A Closer Look at Rio Tinto's Dividend Potential

LONDON -- Dividend income accounts for around two-thirds of total returns, the actual rate of return taking into account both capital and income appreciation. Given that share prices are often volatile and unpredictable, the potential for plump dividends can give shareholders much-needed peace of mind for decent returns.

I am currently looking at the dividend prospects of Rio Tinto (RIO 2.50%) (RIO 2.25%) and assessing whether the company is an appetizing pick for income investors.

How does Rio Tinto's dividend history stack up?

Source: Rio Tinto Company Accounts

The shockwaves of Lehman Brothers' collapse in 2008 on the global economy has caused Rio Tinto's earnings, and thus shareholder payouts, to fluctuate wildly over the past five years. The company cancelled 2009's interim dividend as weak commodity prices and a sickly macro outlook weighed, driving the full-year payout heavily lower.

A near-100% earnings rebound and perkier prospects for natural resources demand prompted reinstatement the following year, more than doubling 2009's full-year payout, and dividends have continued to tread higher albeit at a slower pace. Last year's increase came despite a 38% earnings per share (EPS) decline, due primarily to $14.4 billion worth of writedowns at its aluminum and coal businesses.

Dividend cover during the period has not surprisingly also performed erratically during the period, although it has dropped toward the safety watermark of two times prospective earnings as the company has doled out more cash to shareholders. And earnings pressure last year drove the ratio markedly lower.

What are Rio Tinto's dividends expected to do?

Source: Digital Look. Exchange rate: £1=$1.52090

City analysts expect the dividend to continue heading higher over the medium term, underpinned by convincing earnings-per-share growth which is expected to clock in at 12% both this year and next. And dividend cover is anticipated to remain above two times earnings, a critical tenet for cyclical plays such as mining companies.

Rio Tinto swung to a $2.9 billion net loss in 2012 from a $5.9 billion profit in the prior 12-month period, the result of the huge writedowns weighing heavily on the balance sheet. The company said at the time of February's release that it remains confident over the shape of the business and outlook for long-term commodity demand.

Still, the company has taken steps to address the prospect of decelerating demand for commodities, with planned cost reductions in the region of $5 billion targeted by the end of next year, and has slashed exploration capex by $750 million by slowing modernization and expansion at a number of its sites.

How do Rio Tinto's dividend prospects rate against the competition?

Source: Digital Look

Rio Tinto currently deals on an earnings multiple of 8.1 for 2013, beating the FTSE 100 in terms of both price and yield, although a distorted yield forecast for the entire mining sector makes a comparison with fellow diversified miners BHP Billiton and Glencore Xstrata a worthwhile exercise.

BHP Billiton carries a prospective dividend yield of 3.8% and trades on a forward P/E rating of 12.4, while Glencore Xstrata is expected to yield 3% and deals on an earnings multiple of 11.8. In this respect Rio Tinto offers a much more appetizing dividend package.

However, I reckon that Rio Tinto remains a gamble for investors seeking reliable income. Many of its key markets are expected to record huge surpluses in coming years, particularly the crucial iron ore market, and fears of slowing momentum in resources glutton China could eat into earnings once more. Rio Tinto is a potentially decent income pick, but I do not believe the rewards outweigh the risks for those seeking dividend reliability.

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