Are Fortescue shares a dividend trap?

Is the mining stock a dividend hero or is the big payout just temporary?

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Fortescue Ltd (ASX: FMG) shares are often seen as a passive income option due to the large dividend yield. Could the ASX mining share continue its large payouts or is it a dividend trap?

The idea of a dividend trap is that a stock seems to offer a good yield based on the last dividend payments, but the upcoming dividends are likely to be much smaller – the historical yield is a mirage.

Let's first look at what the miner is actually distributing to shareholders.

How big is the Fortescue dividend yield right now?

Despite the Fortescue share price being up by 33% in the past year, as seen on the chart below, the trailing yield is still very high.

The last two dividend payments from the ASX mining share amount to $2.08 per share, which equates to a grossed-up dividend yield of 10.9%.

Fortescue's latest dividend, the HY24 payment of $1.08 per share, was the biggest six-month payment since 2022 and 44% higher than the HY23 payout.

Could Fortescue shares be a dividend trap?

The ASX mining share's profit is highly dependent on the strength of the iron ore price. Mining costs don't typically change much in the shorter term, so any extra revenue for its production can largely translate into extra net profit.

Fortescue has a dividend payout ratio policy to pay out between 50% to 80% of underlying net profit after tax (NPAT), so higher profit should also translate into a bigger dividend.

However, the reverse can happen when the iron ore price falls – it largely cuts into net profit, and the dividend suffers too. The Fortescue annual payout decreased in FY22 and FY23 partly because of a lower iron ore price.

With the iron price currently sitting around US$117 per tonne, analysts have forecast that Fortescue's annual dividend per share will increase in FY24 compared to FY23.

The estimate on Commsec suggests the FY23 annual payout could be $1.94 per share, which would be a rise of 10.7% year over year. However, the FY24 final payment may be lower than the FY23 final payment, leading to the FY24 grossed-up dividend yield being projected to be 10.1%.

However, analysts don't think the iron ore price will stay this high for long, which could lead to Fortescue's profit falling in FY25 and FY26, causing the Fortescue annual dividend payout to drop to $1.47 per share in FY25 and $1.09 per share in FY26.

Those projections would mean Fortescue shares could have a grossed-up dividend yield of 7.7% in FY25 and 5.7% in FY26. If those projections come true, it would suggest Fortescue shares are a bit of a dividend trap because the future yield could be materially lower than what it pays in FY24.

However, the iron ore price has been very difficult to predict because of the uncertainty of Chinese demand. It's possible that the iron ore price could be materially stronger or weaker than analysts expect. Over the last three years, we've seen the extremes – the iron ore price has been above US$210 per tonne and below US$90 per tonne.

Would I invest today?

I own Fortescue shares, but I'm not looking to invest right now, as the share price is not far off its all-time high. I prefer to invest when the market is fearful about iron ore miners. But, I'm planning to be a long-term shareholder because of the green energy efforts of the business.

Motley Fool contributor Tristan Harrison has positions in Fortescue. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. 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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