Are Rio Tinto shares the perfect income stock? Or is it time to sell?

Rio Tinto shares have recovered strongly, thanks to resilient earnings and a strong dividend. Is it the perfect income stock, or is it too expensive?

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Rio Tinto (LSE: RIO) shares have recovered strongly from their recent lows. In fact, the mining company has risen by nearly 60% from the middle of March, and its current share price is higher than at the start of the year.

With a dividend yielding over 6%, it’s also one of the largest dividend payers on the FTSE 100. At this time of mass dividend cuts, it’s no surprise many investors have bought. But with potential problems on the horizon, and an expensive valuation, is it time to cash out?

Recent trading update

Rio Tinto’s first half underlying earnings were only down 4%, demonstrating the stock’s resilience. This was driven by the sale of iron ore, accounting for 90% of first-half profits. Iron ore has performed strongly, mainly due to Chinese demand and supply constraints. Consequently, its revenues rose 2% over the first half of the year.

Less positive news came from the other divisions. In fact, weak global demand for aluminium saw revenues in this division fall by 12%. The period was particularly challenging for diamond sales too, seeing a decline of nearly 40%. As such, it seems clear the miner is reliant on iron ore prices remaining high. A drop-in demand would therefore have severe ramifications for Rio Tinto shares.

Problems could be on the horizon

The company recently revealed two Aboriginal Australian caves were blown up in May to access an extra 8m tonnes of iron ore. Rio Tinto admitted it missed key opportunities to prevent damage to one of country’s most significant heritage sights.

Although the blasts weren’t deemed illegal, I believe this could still lead to a number of problems. Firstly, there’s the reputational damage. For example, one of the Rio Tinto shareholders, AustralianSuper, has already said “Rio Tinto’s actions are totally unacceptable.” As a result, its already expensive shares could take a hit.

In addition, this incident may make it particularly hard to gain consent for new mines. Future profits could therefore be strained as capital expenditures are forced to increase. Although Rio has confirmed there won’t be any impact this year, it’s reviewing the longer-term implications.

Are Rio Tinto shares the perfect income stock?

While I do have concerns about Rio Tinto shares, there’s no doubt it pays a very strong dividend. This is the one aspect that attracts me to the stock. Firstly, a yield of over 6% is very impressive, especially as nearly half of FTSE 100 companies have cut or cancelled dividends. The dividend also looks safe due to a cover of 1.6. As a result, a cut doesn’t seem imminent. 

Nevertheless, if future profits are hit, such a high payout may be unwise. As a result, I’d be wary of the dividends’ long-term future. For investors looking for good income stocks, there are plenty of companies with better growth prospects. I’d therefore avoid Rio Tinto shares.

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.

Stuart Blair 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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