Rio Tinto has dividend cut in its sights

Rio Tinto is expected to slash its $US4.1 billion ($5.8 billion) annual dividend payout as early as August.

Investors expect the mining giant to announce at its full-year results this Thursday that it is putting its so-called progressive dividend policy under review. The policy provides that the annual dividend does not go backwards in US dollar terms.

Rio Tinto chief executive Sam Walsh has previously said the dividend policy is a matter for the board.
Rio Tinto chief executive Sam Walsh has previously said the dividend policy is a matter for the board. Photo: Bloomberg

It could change it to a payout ratio, whereby it would promise to pay out a certain proportion of its earnings, or it may reset the dividend amount to a lower level and then aim to adhere to a progressive policy again – albeit from a reduced base.

But the expected changes would not affect the final dividend, to be announced at the full-year results this Thursday. Under the existing policy, the company's full-year dividend would be at least $US2.15 – the same as the previous year, while analyst consensus predicts a slight increase to $US2.21.

If rival BHP Billiton kills off its progressive dividend policy at its interim earnings later this month, as it is widely expected to, and cuts its $US6.6 billion annual payout, that would leave Rio as the last man standing among the majors.

London-listed majors Glencore and Anglo American last year abandoned their progressive dividend policies and suspended payouts altogether amid a deepening commodity price rout. Brazil's Vale also suspended its dividend last month.

'Point of differentiation'

Tim Schroeders, fund manager at Rio investor Pengana Capital, said while keeping the policy could provide Rio with a "point of differentiation" among the major miners, "in 12 months or sooner it could change.

"It would have to be a subject of major discussion at board level," he said. "Presumably BHP will address the situation in the next few weeks, then Rio would be the only guys out there doing it on their own, and they are not going to get rewarded for it.

"They can still pay out a healthy dividend, but there is no need to lock yourself into the progressive policy and make a rod for your own back. Why differentiate yourself and be less flexible?"

Rio's underlying earnings for calendar 2015 are expected to come in more than halved to $US4.5 billion, on analyst consensus, from $US9.3 billion the year earlier. It has guided for capital expenditure of about $US5 billion in the year. Rio is likely to have been forced to borrow to fund the 2015 dividend, or to fund growth capital, depending on which way investors look at it.

Ross Barker, managing director of the Australian Foundation Investment Company said it was "not particularly important" for Rio to stick to its progressive dividend policy.

He noted that companies "sometimes used the policy to keep payout ratios low in the good times".

Adherence not particularly important

And as an Australian-based investor in Rio, currency rates dictated whether the dividend was progressive for AFIC, he said. "So we don't see adherence to a progressive dividend policy as particularly important."

Last week, Standard & Poor's put Rio Tinto on negative credit watch, saying its A-minus rating could be lowered one notch "over the coming weeks if the company does not take supportive measures amid the currently weak commodity prices pressuring its cash flows".

An announcement this week that Rio is reviewing the progressive dividend policy could be enough to satisfy the ratings agency.

But Rio is the best placed of the majors and its decision on the policy will not be made under pressure.

Mr Schroeders said the progressive policy "doesn't make sense" for a resources company and had "passed its use-by date as a mechanism".

​Policy a matter for the board

He said while "conceptually a progressive dividend is appealing to investors, retail in particular, it is not optimal in terms of understanding that the demands for capital are lumpy depending on project developments and M&A opportunities through a commodity price, or economic, cycle.

"And to have maximum flexibility and a strong balance sheet to avail yourself of those opportunities is far more sensible than being wed to a progressive dividend."

Rio declined to comment. But chief executive Sam Walsh has previously said dividend policy is a matter for the board.

The aim of Rio's progressive policy is to maintain or increase the US dollar value of dividends each year. Rio's interim dividend is set at one-half of the total dividend for the previous year, and under the policy the final dividend for each year is expected to be at least equal to the previous interim dividend.

Rio's commitment to a progressive policy is not as long-standing as rival BHP, which has not cut its dividend since 1988.

Mr Barker said Rio's policy "was not fundamentally progressive.

"After the disastrous Alcan acquisition Rio were forced to slash their dividend in 2009 to shore up their balance sheet," Mr Barker said.

Not 'fundamentally progressive'

"So we don't regard their policy as being fundamentally progressive. If the debt levels become too onerous the dividend can be cut to help reduce debt, this is as it should be."

Rio's final dividend is expected to be at least the US107.5¢ it paid at its interim result in August, while some analysts expect it to be in line with the year-earlier period, which saw a final dividend of US119¢ paid. Analyst predictions for Rio's full-year payout range between $US2.15 to $US2.33. UBS analyst Glyn Lawcock is tipping a $US2.15 payout, the same as the 2014 year.

Net debt is tipped to increase to $US14.8 billion. Citi analysts, who have a net debt forecast of $US14.5 billion, are expecting cash burn of $US1.6 billion for calendar 2015.

BHP's policy is slightly different in that it provides its payout will be either maintained or increased in US dollars at each half-year payment.

Investors and analysts widely expect BHP to at least halve its final dividend, from 62¢ to 31¢, when it reports on February 23.

Mr Schroeders said he expected BHP to drop its progressive policy, and it could move to a payout ratio, with a dividend reinvestment plan, or scrip-based dividend. "Any combination of those would not be an unreasonable response," he said.