Unfortunately, many small businesses will be wiped out over the next few years. No matter how well any business in question operated in past times, the effects of Covid-19 have changed the world. Any time we have seen significant change or turmoil in the past, there always have been winners and losers. As it is practically inevitable over the next few years that restrictions and lockdowns will continue, small businesses will continue to feel the brunt of how Covid-19 is affecting consumer habits.
This means now more than ever, “yield” or “income derived” portfolios will take on extra importance as we head into this decade. Whereas in better times, an investment portfolio for many was an outlet for funds which may not have been needed for decades, we foresee this paradigm changing significantly as income now becomes a much higher priority.
One such company which we believe has bright prospects going forward from an income standpoint is Rio Tinto (RIO). The miner currently pays out a yield of 6.22% and has a market-cap of over $76 billion. Before we get into the strength of Rio’s dividend, let’s take a long-term view of the US Dollar.
Rio Tinto, for example, has still not been able to take out its 2008 highs. Although Rio has paid a sizable dividend since then, shares have been unable to surpass those highs back in the great recession. Look at how the US dollar has performed since the great recession. The dollar index powered up almost 30% before it finally topped out in early 2017. At the start of this year, the greenback tried to break above its 2017 highs but it was unable to do so. We believe that this occurrence brings a double topping pattern in play. We state this because the greenback is now demonstrating significant bearish divergences on the long-term chart due to very poor momentum numbers. Suffice it to say, we believe it is only a matter of time before the dollar’s 2018 lows (present support) fail to the downside.
We mention the dollar because shares of Rio Tinto went up more than 5-fold in the first decade of this century before finally topping out in 2008. As we can see from the dollar chart above, the dollar index lost close to half of its value during this time frame. The inverse correlation is due to the fact that commodities become more expensive (in dollars) in an environment where the dollar is weakening.
Besides the technicals, the dividend is an excellent metric to research when evaluating the strength of a company. We state this because the strength of the same encompasses all three of the financial statements. Suffice it to say, when the dividend is sustainable and has plenty of runway to grow, it usually means that higher share prices are on the way for the company.
As stated, Rio’s yield of 6%+ will no doubt attract dividend investors but growth in our opinion is equally as important for a number of reasons.
- High growth rates protect against inflation.
- High growth rates usually mean earnings are expected to keep on growing.
- High growth rates enable the shareholder to earn a percentage of the company’s growing earnings.
Astonishingly, Rio has grown its dividend on average by 30% per year over the past 5 years. By any standard, this has been an excellent return for shareholders over this time frame. To see if the company can keep up this blistering growth rate, we go to the cash-flow statement. Over the past four quarters, Rio has generated $14.15 billion of operating cash flow, of which the main outgoings have been the dividend ($6.06 billion), capex ($5.79 billion) and debt repayment ($1.06 billion). Despite the cash balance declining somewhat in recent times, Rio has been very aggressive in bringing down its debt. Free cash flow per share which presently comes in at $5.16 per share over a trailing average means that there remains plenty of buffer to keep on paying that dividend ($3.82 per share).
The trends of the balance sheet (debt to equity ratio), the income statement (interest coverage ratio) and what analysts are predicting with respect to future earnings growth can also give us good insights on where we believe Rio’s dividend is headed. In the latest quarter, Rio’s debt-to-equity ratio came in at 0.34, the interest coverage ratio over a trailing average is 24.65 and $6.51 in EPS is the expected bottom-line number this year. Suffice it to say, Rio’s financials remain very strong, which means the dividend should be well-supported as we head into 2021.
To sum up, although Rio may have refrained from paying out a special dividend this year, we believe rising prices and a growing dividend are on the way for this company. The dollar may be rallying at present but we believe its present rally will be short-lived. Once the greenback’s bear market begins in earnest, Rio should enjoy a sustained move to the upside.
Elevation Code’s blueprint is simple. To relentlessly be on the hunt for attractive setups through value plays, swing plays or volatility plays. Trading a wide range of strategies gives us massive diversification, which is key. We started with $100k. The portfolio will not stop until it reaches $1 million.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in RIO over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.