Some investors believe that ageing heavyweights such as Royal Mail (LSE: RMG), Imperial Brands (LSE: IMB) and Rio Tinto (LSE: RIO) are dinosaurs facing possible extinction. But the evidence suggests a different view.
These companies benefit from their large scale. They use technology to become more efficient and protect their profit margins. For shareholders, they promise to provide a reliable long-term dividend income.
Is recent surge a buy signal?
Shares in Royal Mail have risen by 21% so far this year, thanks to a surge that’s taken the stock from a 52-week low of 412p in February to its current level of 536p.
Investors have been reassured by recent statements from the postal regulator which suggest that the group is safe from further price controls. However, letter volumes seem certain to continue falling and the group faces tough competition in the parcel sector.
So are the shares a buy? As a dividend investor, it’s Royal Mail’s ability to generate free cash flow which appeals to me. Last year, the group generated free cash flow of £292m, or 29.2p per share. That comfortable covers last year’s dividend of 22.1p per share.
City analysts expect Royal Mail’s adjusted profits to be fairly flat this year. The stock currently trades on a forecast P/E of 13.3, with a potential yield of 4.3%. I believe progress is needed in the parcel business to justify further gains, so rate the shares as a hold.
High-tech mining cuts costs
Rio is using technology to cut the cost of mining. The automated trains and unmanned mining trucks being rolled out at its Australian iron ore operations are good examples of this.
Rio’s iron ore cash costs fell by 24% to $14.90 per tonne in 2015. This reduced cash outgoings by a total of $428m before tax. Despite falling iron ore prices, Rio still earned a gross (EBITDA) margin of 60% on its Pilbara iron ore sales last year. That seems like a highly defensive and cash generative business to me.
I believe Rio’s forecast dividend yield of 4.1% should be comfortably affordable. As one of the world’s lowest-cost iron ore producers, my view is that the company will produce reliable dividends for many more years. I rate the shares as an income buy.
Are ethical concerns a dividend risk?
Many investors have concerns about the environmental impact of mining. Ethical concerns also apply to tobacco firms. In both cases some investors believe that the long-term outlook for these businesses is uncertain.
I’m less convinced. While tobacco volumes have declined in western markets over the last decade, total volumes are still vast. Imperial Brands reported total tobacco sales volumes of 133.9 billion stick equivalents for the first six months of 2016. Although that’s a 3.1% decline on the same period last year, Imperial still reported a 21.8% rise in adjusted operating profit and increased its dividend by 9.8%.
Regular takeover and merger deals have helped Big Tobacco increase profits, despite falling sales. My only reservation is that Imperial’s growth in recent years has left the group with a lot of debt.
If interest rates rise, Imperial might be forced to repay some of this debt. This could put pressure on the group’s dividend. But for the time being, Imperial’s forecast 4.1% yield looks safe enough to me.