Policy: “The board expects total cash returns to shareholders over the longer term to be in a range of 40 to 60 per cent of underlying earnings in aggregate through the cycle”
Yield: 4.11%
Payment: Twice a year, declared in dollars, paid in sterling.
Last cut: 2016 (re-set from progressive policy)
It was always going to be tough for Rio Tinto (RIO) to stick to a progressive dividend policy. For two decades until the beginning of 2016, the mining giant managed to increase shareholder returns year on year, before weak prices and swelling debts forced it to confront the harsh realities of the commodities cycle. For income-seekers, this re-set has not been as onerous as it may have seemed; indeed, Rio boasts a well-supported nominal dividend yield of 4 per cent. Add to that an increasing management focus on share buybacks, and an investor base averse to the kind of grandiose acquisitions, mergers or ill-fated mega-projects that swallowed up capital last time the balance sheet was robust, and the income case for Rio Tinto looks good.
Forecast use of free cash flow 2017 & 2018
First, a brief overview of the business for those unfamiliar. The vast majority of Rio’s earnings come from iron ore production, particularly the group’s long-life, phenomenally low-cost Pilbara operations in Western Australia. This is followed by contributions from aluminium, copper and alumina production and smaller divisions such as diamonds, uranium and coal. Altogether, analysts at Macquarie Research think Rio should generate $7.2bn in net profits this year, assuming average prices of $62 and $181 per tonne of iron ore and coking coal respectively, and $2.60 and $0.87 per pound of copper and aluminium.
Those prices may be far below the levels seen at the beginning of the decade, but represent something of a sweet spot for Rio’s cash flows. That’s despite widespread expectations that tepid global demand and oversupply will weigh on prices in 2018. In the meantime, Rio management plans to divert around $5bn-$6bn of annual operating cash flows on existing and expansionary projects, and to move towards a net debt neutral position by the end of the decade.
Such a smooth trajectory rarely reflects the realities of mining. This year’s strike at Rio’s part-owned Escondida copper mine in Chile, and the calamity that has been the Grasberg copper and gold project in Indonesia, show that it normally pays for investors to lower their expectations for commodities groups. Nonetheless, Rio has emerged from the downturn with a chastened attitude towards blockbuster expansion, and will be keen to prove that shareholder value creation, not volume production, is the primary goal. One way to do this is by juicing dividends, and regularly paying out 60 per cent of underlying earnings, at the top of the range under the new distribution policy.
Another method, beloved of corporate advisers, is to accelerate buybacks. This route has in fact been advocated by the Rio board, which in February announced a programme to retire $0.5bn of Rio stock in the open market over the course of 2017. By reducing its total number of shares, Rio is able to support or lift its share price, which should re-rate to maintain the same implied valuation. If done well, the strategy also makes it easier for Rio to pay a proportionally higher dividend per share each year – a critical consideration for the income case.
