Why 5.5%+ yielder Rio Tinto may be the best FTSE 100 dividend stock

With its dividend yield 2 percentage points above the FTSE 100 (INDEXFTSE: UKX) average, Rio Tinto plc (LON: RIO) could be an income investor’s dream.

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As of July 31, the average dividend yield for FTSE 100 constituents stood at a respectable 3.79%, but for investors seeking index-beating income I think there is at least one large-cap stock out there that they should consider.

That’s none other than miner Rio Tinto (LSE: RIO), whose new CEO has focused his efforts on juicing shareholder returns and reducing debt levels at a time when rising commodity prices have boosted the company’s earnings power.

This sounds like a common sense move, but for an industry that has long spent the good part of its business cycle overpaying for mediocre assets, it’s a big change. That Rio’s focus has shifted is clear in the company’s first-half results.

In the six months to July, its operations generated $5.2bn in net cash. Of this, a solid $2.4bn was reinvested in the business in the form of $1bn in ongoing maintenance requirements and the remaining in expansion opportunities. But the bulk of cash generated went straight back to shareholders via dividends totalling $3.2bn and share buybacks of $1.5bn.

For shareholders, this dividend works out to a whopping 5.7% yield. Of course, eagle-eyed investors will notice management returned more in cash than the business generated in H1. But this isn’t a big problem as the company was able to afford these excess payouts because it is selling non-core assets to focus only on its most profitable business lines where it has low production costs, advantages over rivals, and good long-term growth prospects.

In total, Rio announced $5bn in asset disposals in H1 with around 80% of these sales already completed. With earnings robust and growing despite asset disposals, I reckon Rio Tinto shareholders should continue to receive cash payments well ahead of the FTSE 100 average. And with plenty of non-core assets still to sell and the company’s gearing ratio at just 10%, its balance sheet is in great health and can support increased returns.  

When a government plays hard ball 

Unfortunately, not all miners are in as good a position as Rio Tinto is. Foremost among those whose shareholders are suffering is gold miner Acacia (LSE: ACA). The company currently pays no dividends to shareholders as its board is conserving cash due to the relatively new government in Tanzania, where all three of its mines are, banning the export of some of its gold until the company pays what it claims is $190m in back taxes due.

This dispute has dragged on for more than a year now and while its majority owner Barrick Gold continues to work on a resolution, I’d be hard pressed to recommend buying its shares. This is a shame because the company is doing well in a tough environment with its operations still profitable and contributing to a solid net cash position.

But while the price of gold Acacia receives may be rising quickly, the company’s earnings are falling and with the high level of uncertainty over its operations in Tanzania, I do not see this as the opportune moment for long-term investors to begin a position with an eye towards dividend-paying retirement stocks. 

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Ian Pierce has no position in any of the shares mentioned. 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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