Over the past 12 months, Rio Tinto (LSE: RIO) has emerged as one of the FTSE 100’s top income stocks.
At the beginning of February, the company rewarded its shareholders with the biggest dividend it has ever paid, as well as a share buyback programme. Together these two cash returns totalled $6.2bn, around two-thirds of the group’s full-year 2017 earnings of $8.6bn.
This dramatic turnaround comes several years after Rio was forced to slash its dividend due to falling commodity prices and rising debt. Ever since, management has been working hard to get the company’s house in order, and it now looks as if this transformation is coming to an end. At the end of last year, net debt had fallen to $3.8bn, from $9.6bn at the beginning of the year, while free cash flow surged 60% to $9.5bn.
Uncertain dividends
Lower costs, as well as higher commodity prices, helped Rio throughout 2017. Overall, higher commodities prices added more than $4bn to underlying earnings. Without this boost, Rio certainly wouldn’t have been able to announce a record distribution. The company has committed to paying out between 40% and 60% of underlying earnings to investors via dividends, so payouts will vary from year to year.
The miner’s total dividend per share for 2017 was $2.9, or 210p, a dividend yield of roughly 5.6% at the time of writing. City analysts are currently expecting the company to announce a similar level of distribution for 2018. But in 2019, based on current iron ore price forecasts, the distribution is set to fall by around 10%.
And this dependence on iron ore prices is the key reason why I’m cautious about the outlook for Rio. The company is a dividend champion today, but if prices suddenly fall, as they did between 2013 and 2015, the dividend will fall as well.
With this being the case, I’m much more positive on the outlook for small-cap growth stock Cello (LSE: CLL).
Market leader
Cello provides marketing services to healthcare companies, a business which is online likely to see demand expand over time. Today, the company reported an increase in profit before tax of 11.9% for 2017 and statutory basic earnings per share of 4.09p, up from 3.2p for 2016. Headline earnings per share hit 7.9p.
Growth is the key reason why I like Cello over its blue-chip peer Rio. While Rio’s growth is tied to the price of iron ore, Cello’s future is in its own hands. The company is leveraging its position in the healthcare industry to reach out to more clients and the firm now has relationships with 24 of the top 25 pharmaceutical companies. A total of 49 new client wins in 2017 is a testament to the group’s offering and service to customers.
As management builds on this success, City analysts are expecting earnings to grow steadily by around 10% over the next two years. True, this doesn’t make the firm the fastest growing business around, but Cello’s offering to the highly defensive healthcare industry, which requires specialist knowledge, implies the company is unlikely to be displaced anytime soon. So this steady growth should continue for many years to come, in my opinion. With this being the case, Cello’s valuation of 13.9 times forward earnings, doesn’t appear too demanding.
