Mining for mid-tier yields

Summary: While the sector of mid-tier, dividend-paying miners has fallen under the radar for many years, it's showing signs of a revival.

Key take-out: The opportunity for dividend streams out of mining stocks is growing, but remember there are risks given these stocks are closely linked to commodity prices.

A class of resource stocks which hasn't been prominent on the Australian stock market for at least the past 10 years is showing signs of making a return. That market being: dividend-paying, mid-tier miners.

Relatively high commodity prices are the key to the revival of mining companies, which are yielding a return on capital as well as the potential for capital gains – the traditional reason for investing in resources. The trend towards mid-tier miners paying dividends has rarely been as widespread as it is today with producers of copper, gold, nickel, iron ore and coal joining the ranks of dividend payers.

Sector leaders, BHP and Rio Tinto, remain resource favourites thanks to their long-life, high-quality projects which mitigate risk by spreading their interests across a range of resources.

Copper, which is the most widely-produced base metal, is a useful starting point for examining the dividend-paying habits of the mid-tiers, with OZ Minerals and Sandfire useful case studies.

Like BHP and Rio Tinto, OZ and Sandfire are enjoying the same benefit as the leaders from a copper price which has risen by more than 50 per cent over the past two years, from less than $US2 a pound to more than $US3/lb.

Exposure to the rising copper price has helped boost the share price of OZ over the past two-years by 160 per cent, from $3.54 to $9.18. Sandfire is up 70 per cent from $4.90 to $8.35. But a secondary factor in the copper miners reaching 12-month share price highs over the past few weeks appears to be an inflow of funds seeking to share in increasingly generous dividends.

OZ paid 20 cents in dividends last year and is tipped by Macquarie Bank to pay 24 cents this year, lifting the yield on its shares from 2.3 per cent to 2.7 per cent. Sandfire paid 18 cents last year and is forecast by Macquarie to pay 30 cents this year, lifting its yield from 2.6 per cent to 4.3 per cent.

A risk worth taking?

Risk with resource companies is always higher than most of sectors of the market because of their exposure to commodity-price fluctuations and the need to continually replenish ore bodies which start to deplete from the moment mining starts.

Whether the current conditions are any different to past periods of strong mineral prices which eventually decline as supply rises is an important consideration for investors.

But, what could ensure a reasonable period of strong earnings for the mid-tier miners is the project development drought of the past five years with few new mines expected to come on line over the next few years and exploration subdued which means the pipeline of prospective projects is thin.

Mid-tier miners to watch

Goldminers, a group nearly always valued against the underlying price of gold and not for their yield, have also been developing the dividend-paying habit.

Newcrest, the gold leader, while not regarded as a mid-tier stock with a market value of $15.6 billion, is interesting because most investment banks tip it as a sell with its share price seen as more likely to fall than rise because of operational problems at several of its mines.

From a dividend perspective Newcrest is expected to be more generous over the next few years, with Credit Suisse tipping a rise in the annual payout from 15 cents a share to 30 cents which implies a modest yield of 1 per cent, rising to 1.9 per cent, while also retaining its primary attraction of exposure to gold.

Regis Resources, a smaller goldminer with a market value of $2.4 billion is forecast by Macquarie to lift its dividend from 15 cents a share last year to 26 cents this year, indicating a future yield of 5.5 per cent at its latest share price.

Northern Star, which also has few buy tips after a 50 per cent increase in its share price over the past 12 months, is attracting interest as its dividend rises. Credit Suisse is forecasting a modest increase in last year's payout of 9 cents a share to 9.32 cents, but the cash return is more of bonus for investors who follow the stock for its rising gold output.

Other mid-tier miners which are showing signs of adding yield to their customary capital gain appeal include:

• Iluka Resources, which is riding high on strong demand for its titanium minerals and zircon, is tipped by Macquarie to lift its dividend from 31 cents last year to 33 cents this year, implying a modest rise in the yield from 2.7 per cent to 2.8 per cent. But if the upward mineral-price trend continues the bank reckons the annual payout could hit 46 cents in 2020, by which time the yield will be 4 per cent.
• Alumina, which has been benefiting from sharply higher prices for aluminium and alumina, is forecast by Credit Suisse to increase it dividend from 13.5 cents last year to 16.5 cents this year, increasing the yield from 6 per cent to 7.4 per cent, but with dividends and yield declining in 2019.
• Whitehaven Coal is riding a higher-than-expected coal price, made a return to dividend payments this year with a 13 cents half-year payout and with Credit Suisse forecast a full year return to 25.5 cents, putting the stock on a yield of 5.8 per cent, and
• Mt Gibson Iron, which is staging a rebound after a flood at its flagship Koolan Island mine in WA, is expected to maintain a steady 2 cents a share dividend for the next few years, which implies an ongoing yield of 5.1 per cent.

The trend towards mid-tier miners paying dividends means that investors can consider an alternative form of exposure to commodities, while never forgetting that mining and oil always carry a higher risk rating than most other investment categories.