Today I am looking at why I believe income hunters could be disappointed by Rio Tinto (LSE: RIO) (NYSE: RIO.US).
Further dividend growth on the cards
Since the financial crisis of five years ago crushed commodities prices and with it earnings across the mining sector, Rio Tinto has worked diligently to rebuild its previously robust dividend policy.
The full-year payout has risen at a compound annual growth rate of almost 44% since 2009, and although dividend rises have since normalised the business still lifted the payment an impressive 15% during the last 12-month period, to 192 US cents per share.
And City analysts expect the dividend to continue marching higher during the medium term at least. Indeed, an estimated 213.7 cent dividend is pencilled in for 2014, up 11% year-on-year. And an extra 8% rise is anticipated for next year to 230.8 cents.
Bumper yields… But for how long?
And at face value, projected dividends at the mining giant appear to be relatively secure, too. Despite expected earnings slippages of 8% and 2% in 2014 and 2015 correspondingly, forecasted payouts at Rio Tinto are still covered 2.4 times and 2.2 times by earnings in these years. Any reading over 2 times is considered theoretically safe.
The business has managed to maintain solid dividend growth in spite of rolling earnings weakness — Rio Tinto has slipped into the red during two of the past five years — as a result of its relatively-strong capital position.
Impressively, Rio Tinto has kept the balance sheet in good shape through strict cost-cutting and an extensive scaling back of capital expenditure. Indeed, the business saw operating cash costs improvements register at $2.3bn last year, comfortably surpassing its target of $2bn.
On top of this, Rio Tinto also remains engaged in an aggressive divestment programme to strengthen the balance sheet and de-risk its operations. The company raised $3.5bn last year through the sale of non-core assets, and more recently the business completed the sale of its coal assets in Mozambique this month. The miner is also reviewing its stake in the Bougainville copper project in Papua New Guinea.
However, the company’s self-help measures can only go so far towards mitigating the effect of weak commodity markets, where prices could worsen further should the global economic downturn accelerate.
Although dividends are expected to remain impressive during the medium term — projected payouts for this year and next create chunky yields of 4.6% and 4.9% respectively — shareholders should be prepared for further slowdowns in dividend growth if revenue prospects continue to deteriorate.
