Mining sector's safest dividends

Commodity prices have been in freefall for the past four years and mining shares are currently struggling at six-year lows. According to the resources team at JP Morgan, risk premia for mining sector dividend sustainability are now at record highs. None of the majors covers its dividend from free cash flow (FCF) on 2016 estimates, but some are better placed to ride out the cycle and keep rewarding shareholders for their patience.

"We believe both Rio Tinto (overweight) and BHP Billiton (neutral) have sufficient potential for productivity gains, capex cuts and increased gearing to safeguard dividends over the next 12 months," writes the broker.

"However the picture for Anglo American (AAL) and Glencore (both underweight) appears more urgent and H2 is a critical period for both. We remain concerned AAL will struggle to deliver on portfolio restructuring and GLEN will fail to demonstrate deleveraging in marketing without impacting earnings."

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Record yields of 7% at BHP and 6.2% at Rio "overstate near-term risks" to the payout, believes JPM, which estimates BHP's free cash flow is $5.1 billion below its dividend commitment. There's a $1.8 billion gap at Rio, $2.1 billion at Anglo and $3 billion at Glencore. However, if BHP cut $2-$4 billion of discretionary capital expenditure from its own guidance for $9 billion, the FCF gap would shrink to $1.1-$3.1 billion.

If Rio trimmed growth capex of $2.6-$3.2 billion for 2016/17 that is yet to be approved by the board, the FCF deficit would be wiped out.

Glencore and Anglo dividends on the other hand are vulnerable. JPM thinks the former covets and needs its investment grade credit rating so much that it could be forced to slash net debt by a colossal $18 billion from $30.5 billion at the end of 2014 "We believe protection of the credit rating ranks ahead of our $2.6bn FY'16E dividend," it says.

Anglo could suffer a ratings downgrade by the end of 2015. That will ratchet up the pressure on management to sell assets in the second half, but it's not straightforward just now, and offloading South African assets will not be easy.

"Given these dynamics, we would expect GLEN and AAL to trade at higher dividend yields than RIO and BHP, but this is not the case," says JPM. "BHP's 7.0% and RIO's 6.2% 2016E yields, compare to AAL's 6.9% and GLEN's 6.3% yields, yet BHP's and RIO's are more secure on a twelve month view, in our opinion."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.