Ethical considerations aside, I think these companies are highly attractive income plays because they’re throwing off cash. On top of this, each business has its unique qualities, which make it stand out.
Economies of scale
Rio Tinto is the world’s largest producer of iron where it has unrivalled economies of scale in production. These economies of scale, coupled with the company’s asset disposal programme, have helped the business generate $46bn from its operations and assets sales since 2016, a colossal amount of money.
Most of this has been returned to investors, with $29bn distributed to shareholders via dividends and share buybacks. Rio has also used $14bn to pay down debt.
I think it’s unlikely this level of cash return will continue because the company’s asset sales seem to be slowing down. However, Rio is still generating billions of dollars in cash from its operations. City analysts expect the group to report a net profit of $11.3bn in 2019, funding a total dividend distribution of $4.60 per share, according to forecasts. At the current share price, this translates into a dividend yield of 7.5%.
Glencore’s unique trait is its trading business. Even though the company does make money from pulling commodities out of the ground, the bulk of its earnings come from trading, which involves acting as a middleman between buyers and sellers of commodities around the world.
The great thing about this business is it’s relatively stable. If earnings at Glencore’s production businesses fall, the trading division usually picks up the slack, providing much-needed cash to support the business and the dividend.
Last year, trading earnings before interest and taxes was $2.4bn, which helped support management’s decision to return $3bn to shareholders by way of a share buyback.
Another reason why I like this commodity business is the fact its managers own a significant stake in the group, so they profit alongside other investors. City analysts believe the company’s dividend yield will be 5.5% this year. Based on current estimates, the stock is trading at a forward P/E of 11.7.
Finally, we have BHP. This is the world’s largest diversified mining group, and size is its most significant advantage over the rest of the industry. Like peer Rio, during the past few years, the company has been concentrating on optimising its operations. Debt has been reduced and now sits below management’s targeted $10bn-$15bn range. Shareholder distributions have been increased as cash generation has improved. Total returns in the last six months alone exceed $13bn, and it doesn’t look as if BHP is going to stop there.
Now debt has fallen below management’s targeted range, the company has said it will increase dividends, from a minimum of 50% of earnings to 75%. Analysts’ initial figures suggest this could mean shareholders are in line for a total dividend of $2.06 this year, a dividend yield of 8.2% on the current share price.
In addition to this market-beating level of income, the stock trades at a highly attractive forward P/E of 12.4. While mining companies wouldn’t be for everyone, it’s difficult to ignore these attractive metrics.