Are Storm Clouds Gathering Over Rio Tinto plc And BHP Billiton plc’s Dividends?

Rio Tinto (LSE: RIO) and BHP Billiton (LSE: BLT) are currently facing an unprecedented number of problems.

So, in an attempt to main profit margins and shareholders returns, the two mining giants are ramping up production. But can this really safeguard their dividends?

Reassuring update

Rio’s quarterly production update, released today, showed how the mega-miner is ramping up production to lower costs and maintain growth. During the first three months of this year, Rio’s iron ore production rose 12% year on year. Copper output fell 9% year on year while aluminium production remained stable. Rio’s production of coking coal rose 10%.

And alongside the company’s production figures, Rio’s management used today’s release to reassure shareholders that the mining giant was working overtime to maximise shareholder returns. 

“We continue to drive efficiency in all aspects of our business, which is reflected in our solid production performance during the first quarter…By making best use of our high-quality assets, low-cost base and operating and commercial capability our aim is to protect our margins in the face of declining prices and maximise returns for shareholders throughout the cycle.”

Uncertainty ahead 

However, despite this relatively upbeat trading statement from Rio, storm clouds are gathering over the company and its larger peer BHP. 

Last week, credit ratings agency S&P placed Rio and BHP on ‘credit watch negative’ ahead of a possible credit rating downgrade. The agency stated that it was concerned about the miners’ financial stability, as the prices of key commodities continued to plummet. 

Further, some City analysts have already started to question the sustainability of BHP’s dividend.

In particular, based on current iron ore prices and capital spending plans, it’s believed that BHP’s free cash flow from operations will not be able to cover the company’s current dividend payout. As a result, it’s likely that the company will be forced to issue debt to support its dividend.

Luckily, BHP can afford to borrow a bit more to sustain the payout. The company’s net debt currently stands at 1.5 times earnings before interest, tax, depreciation and amortisation, which isn’t overly concerning. 

On the other hand, analysts are positive about Rio’s dividend potential. Analysts believe that Rio’s dividend cover will fall to 1.2 times during 2015, before rising back to 1.5 times during 2016. 

The bottom line 

So overall, despite falling commodity prices, the dividends of Rio and BHP look fairly safe for the time being.

BHP’s strong balance sheet can take on more debt to help fund the company’s dividend payout, while Rio’s rising output and falling costs will help the company maintain its dividend.