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Are Fortescue, Rio Tinto and BHP shares a buy for their dividends?

ASX 200 iron ore miners BHP Group Ltd (ASX: BHP), Fortescue Mining Group Ltd (ASX: FMG) and Rio Tinto Limited (ASX: RIO) have all staged significant share price recoveries after iron ore supply woes throughout August. But are they a buy for their dividends, on current prices?

What’s the outlook for iron ore?

The iron ore spot price currently sits at around US$90 per tonne, while Chinese iron ore futures soared by more than 2% on Wednesday. I believe the market has largely internalised the news that the world’s largest iron ore miner, Vale SA, is returning to form after its tailings dam disaster earlier this year. The Brazilian miner maintained its 2019 iron ore and pellet sale guidance of 207–322 million tons, with sales expected to be around the mid-point of that range.

With that in mind, the Australian government sees iron ore prices in 2019 averaging around $80 per tonne FOB, reflecting the full effect of supply disruptions and firm demand from China. However, it also expects the price to gradually decline to average $57 by 2021, as the seaborne market gradually returns to balance. 

In terms of global economies, China has maintained a steady level of steel production with its central bank announcing that it will continue to implement a prudent monetary policy and increase the strength of counter-cyclical measures. This should buoy the iron ore spot price and steel production levels.

On the flip side, US manufacturing purchasing managers’ index (PMI) signalled that manufacturing business activity was contracting at a stronger pace than expected. This reflects lower consumer demand and a contraction in new export orders. 

In the short term, the iron ore spot price could maintain the US$80–90 mark as the Australian dollar continues to pivot lower on the back of lower interest rates. This could expose investors to both capital upside and strong dividends. 

In terms of dividend yield, Fortescue pays a whopping 14% gross yield thanks to its 195% increase in underlying net profit and 266% increase in earnings per share in FY19. This represents a 78% dividend payout ratio – a delicate position where there isn’t too much space to increase dividends, while a lower iron price could potentially lower dividends in the future. 

BHP and Rio Tinto, on the other hand, pay a 7.8%  and 8.7% gross yield, respectively.

Foolish takeaway

Current market conditions are volatile as lower interest rates drive capital inflows into equity markets, while global economic is showing signs of sluggish growth. A short-term opportunity may exist for investors as iron ore prices remain steady and miners continue to reap the benefits of a higher spot price and increased steel production from China. However, investors should be wary of the medium–long term outlook and the implications that may have on dividends.

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Motley Fool contributor Lina Lim has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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