Rio Tinto shares are dirt cheap and yield 7.88%. Are they a screaming buy?

Now looks like a good time for me to buy Rio Tinto shares but I do have one question. Exactly how secure is the dividend really?

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Rio Tinto (LSE: RIO) shares are picking themselves up after a rough ride and I’m wondering whether to add them to my portfolio before they race off again.

The world’s biggest iron ore producer was caught up in the general commodity stocks sell-off over the summer as the Chinese growth miracle finally bumped into reality. As the world’s biggest consumer of metals and minerals, China is a swing consumer, if there’s such a thing.

Cyclical sector

I was therefore surprised to see that the Rio Tinto shares price is up 7.16% over the last year, which looks good. Then I recalled that the market generally was really in the doldrums last October. I know, because that’s when I added Rio to my portfolio. It was too cheap to resist.

Looking at its performance chart over the last five years, the stock price has gone up and down, up and down, as the pandemic, energy shock and cost of living crisis played out. Commodity stocks are cyclical and I prefer to buy when they’re in one of their troughs, as Rio Tinto is today. It looks cheap too, trading at 7.7 times earnings.

This morning, Rio reported a rise in quarterly output across its copper and aluminium portfolios. However, the stock dipped almost 1% after the board cut the annual estimate for its Canadian iron ore business due to operational failures. Extended plant downtime, conveyor belt failures and wildfires in Northern Quebec took their toll.

That’s a blow as Rio generates 70% of its profits from iron ore. But it wasn’t all bad news. Q3 iron ore shipments rose 1.2% and the price is rising too, thanks to Chinese stimulus. And its copper business is doing well.

“Softer market conditions” hit the Anglo-Australian miner’s first-half results, published in July, with underlying EBITDA earnings falling 25%. It still earned $11.73bn so no reason to hit the panic button.

All about the dividend

Rio Tinto generated $6.98bn of net cash from operating activities, down by a third but not too shabby. The interim dividend totalled $2.9bn, in line with its practice of paying out 50% of underlying earnings. I respect that commitment to rewarding shareholders.

Stable free cash flow generation is important to fund the dividend, and this fell 47% to $3.8bn in the first half. It confirms my view that this isn’t going to be the most stable dividend on the FTSE 100. 

I took a small stake in Rio Tinto in October last year, when it was yielding more than 10%. In February, the full-year 2022 dividend was slashed by more than half to $4.92 per share, although in fairness, that did follow a record 2021 payout of $10.40.

July’s proposed interim dividend of $1.77 a share was down 34% on last year’s $2.67. So the dividend isn’t totally reliable, but it should still prove rewarding over time. Consensus forecasts suggest the stock will yield 6.56% in 2023 and 6.47% in 2024. Bond yields may be rising, but that is still a juicy income stream.

The group’s fundamentals look sound, with net debt manageable at $4.35bn. I wouldn’t call the stock a screaming buy, but it’s still a buy for me. I hold FTSE 100 miner Glencore and my planned Rio Tinto buy will complement it nicely.

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.

Harvey Jones has positions in Glencore Plc and Rio Tinto Group. 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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