields of 6.3% and 6.7%, respectively, for their current financial years. I worry about their ability to keep paying handsome dividends long into the future as global supply promises to keep rising in the years ahead and, with it, put pressure on earnings growth at the big mining groups.
There’s plenty of great income shares that investors can snap up from the FTSE 100 today. I’m afraid I consider neither of the big-caps described here to be among that group.
