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Have £2,000 to invest? FTSE 100 5% yielder Rio Tinto could help you retire early

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A miner down a mine shaft
Image source: Getty Images.

Mining giant Rio Tinto (LSE: RIO) is one of the largest holdings in my personal portfolio. It’s been a successful investment for me. But with the mining recovery now largely complete, I’m wondering whether to sell up or stay put and enjoy more of the miner’s generous dividends.

Today’s half-year results confirmed that the firm’s post-2016 focus on returning surplus cash to shareholders will continue. The company announced $7.2bn of planned shareholder returns today — equivalent to about £3.20 per share.

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Not all of this will be paid in cash. The interim dividend of 127 cents per share will account for about $2.2bn. But $1bn will be returned through share buybacks. And the final $4bn won’t be handed out until asset sales agreed during the first half of the year have completed. The company hasn’t yet said how or when this will happen.

Why are the shares down?

Rio Tinto’s share price fell by around 4% on Wednesday, as the market digested a slight profit miss. Although underlying net earnings rose by 33% to $4.4bn, this was slightly lower than City analysts expected.  The shortfall was due to rising oil prices, labour disruption at a number of mines, and higher raw material costs in the aluminium business.

One positive factor was that profits from aluminium and copper both improved. This reduced Rio’s dependency on iron ore, which still accounts for about 70% of profits.

An income buy

Today’s figures confirmed my view that the rapid growth in profits we’ve seen over the last year is likely to slow. Analysts’ consensus forecasts are for underlying earnings to be broadly flat this year, at $4.99 per share, compared to $4.82 per share in 2017.

On the other hand, the forecast dividend yield of 5.8% should be well supported by free cash flow. And the stock’s forecast P/E of 10.6 seems very affordable to me. Overall, Rio Tinto remains my top pick in this sector.

A takeover opportunity?

One rival company with a more uncertain future is South Africa-based Anglo American (LSE: AAL). Unlike Rio, Anglo is still involved in coal mining. And the group’s large platinum operation in South Africa means that it faces additional political risks.

This slightly riskier profile could provide an opportunity for investors. I believe the group could become a takeover target. Anglo shares also trade at a significant discount to those of Rio.

Ratio

Rio Tinto

Anglo American

Price/book ratio

1.9

1.4

Price/free cash flow (last 12 mo.)

11.9

8.3

2018 forecast P/E

10.6

9.2

2018 forecast dividend yield

5.8%

4.6%

However, I think there are several reasons why Anglo shares probably should be cheaper.

One is that this smaller company isn’t as profitable as Rio. Over the last 12 months, Rio has earned an operating margin of 35%. This compares with 19.4% for Anglo American.

A second reason is that Anglo’s dividend yield is already lower, despite its more modest valuation. The firm’s first-half payout ratio of 40% of underlying earnings was lower than at Rio, which is now paying 50% of earnings. Investors may be reluctant to pay more for Anglo stock unless there’s more cash (or growth) on offer.

This leads me to one final thought. Earnings at both firms are expected to fall in 2019. This isn’t necessarily a big concern, but it does mean that it’s probably more sensible to put your cash into the more profitable firm. In my view, that means Rio Tinto.

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In fact, we think it could become as big… or even BIGGER than Shopify.

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Roland Head owns shares of Anglo American and Rio Tinto. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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