The FTSE 100 index of leading shares contains a lot of large, well-established companies that are familiar to many investors. So for such shares to offer double-digit percentage yields is quite unusual. Right now, homebuilder Persimmon has such a yield. I think many investors are concerned that the risk of a housing market downturn could spell trouble for profits and the dividend at Persimmon.
But Persimmon is not the only FTSE 100 share with a double-digit dividend yield. Rio Tinto (LSE: RIO) yields 11.9% at the moment, while fellow miner Antofagasta (LSE: ANTO) offers 10.1%.
Those seem like very high yields to me. So what is going on – and should I buy the shares for my income portfolio?
Mining cycle
It is no coincidence that both of those companies are miners. I think the high yield reflects investor concerns about dividend sustainability.
Mining is what is known as a cyclical industry. What happens is that when prices are high, miners spend money developing new projects to take advantage. But such projects typically take years or even decades to move to production. So, at some point output starts to rise while demand and prices may have gone in the other direction. That mismatch of supply and demand pushes prices down further. Producers stop developing new projects and close or mothball existing ones as a low selling price makes them economically unattractive. At some point, supply struggles to match demand, prices go up and the whole cycle starts again.
That means investors can do well in some mining stocks – but they need a long-term outlook and a strong stomach. Watching a share you own lose lots of value in a matter of months despite having wonderful assets is never easy.
Potential trouble ahead
I think that cycle helps explain why both Rio Tinto and Antofagasta have unusually high yields right now. Looking ahead, investors are concerned that their dividends may need to be cut.
Both these FTSE 100 miners have done well from a boom in metals demand. Rio Tinto grew its annual dividend by 89% over the past three years. The growth at Antofagasta in the same period was even stronger, with the annual dividend more than tripling!
That sort of dividend growth can be great for an investor – if he owns the shares to start with. But what if I buy the shares now, with their double-digit yields? There is a clear risk that, when metal prices start to ease off again, the payouts will be cut. That in turn could lead to a share price fall.
The Rio Tinto share price is already down 20% over the past year, with Antofagasta shares losing 23% of their value in the same period.
My move on these FTSE 100 shares
I like both of these companies. I think they have attractive assets, long experience in the complexities of global mining, and expertise in getting product to market. That helps explain why both have made it to the prestigious FTSE 100 index in the first place.
But a worsening outlook for metal prices could spell trouble for their dividends. I think that helps explain why their share prices have been sliding. For now, I do not plan to buy either share for my portfolio at this point in the metal price cycle.
