Rumours are circling that Rio Tinto [ASX:RIO] is set to announce changes to its dividend policy, which may take effect as early as August. With the ongoing volatility taking place across commodity markets, analysts expect Rio to cut its dividend outlook later this week.
Rio pays out roughly $5.8 billion in dividends every year. But that amount will come under threat on Thursday, when the mining giant delivers its full year results. The earnings figures aren’t likely to make for pretty reading, but that’s not altogether surprising. The commodity price rout has left the entire industry facing weaker earnings.
What investors will be less happy about instead is any attempt to reduce future dividend payouts.
Rio wears its so-called ‘progressive’ dividend policy as a badge of honour. But it’s a badge of honour that can, at times, resemble a noose around its neck. Investors have come to expect strong dividends. A progressive policy is a fancy way of saying dividend payouts will keep rising every year. Or, at the very least, dividends will maintain their current level.
Rio’s interim dividend should amount to one half of the total dividends from last year. And the final dividend each year ‘should’ be equal to the previous interim dividend, at the least.
If Rio goes back on its word, it could lead to restlessness.
With that kind of policy, it’s small wonder people invest in the company. Even a shoddy commodities market isn’t enough to dent confidence. Most investors are happy when a company doles out dividends regardless of what’s happening elsewhere.
Of course, we don’t know for certain what exactly Rio will announce this week. Maybe they won’t give any indication at all.
There are some suggestions Rio may hold off until BHP Billiton [ASX:BHP] makes the move first. BHP is another of the blue chip mining stocks showering investors with progressive dividends. Yet, as with Rio, questions over BHP’s policy are coming in thick and fast.
Ultimately, the longer the rout continues, the harder it’ll be for either company to maintain its dividend policy. Some analysts forecast BHP paying out half of its full year dividends from last year. Others believe it could cut interim dividends in half when it announced results soon. Rio may have to do something similar.
Either way, any change won’t affect short term payouts. As the Australian Financial Review reports:
‘Under the existing policy, [Rio’s] full-year dividend would be at least US$2.15 billion — the same as the previous year, while analyst consensus predicts a slight increase to US$2.21 billion.
‘If rival BHP Billiton kills off its progressive dividend policy at its interim earnings later this month, as it is widely expected to, and cuts its US$6.6 billion annual payout, that would leave Rio as the last man standing among the majors.’
Yet it’s unclear whether being the last man standing in this case is a good thing or not.
What can Rio do going forward?
Of course, Rio has a couple of options available to it in how it goes about changing its policy.
It could, for instance, adopt a dividend strategy based on payout ratios. This simply refers to a ratio the company would pay as a percentage of its income. In other words, it’d tie its dividend policy to earnings.
At the same time, it could simply lower the dividend yield. That’d allow it to reset its dividend policy, working its way up again as the commodity market rebounds.
Both are viable options. And they make given the circumstances facing the company.
The only question then is: will Rio change its dividend policy?
Well, let’s assume BHP decides to lower dividend yields by the end of this month. That’d leave Rio as the only major player still sticking by its progressive policy. Vale and Glencore have already done away with this, going as so far as to suspend dividends altogether.
That’d leave Rio as something of a lone wolf in the industry. Would that be a wise move? The other companies would have an advantage in that they’d have greater flexibility. More than anything, mining companies need stronger balance sheets. Costly dividend policies won’t help them get there.
Now, that’s not to say Rio can’t continue to pay out a healthy dividend. But it doesn’t need to one-up itself time and again when conditions aren’t suited for it. Better to create flexibility that’ll allow it more control over how to manage its balance sheet.
When it announces its results on Thursday, Rio’s earnings are expected to be US$4.5 billion. That’s half what the company announced last year. Worse still, Rio is likely to announce it borrowed money to fund dividend payouts last year. Investors may not care too much about that. But it won’t help Rio’s balance sheet in the long run, that’s for certain.
Tim Schroeders, a fund manager at Pengana Capital (which owns shares in Rio) says cutting dividends makes sense. He notes:
‘[Rio] can still pay out a healthy dividend, but there is no need to lock yourself into a progressive policy and make a rod for your own back. Why differentiate yourself and be less flexible? In 12 months or sooner [the dividend policy] could change.’
Dividend hungry investors may think otherwise. But, in the long run, the company will be better off by going back to square one.
Even if Rio doesn’t make any changes to its policy on Thursday, it won’t be long before it does. The commodity price rout hasn’t disappeared. And it won’t for another good few years in all likelihood. Considering we’re in the middle of the worst iron slump in a decade, there’s a good chance things will get even worse.
So when will iron ore prices bottom out? Will we see a recovery this year? And should investors be keeping faith with miners now?
As The Daily Reckoning’s Greg Canavan explains, the answer might be ‘no’. Greg says some miners will survive the great iron ore slump. Many others won’t.
One company is under particular risk. This well-known company comes in a close third to BHP and Rio Tinto in iron ore production. Yet, as Greg will show you, there are two reasons why this company may not survive the next leg of the iron ore bear market.
Greg’s no stranger to the iron ore market. In 2013 he predicted the downfall of Australia’s biggest export. At the time, he advised readers of his investment advisory Crisis & Opportunity to bet against iron ore giant Fortescue Metals [ASX:FMG]. So far, his readers are sitting on a gain of 66.72%.
You’ll learn about all this and more in Greg Canavan’s brand new report: ‘The Great Iron Ore Slump: Why Australia’s biggest commodity export is headed below $20 a tonne’. Greg shows you why iron ore could plunge as low as US$20 a tonne. He’ll explain what this means for the Aussie economy and for your stock portfolio.
To download the free report, click here.
Junior Analyst, The Daily Reckoning