Dividends from mining stocks are famously volatile. Cash payouts on Rio Tinto (LSE:RIO) shares surged in the wake of Covid-19 when commodity prices boomed and earnings leapt. The mega miner also paid a special dividend during that period.
However, dividends have fallen for two straight years since as material prices have reversed. And City analysts believe they’ll drop again all the way through to 2026, as the table below indicates:
| Financial year | Dividend per share | Dividend fall | Dividend yield |
|---|---|---|---|
| 2024 | 391 US cents | 10% | 8.3% |
| 2025 | 383 US cents | 2% | 8.1% |
| 2026 | 382 US cents | >1% | 8.1% |
These figures reflect forecasts of small-to-mid-digit earnings falls over the period.
Having said that, the rate of annual declines slows sharply over the period. As a consequence, the yields on Rio Tinto shares still sit comfortably above 8%. To put that in context, the average forward yield on FTSE 100 shares is way back at 3.5%.
However, I need to consider how realistic curent dividend projections are. And I must think about whether Rio Tinto’s share price may keep dropping, offsetting the benefit of more bulky dividends.
Here’s my verdict.
Good and bad
The first thing to consider is dividend cover. As an investor, I’m looking for a reading of at least 2 times. This is especially important for companies that can witness severe earnings volatility like miners.
Unfortunately, Rio Tinto doesn’t score as well as I’d like on this front. For the next three years, its predicted dividends are covered 1.7 times by expected earnings. This doesn’t leave much wiggle room if profits fall short of forecast.
However, Rio Tinto’s strong balance sheet assuages any fears I have over a potential dividend collapse. Its net debt to underlying EBITDA ratio was just 0.4 as of June. This provides plenty of flexibility to maintain its expensive operations and embark on fresh acquisitions while still hitting its dividend target.
Rio’s goal is to pay 60% of earnings out in the form of dividends. It’s a record the firm’s kept for eight years straight.
Uncertainty to 2026
Predicting mining dividends is in a way tricker than forecasting payouts from other types of shares.
Commodity prices can move sharply and unexpectedly on many supply and demand factors, pulling company earnings (and by extension dividends) through the roof or, alternatively, driving them through the floor.
At the moment, Rio Tinto shareholders like myself remain nervous about key markets like iron ore and copper. Prices could sink if China’s economy remains under the cosh.
Taking a long-term view
However, there’s also reasons to be optimistic. China remains committed to stimulus measures to kick-start its ailing economy. Falling interest rates across the globe might also energise broader commodities demand.
I’m certainly optimistic that Rio Tinto can deliver impressive share price gains and large dividends over the long term. A lack of new supply coming online in critical markets should boost metal prices. I’m also confident on the impact of themes like decarbonisation, urbanisation and technology on demand.
Given its 8%+ dividend yields and low price-to-earnings (P/E) ratio of 9.1 times, I’ll be looking to buy more Rio Tinto shares when I next have cash on hand to invest.
This post was originally published on Motley Fool
