Shares in global mining firm Rio Tinto (LSE: RIO) offer investors the prospect of making significant passive income. And better still, they are trading 22% lower now than they were on their 26 January high this year. This suggest to me that there may be share price gains to add to passive income returns.
The fall in share price over Q1 seemed reasonable enough. It was based mainly on China’s uncertain growth prospects following three years of Covid.
Before that, the country’s dramatic economic growth had powered commodity price gains from the mid-1990s.
However, since Q1 signs have emerged that China’s economy will recover more strongly than many think.
China’s recovery matters for miners
Last week (3 August) saw data released showing a rise in services activity in July. The service sector is expected to be a main driver of China’s economic growth this year.
On 17 July, China’s Q2 GDP showed economic growth increased by 0.8% in the quarter, compared to Q1. This was better than consensus analysts’ expectations of a 0.5% increase.
On a year-on-year basis, the economy expanded 6.3% in Q2 — significantly better than the 4.5% rise in Q1.
There is a risk in the shares, of course, that China’s economic recovery may stutter.
A world-class mining operation
Rio Tinto is the world’s second-largest metals and mining company, producing many commodities needed by China.
Iron ore is used in the steel that is key to China’s infrastructure build-out. Aluminium is used in the jet engines, electric vehicles, and mobile phones manufactured there.
Lithium is essential in China’s batteries for hybrid and electric cars, laptops, and other devices. And copper plays an essential role in Chinese-made computers, smartphones, and other electronic devices. It is also used in wiring for construction.
Major passive income opportunity
In 2022, Rio Tinto shares yielded 6.7%, in 2021 the figure was 12.7%, and in 2020 it was 6.7% again. Currently, the yield is around 6.3%, compared to the FTSE 100’s average payout of about 3.7%.
The company’s yields have been reasonably well-supported by dividend cover ratios of 1.66-1.67 in these three years. A ratio above 2 is considered good, while below 1.5 may indicate the risk of a potential dividend cut.
Additionally positive is that the company is paying out $2.9bn after disappointing H1 results. It stuck to its policy of paying out to shareholders 50% of its underlying earnings.
Even at a 6% average over 10 years, a £10,000 investment now would make me £6,000 in passive income over that period.
This return would not include further gains from any reinvestment of dividends or share price appreciation. On the flipside, there would also be tax liabilities, of course.
I already have holdings in the sector, but if I did not, I would buy Rio Tinto today for three key reasons.
First, the possibility of the 22% share price loss being recouped. Second, the prospect of further share price gains based on China’s recovery. And third, the high passive income I could make from them.
