Why dividends are set to disappoint at Rio Tinto plc and Centrica plc

Today I’m explaining why dividends are set to fall short at two FTSE 100 giants.

Digger in dire straits

A steady deterioration in commodity prices had prompted frenzied speculation that Rio Tinto’s (LSE: RIO) previously-generous dividend policy could be coming to a close.

And so it has come to pass. The diversified digger announced in February that “maintaining the current progressive dividend policy would constrain the business and act against shareholders’ long-term interests.”

Still, the sea change in Rio Tinto’s payout programme remains shocking. The firm had lifted dividends at an annualised rate of 47.8% in the five years since emerging from the 2008/09 global recession.

But the colossal pressure on the balance sheet prompted Rio Tinto to lock the dividend for 2015 at 215 US cents per share. And much worse is expected to come — the business warned that total payments for this year could fall to as low as 110 cents.

While the City expects the miner to meet this target, I’m not so optimistic. A predicted 40% earnings dip in 2016 leaves the dividend covered just 1.6 times, well below the safety benchmark of 2 times.

For many blue-chip companies this reading wouldn’t be a problem. But with Rio facing the prospect of further commodity price weakness — and tackling net debt of $13.8bn as of December — I reckon dividends could end up being slashed more than expected.

And a 3.6% yield, nudging fractionally above the FTSE 100 average, simply isn’t worth the gamble in my opinion.

Power problems

Electricity play Centrica (LSE: CNA) isn’t immune from the chronic supply/demand imbalance washing over commodity markets either.

Sure, Brent oil may have climbed back towards the $50 per barrel market in recent weeks. But a flailing Chinese economy, allied with heaps of new supply entering the market from OPEC nations, threatens to send crude values sinking again, a terrifying prospect for Centrica’s upstream divisions.

Meanwhile, the company’s retail arm is also facing an uphill battle just to stand still. Centrica’s British Gas division lost a further 224,000 clients during January-March, meaning the number of accounts on its books now stands at 14.4m versus 14.8m a year ago.

The relentless rise of independent suppliers has seen Centrica’s earnings fail to grow in the past three years, forcing the power play to cut the dividend in both 2014 and 2015.

And although another bottom-line fall is predicted for the current period — this time by a chunky 11% — the City expects it to lift the dividend from 12p per share in 2015 to 12.2p.

I fail to see how Centrica will elect to raise payouts as its revenues outlook remains murky and the firm is still getting to grips with its colossal debt pile. Net debt clocked in at an eye-watering £4.7bn as of December, and with the projected dividend covered just 1.2 times by predicted earnings, I reckon those enticed by Centrica’s 5.3% yield could also end up disappointed.

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Royston Wild has no position in any shares mentioned. The Motley Fool UK has recommended Centrica and Rio Tinto. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.