As the world’s leading iron ore producer, Rio Tinto (LSE: RIO) reported satisfactory earnings along with a mammoth dividend on Wednesday. With disposable income expected to fall in the current high inflation environment, I’ll run through the reasons why I’m looking to add Rio Tinto shares to hedge against this — and introduce more passive income to my portfolio.
A dividend yield that outstrips inflation
Inflation is expected to get hotter going into April as energy and food prices continue to soar. While the Bank of England is expecting inflation to peak at 7.25%, Rio Tinto announced an enormous 8.8% dividend yield ($10.40 per share) on its earnings call. This would outstrip the expected inflation rate, assuming one is to buy the stock at its current price, as dividend yields get lower when the stock price goes up. As such, this makes the commodity giant’s stock a lucrative one to add to my portfolio.
Upside potential
Although many analysts are predicting a slowdown in Rio Tinto’s growth in the short-to-medium-term, I am still confident in the company’s ability to at least maintain its current trajectory. As the world’s largest producer of iron ore, the majority of its revenue comes from China (57.2%). And as an emerging market with room to grow on the manufacturing front, Rio Tinto stands to benefit from the strong economic rebound post-Covid. Historically, many countries tend to invest heavily in manufacturing post-recession, and China will be no different. This sentiment is further aided by positive official manufacturing production figures that have continued to grow every month since April 2020.
Moreover, a bullish commodity market currently will help profit margins for the foreseeable future as the price of iron ore continues to creep back up towards the $150 per Dry Metric Ton mark. It is also worth noting that Rio’s shares are currently trading at 13% off their all-time-high. With a tremendously healthy price-to-earnings (P/E) ratio of 6.63, the share price has room for growth leading up to its ex-dividend date in April.
Potential headwinds
Despite of all the positives in buying Rio Tinto, however, there are a couple of risks associated with the stock that are worth mentioning. For one, many analysts are predicting that the stock’s dividend could shrink over the next three years due to slower economic growth and high processing costs, possibly dissipating any special dividend and forcing Rio Tinto to revert to its standard dividend yield of approximately 5%. The company itself has already warned in its earnings report that increasing energy and labour costs placed a cap to its earnings potential in 2021.
Additionally, Rio Tinto’s profit margins will also be at the mercy of the price of iron ore, as there is a possibility that the price of iron ore could plummet like it did in late 2021.
Nevertheless, I am strongly considering acquiring shares in Rio for my portfolio whilst monitoring the wider macroeconomic landscape leading up to its ex-dividend date.
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John Choong has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
