Will the big miners be paying dividends?

Using the share market for income has been a feature of investor behaviour in recent years, a shift driven by low interest rates and parsimonious term-deposit returns – currently offering about 1.6%–1.7% at best.

Plenty of investors have been prepared to sift through the share market for much better returns than that, turbo-charged by dividend imputation. According to Thomson Reuters, the Australian share market’s average historical (FY19) nominal yield is 2.9%, which grosses-up to 4.2%. On FY20 expected dividends, the market’s average forward yield is 3.9%, equivalent to 5.6%.

And of course, the above-average dividend yields can be significantly higher than that.

By now, however, there cannot be an investor who does not understand the risks attached to share dividends – which are not contractual. The Coronavirus impact should demonstrate once and for all that dividends are wholly at the discretion of the company, and can be cut, or dispensed with altogether, if the financial circumstances dictate.

The other main risk – which is also, yet again, starkly apparent from the Coronavirus correction – is that while you are holding the shares for yield, the share price can fall.

Nonetheless, the dividend yield situation still attracts investors to the share market, despite well-founded concerns that the most popular yield generators – the four major banks – face huge pressure on their dividends. Paul Rickard discusses this in his article here a few weeks back.

Where there is heightened uncertainty about expected dividends, investors can usually base their yield expectation on the “historical” dividend, that paid in the most recent full-year. This at least has the benefit of being a cold hard fact, unlike dividend estimates.

More recently, many investors have focused on the big miners’ dividends, taking advantage of changes in the companies’ dividend policies, as well as the strong cash flows feeding into healthy dividends. In particular, the iron ore miners have enjoyed robust prices and margins, and even though there is plenty of uncertainty – and volatility – stemming from the Coronavirus outbreak, the prospect of China implementing commodity-intensive stimulus to dampen any economic downturn should support iron ore prices reasonably well.

On this reading, the big trio of Fortescue Metals Group, Rio Tinto and BHP should be able to pay above-market dividend yields this year.

 1. Let’s look at Fortescue (FMG:ASX)

As a pure iron-ore exposure, healthy iron ore prices continue to drive earnings and free cash flow (FCF) momentum for Fortescue. In its half-year results for December 2019, Fortescue posted a realised price of US$80 a tonne for its ore, against a production price below US$13 a tonne. Its underlying EBITDA (earnings before interest, tax, depreciation and amortisation) margin was 65%.

Even if the iron ore price were to fall to the low US$70s, the cash flows that pour off this business could be reasonably expected to support a strong dividend yield.

At $11.40, FMG is trading on a prospective FY20 yield of 13% (equivalent to a grossed-up yield of 18.6%).
The FY19 dividend was US$1.14 a share.
FY20 analysts’ consensus estimate, FN Arena: US$1.43 (76 Aust cents already paid)
FY20 analysts’ consensus estimate, Thomson Reuters: A$1.4869 (76 Aust cents already paid)

Let’s stress test that a little.

If the FY20 dividend cut by 25% = 85.5 US cents: prospective yield = 11.7% (grossed-up, 16.8)
If FY20 dividend cut by 50% = 57 US cents: prospective yield = 7.8% (grossed-up, 11.2%)

So, even if there is, in effect, no second-half dividend, FMG will produce, on the current price, a grossed-up yield of 9.5%.

2. Let’s do the same for BHP (BHP:ASX)

FY19 dividend per share: US$1.33
FY20 analysts’ consensus estimate, FN Arena: US$1.30 (65 US cents [99.4 Australian cents] already paid)
FY20 analysts’ consensus estimate, Thomson Reuters: A$1.972 (99.4 Australian cents already paid)
BHP trading on FY20 prospective yield of 6.3% (grossed-up, 9%)

If FY20 ordinary dividend cut by 25% = 99.75 US cents: prospective yield = 4.9% (grossed-up, 7.0%)
If FY20 ordinary dividend cut by 50% = 66.5 US cents: prospective yield = 3.3% (grossed-up, 4.7)

3. And now to RIO…Rio Tinto (RIO:ASX)

FY19 dividend per share: US$4.43
FY20 (December) analysts’ consensus estimate, FN Arena: US$3.802
FY20 (December) analysts’ consensus estimate, Thomson Reuters: A$4.9773
RIO trading on FY20 prospective yield of 5.5% (grossed-up, 7.9%)

If FY20 dividend cut by 25% = US$3.3225: prospective yield = 5.8% (grossed-up, 8.3%)
If FY20 dividend cut by 50% = US$2.215: prospective yield = 3.9% (grossed-up, 5.5%)

Another stock in a similar position is Alumina (AWC), which owns 40% of the Alcoa World Alumina & Chemicals (AWAC), the world’s largest alumina (aluminium oxide) and bauxite (aluminium ore) business. As a commodity, alumina does not make for pretty reading at present: after a strong start to 2020, prices slumped to four-year lows in March as the Covid-19 pandemic hit.

AWC has been a dividend darling, but 2019 saw a 65% cut to the dividend, to 8 US cents, as profit slid by 53% on the back of production rises at some of Alumina’s rivals. The prevailing gloom in the alumina market raises the possibility of further cuts to Alumina’s dividend: analysts are not yet quite ready to take the scissors to their expectations, but stress-testing shows that AWC would still look fairly attractive on yield grounds for 2020.

4. Alumina (AWC:ASX)

FY19 dividend per share: 8 US cents
FY20 (December) analysts’ consensus estimate, FN Arena: 7.5 US cents
FY20 (December) analysts’ consensus estimate, Thomson Reuters: 10.33 Australian cents
AWC trading on prospective FY20 yield of 6.8% (grossed-up, 9.7%)

If FY20 dividend cut by 25% = 6 US cents: prospective yield = 6.1% (grossed-up, 8.8%)
If FY20 dividend cut by 50% = 4 US cents: prospective yield = 4.1% (grossed-up, 5.9%)