Should I Invest In Rio Tinto plc Now?

At today’s share price around 3028p, Rio Tinto’s (LSE: RIO) (NYSE: RIO. US) forward dividend yield of 4.8% or so seems tempting to those of us hunting reliable income from our stock market investing.

Production going up

In last month’s third-quarter update, the firm’s Chief Executive said iron ore production is at record levels, and the company is performing well on copper and aluminium production. He reckons a strategy of focusing on long-life, low-cost assets means Rio Tinto will continue to generate strong cash flows despite a lower price environment for the firm’s output, resulting in increased and consistent cash returns to shareholders.

That all sounds great for the dividend, I have to admit, but it’s the fluctuating nature of the share price that bothers me. Output selling prices waggle up and down, which makes profit predictions fluid. Just recently, City analysts reduced their forecasts. They now expect Rio’s earnings to decline around 11% by the end of 2014 and by a further 4% during 2015.

Such profit contraction seems to leave forward P/E ratings looking stretched. The current forward rating of over 10 seems high for cyclical firm mid-way through the macro-economic cycle. Either earnings need to increase or the share price needs to fall if we are to get to a more comfortable single-digit rating. Right now, earnings continue to fall despite Rio’s efforts to ramp up production. If earnings don’t grow soon, perhaps the share price will decline, which could wipe out years’ worth of investor income gains.

But the dividend record is good

Despite fluctuating output prices, RioTinto keeps its dividend growing:

However, the profit and cash flow performances backing the dividend payout seem volatile. As the dividend rises, cover from earnings and cash flow is getting thinner, which raises the stakes.

Any slump in profits in the future could easily sink both the dividend and the share price, and the main problem with out-and-out cyclical firms such as Rio Tinto is that we don’t know when the next macro-economic collapse will arrive.

For that reason, it’s best to view Rio Tinto first as a cyclical company and second as a good dividend payer. Personally, I wouldn’t entertain a flutter on any of the big miners unless the share price had recently collapsed. Under those conditions, there’s a fair chance of catching the next cyclical up-leg, and less of a chance of suffering a cyclical plunge.

Right now, with the shares hovering mid way between extremes on the chart, I think Rio Tinto packs a lot of risk for investors.