3 Top Dividend Stocks in Mining

High-yielding dividend stocks in the mining industry are few and far between. That's because the mining sector is capital-intense, which forces many to invest all their free cash flow into developing new mines. On top of that, commodity prices fluctuate wildly, which can cause cash flow to dry up, often taking dividends with it.

That said, several miners do currently pay a dividend. Here are 10 of them:

Data source: YCharts. Dividend yield as of June 12, 2017.

Of this group, three that stand out as top options for income investors are Rio Tinto, BHP Billiton, and Alliance Resource Partners, because each offers a compelling yield backed by solid financials. It's worth noting that while iron ore giant Vale also has a high yield, it doesn't make the cut because its financials aren't as sound. 

Image source: Getty Images.

Coal might be dying, but it's not dead yet

Coal-producing MLP Alliance Resource Partners and its high-yielding general partner Alliance Holdings GP (NASDAQ: AHGP) (which also yields 8.1%) offer one of the highest yields in the mining sector. That's partially because Alliance Resource Partners is a master limited partnership, which is a pass-through entity that doesn't get taxed at the corporate level. Another driver of its high yield is the fact that investors are worried about the coal industry, which has been losing market share to cheaper, cleaner-burning natural gas.

That said, while the coal industry has had its struggles in recent years, Alliance Resource Partners has been able to stay afloat because it secures long-term volume contracts with utilities for the bulk of its capacity. Furthermore, the company maintains a much lower leverage profile than its rivals, with it averaging just 0.8 times total debt to adjusted EBITDA over the past 12 months while peers average a 2.8 times leverage ratio. Finally, Alliance Resource Partners more than adequately covers its current distribution, having maintained a 2.5 times coverage ratio over the past four quarters, using the excess cash to pay off more debt. 

Because of its healthy finances and strong contract backlog, Alliance is starting to consider increasing its already generous distribution now that the coal market is showing some signs of life. Additionally, given that demand for coal is expected to grow 1.7% through 2025 according to the most recent forecast from the U.S. Energy Information Administration, it suggests that the death of coal isn't as imminent as the market might fear. Because of that, investors willing to take on the higher risk of investing in a coal miner can collect a very high yield with Alliance Resource Partners. 

A copper core with plenty of diversification

BHP Billiton is the fourth-largest copper producer in the world. That said, it's also a major producer of iron ore and coal, as well as oil and natural gas. That diversification enables it to pay a compelling dividend because it benefits from stronger-performing commodities offsetting weakness in other segments. For example, while revenue in its petroleum business declined in its most recent reporting period, the company more than offset that thanks to improving results in its copper, iron ore, and coal segments, which led to a 46% surge in operating cash flow.

Another driver of BHP Billiton's compelling dividend is its payout policy. After financing maintenance capital expenditures and strengthening its balance sheet, the company plans to pay out at least 50% of what's left in dividends to shareholders each period. Meanwhile, it plans to allocate the other half toward a balance of debt reduction, buybacks, organic growth, and additional dividends. 

That progressive dividend policy was on full display during BHP Billiton's most recent reporting period. Thanks to its robust cash flow, the company declared $0.30 per share in dividends under its minimum dividend policy. To top it off, because of its strong balance sheet, the company decided to pay an additional $0.10 per share in dividends for the period. Meanwhile, if cash flow increases in the future due to higher commodity prices or the start up of growth projects, investors stand to collect even larger dividends.

Image source: Getty Images.

The strongest balance sheet in the sector

Rio Tinto is similar to BHP Billiton in that it's a diversified mining giant, producing not only copper and iron ore but aluminum and diamonds. It also has a progressive dividend policy to pay out 40%-60% of its cash flow. That said, one area where it has a leg up on its global resources rival is its balance sheet, which is the best in its peer group. Currently, Rio Tinto has just 0.7 times net debt to EBITDA, which is better than BHP's 1.2 times leverage ratio. And it's light-years ahead of iron-ore focused Vale, which had a 2.1 times leverage ratio at the end of last year. 

Another reason Rio Tinto is a top dividend stock is that it has several initiatives underway to increase cash flow. These include three large capital projects that should deliver low-cost production growth in the years ahead. It's also working on improving the productivity of its equipment and processing plants, which it believes will increase free cash flow $5 billion by 2021. These two sources of free cash flow growth should give Rio Tinto plenty of money to continue paying one of the most generous dividends in the mining sector.

Investor takeaway

These three top dividend stocks in the mining sector have two things in common. First, each has taken steps to insulate revenue from market shocks either by securing long-term volume contracts or through diversification. Second, all three have top-tier balance sheets with low leverage ratios. Because of that, Alliance Resource Partners, BHP Billiton, and Rio Tinto have the cash to pay compelling dividends that should remain sustainable throughout market cycles, making them the top choices for investors seeking income from the mining industry.