Today I am explaining why Rio Tinto (LSE: RIO) (NYSE: RIO.US) could seriously disappoint dividend hunters.
Brokers predict bumper dividend hikes
Through a programme of aggressive asset shedding and cost-cutting, diversified mining leviathan Rio Tinto has managed to hurdle the problem of stagnating revenues growth as commodities prices have collapsed, and continue pumping out market-beating dividend yields.
And although commodity markets remain in very real danger of further serious deterioration, City analysts expect Rio Tinto to keep hikes in the annual dividend rolling at a rate of knots. The company is anticipated to fork out a payment of 218 US cents per share in 2015, up 5% from the anticipated 208-cent payment this year.
And the good news does not stop there, with Rio Tinto expected to deliver a further 9% advance in 2016, to 238 cents. Consequently the business yields a mammoth yield of 4.9% in 2015, and which moves to an even-more impressive 5.3% for next year.
… but worsening market fundamentals suggest otherwise
Still, I believe that investors should take such projections with a massive pinch of salt given the precarious state of Rio Tinto’s end markets, particularly in the iron ore sector — the business sources around 75% of total profits from this one resource alone, so signs that prices look set to maintain their downtrend does not bode well for the firm’s earnings outlook.
Prices of the steelmaking ingredient almost halved in 2014, resulting in December’s five-year trough below $67 per tonne. Iron ore has received a boost in recent days amid reports of Chinese restocking, but this is likely to prove a temporary positive phenomenon.
Indeed, Yang Zunqing, deputy secretary of the China Iron and Steel Association, said this week that weak demand felt by the country’s steel mills will keep iron ore prices on a “downward track” during the course of 2014.
Despite these concerns, however, Rio Tinto and its major industry peers continue to ramp up production at a stratospheric rate. Bloomberg reported this week that Brazilian iron ore exports leapt 18% during December, to 37.4 million tonnes, as major domestic producer Vale kept the excavators on overdrive.
For Rio Tinto, these pressures are likely to result in a calamitous 14% earnings decline this year, which in turn leaves the dividend covered just 1.8 times — any reading below 2 times is generally considered cause for concern.
The iron ore sector is currently facing the same perils as those currently being seen in the oil market, as the investment community grapples to project what the fossil fuel price will bottom out at. With this in mind, I believe that any potential earnings rebound at Rio Tinto is impossible to predict, a worrying omen for dividends this year and beyond.