Rio Tinto – an income stock

Thursday, May 17th, 2018

Company: Rio Tinto Limited
ASX Code: RIO
Share Price: A$81.37
12-month estimated Dividend per share: A$3.67ps
12-month estimated Dividend Yield: 4.5%

Rio Tinto is one of the largest mining companies in the world and one of the largest listed companies in Australia. However, it is a mining company – a sector not renowned for stable incomes. Commodity prices are affected by global economic and market forces which are hard to forecast. Companies dependent on these prices tend to have significant periods where they deliver sub-optimal returns to shareholders. But if the companies survive in the long-run they will also have had a period of significant out-performance. Over time these swings can generate a strong economic and share price return but share prices are more volatile than the average income generating industrial company.

With a volatile business mining companies historically tended not to focus on generating short term returns or paying cash to shareholders. Now policies are changing – investors have become more willing to contribute capital when it is needed and to take it back when it is surplus. We are also benefitting from a global economic recovery and are at the beginning of a period of stronger commodity prices. Lack of investment in exploration over the past nine years has left many commodity markets undersupplied in the next three to five years. Consequently, companies have started to change their behavior. In the mining sector we see much more attention paid to return on capital and returning surpluses to shareholders.

Rio has been at the forefront of this process, strengthening the balance sheet by reducing debt with cashflows from the lowest cost Iron Ore projects in the Pilbara, selling surplus assets in the coal and aluminium divisions and returning cash to shareholders, while balancing investment in growth projects such as the copper project at Oyu Tolgu in Mongolia. RIO returned A$12.8bn (US$9.7bn) to shareholders via dividends and share buy-backs (A$7.25 ps.) 2017.

This process continues in 2018 with coal and aluminum assets sold recently raising A$6.7bn (US$5bn). We expect the board will resolve to continue a share buyback with these proceeds but will also maintain the dividend policy. Combined with relatively strong prices for iron ore, copper and aluminium this year RIO should report strong profits again in 2018. Based on market consensus forecasts RIO should report a profit of US8.2bn, slightly higher than in 2017. This translates to around A$6.00ps and consensus also expects a payout ratio consistent with 2017 of 60% or a dividend of A$3.67ps. This places RIO on a 12-month yield (to March 2019) of 4.5% fully franked – a grossed up yield of 5.8%. Add to this the expected buyback and RIO is a mining company which, this year, looks like an income stock. The company is trading on a FY18 PE of 13.4x consensus forecast earnings per share.

 

Clime Group owns shares in RIO for and on behalf of various mandates for which it acts as investment manager.

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