Iron Ore: Navigating big dividends

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
11 August 2021, 3:00 PM
Sectors Covered:
Mining, Energy

  • We still view the value downside vs big dividend return as a trade-off that on a total return basis is skewed to the downside for the big iron ore miners.
  • In the two most recent dividend periods, BHP/RIO/FMG have not been able to carry their dividends once going ex, and we expect that to occur again this half.
  • Having already outperformed, we still see BHP as the best placed of the big miners given its diversification and lack of operational/strategy issues (vs RIO/FMG).
  • We maintain a HOLD rating on BHP/RIO, with a REDUCE rating on FMG.

Is holding for the dividend a good idea?

With Rio Tinto (ASX:RIO) due to go ex-dividend tomorrow (12 August) this is a pressing concern and material to our short-term investment strategy for the bulk miners.

The iron ore miners have shown a diminishing ability to carry their dividends as the iron ore cycle has progressed. In February, we saw all three large miners fall by more than three times their dividend in the month after going ex-dividend.

With more signs of the iron ore cycle slowing, we see a similar risk this dividend season. In particular for RIO & BHP Group (ASX:BHP), who have both outperformed iron ore prices over the last month, while Fortescue Metals Group's (ASX:FMG) share price has trailed its bigger peers.

While we expect the big miners to come under selling pressure once they go exdividend, we do expect strong equity market support around their dividend announcements. For example RIO which rose on a large dividend being announced at its result while 1H21 earnings slightly trailed estimates.

This is a tactical call not relevant for all long-term investors.

The market knows strong results are coming

RIO has already reported, while strong FY21 results from BHP & FMG look certain, with all three miners riding the iron ore upcycle.

BHP is scheduled to release its full year result on 17 August. We are expecting FY21 underlying EBITDA of US$37,144m and underlying NPAT of US$17,674m. This would be BHP’s biggest earnings since FY11, and +32% growth yoy.

FMG will post its full year result on 30 August. Similarly we are expecting strong earnings on high iron ore prices. We forecast FY21 underlying EBITDA of US$16,507m and underlying NPAT of US$10,419m. We expect EPS to be up a staggering 75% yoy, albeit we attribute over 90% of this to higher iron ore prices with the remainder from impressive shipments post Eliwana’s start up.

Changes to estimates

We have increased our assumption around how far BHP and FMG will flex their dividend payout ratio for their final dividend, forecasting full year FY21 DPS for BHP of US$2.81 and FMG of A$2.14ps. BHP has divestment proceeds from Cerrejon on the way and comfortably low capex requirements across the business.

FMG has shown a tendency to flex its payout ratio as an approach to maximising shareholder value. In addition to the dividend change we have also trimmed our FY22/23 C1 assumptions for Escondida, impacting both RIO/BHP, to US$0.97/lb (from US$1.10/lb).

Post changes our target prices on BHP is now (login to view), RIO is now (login to view) and FMG now at (login to view).

Investment view 

BHP remains our top preference of the three big miners, despite having already materially outperformed so far in 2021. We view the big miner as a core holding for most clients and benefiting from its better diversified business.

BHP also benefits from a lack of near-term risks, where we have lower conviction on RIO and FMG. RIO is working to improve its Pilbara iron ore operations, WA mitigate heritage risks, social licence fallout, and Oyu Tolgoi underground expansion issues.

While FMG is battling difficult execution/cost pressures around its Iron Bridge magnetite project, slipping C1 cost performance and growing market concern around its aggressive grassroots push into global renewables.

We maintain a HOLD rating on BHP and RIO, and Reduce rating on FMG.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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