If you're a retiree, dividend investor or just someone who likes passive income, you have probably considered one or more ASX resource stocks for your income portfolio. Whether it's big miners like BHP Group Ltd (ASX: BHP) or smaller oil companies like Santos Ltd (ASX: STO), the ASX is littered with resource stocks that can offer big yields. Mining is, after all, our second biggest sector on the ASX in terms of total market capitalisation (behind banking, naturally).
But should resource stocks form a large chunk of your dividend portfolio? There's a big pro and a big con, so let's have a look.
The Pro
The main advantage of having resources in your dividend portfolio is… the dividends (shock and awe). As resource companies have relatively fixed cost bases, the prices of the commodities they procure more or less determine the profitability of the company itself. Take Fortescue Metals Group Ltd (ASX: FMG). Fortescue mines iron ore at a cost base of US $12.36 per tonne.
If the company can sell a tonne for US $22, it makes a (rough) $10 of profit per tonne and at the current price of US $88, it's making around US $76 of profit per tonne. Every time the iron price goes up (and stays up for a while), Fortescue can take the cream off and give it straight to shareholders. This is why BHP and Fortescue have been able to shovel out record amounts of cash this financial year in dividends and buybacks. Sounds pretty good, right…
The Con
And it is. But the big problem with resource stocks is that the cash can ebb and flow in a big way. Just as Fortescue can make it rain when the price is high, it must also declare a drought if the price drops. If the iron ore price (hypothetically) went from US$88 today to US$20 tomorrow… well Fortescue shares would be on its coattails and the dividends with it (possibly for many years). Today, Fortescue has a trailing annualised yield of 6.61% (higher than half of the Big Four banks), but no one is expecting this to stick around because the iron ore price has gone from over US$120 to US$88 in just 3 months.
Foolish Takeaway
So long story short – resource companies can give off huge dividend yields (pro) but these are not (and won't ever be) consistent (con). If you're not reliant on dividend income, then resource stocks can be an excellent income play. But if you do rely on a steady cheque, then it might be best to steer clear (or at most only have a small exposure).
