When deciding which stocks are most appealing for income-seeking investors, mining companies are usually not included. That’s simply because, historically, their yields have not been as high as those of insurers or utility stocks, for example, but also because their earnings and financial outlook are relatively volatile and open to sudden shocks such as a fall in the price of a key commodity which they produce.
Clearly, Rio Tinto’s (LSE: RIO) (NYSE: RIO.US) appeal as an income stock is hampered somewhat by its large exposure to iron ore. In fact, it relies on the sale of the steel-making ingredient for around 90% of its profit and, as such, is less stable than index peers in other sectors. However, Rio Tinto’s yield, dividend coverage ratio, growth prospects and valuation mark it out as a top notch income stock.
For example, Rio Tinto currently yields a whopping 5.3%, which is among the highest on offer in the FTSE 100. This compares very favourably to the likes of RSA (LSE: RSA) and Pennon (LSE: PNN), which are perhaps viewed as more traditional income plays. They yield 2.6% and 4% respectively, which are a long way behind Rio Tinto’s yield. And, even though both RSA and Pennon are forecast to increase their dividends significantly next year so as to trade on forward yields of 3.6% and 4.3% in 2016, Rio Tinto is expected to do the same and, as a result, should yield 5.5% next year.
Of course, there is more to the income appeal of a stock than a fast-growing, high yield. The sustainability of dividends are also hugely important, since a dividend cut not only means less income for the company’s investors, but can also lead to a significant fall in the company’s share price.
However, on this front, Rio Tinto also impresses, with its dividends set to be covered a healthy 1.3 times by profit next year. Although this is lower than RSA’s dividend cover of 2.2 and is less appealing than Pennon’s coverage ratio of 1.2 (since Pennon is a more stable business, it can pay out a greater proportion of earnings as a dividend and still offer a sustainable income outlook), Rio Tinto can clearly afford its current level of payments. As such, its outlook as an income stock seems to be sound.
Looking ahead, Rio Tinto also offers superb growth prospects alongside a great dividend. For example, its bottom line is expected to rise by 20% next year, versus a rise of 13% for RSA and an increase in earnings of 8% for Pennon. As such, Rio Tinto appears to have a positive catalyst to push its share price higher, while its price to earnings growth (PEG) ratio of 0.7 also compares favourably to RSA’s PEG ratio of 1 and Pennon’s PEG ratio of 2.3.
Therefore, while its profitability may be hit by a fall in the price of iron ore, this appears to be fully priced in, meaning that Rio Tinto is a more appealing income stock than either RSA or Pennon.
