2 Top Dividend Stocks in Copper

By Matthew DiLallo Markets Fool.com

Copper is one of the most important base metals in the world because it's so essential to our modern economy. Not only is it crucial for delivering both electricity and water to our homes and businesses but it's a vital component in transportation, computers, and smartphones. Because of that, copper is always in high demand.

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That said, just because the need for copper continues to grow doesn't mean its price always follows suit. Instead, it can be quite volatile, which forces copper producersto carefully allocate their finite financial resources on growing production to meet demand as well as keeping their finances afloat. As a result, most of the world's top global copper producers, including Freeport-McMoRan (NYSE: FCX), either don't pay a dividend or it's too small to matter. In Freeport-McMoRan's case, it paid a generous dividend for years but stopped paying one in 2015 to reallocate that cash toward debt reduction and financing growth-focused capex. That said, copper investors still do have two excellent options for a copper-backed dividend:

Copper Stock

Ticker Symbol

Dividend Yield

BHP Billiton

(NYSE: BHP)

2.96%

Rio Tinto

(NYSE: RIO)

4.40%

Data source: YCharts. Dividend yield as of May 23, 2017.

Here's a closer look at the dividend dynamos of the copper sector.

Image source: Getty Images.

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The dividend is at the core of the value proposition

BHP Billiton is one of the world's largest global resources companies, producing iron ore, copper, coal, and oil and gas. When it comes to copper, BHP is the fourth largest producer on the planet behind Chile's state-owned Codelco, Freeport-McMoRan, and Glencore Xstrata (LSE: GLEN). That said, it's the company's resource diversification that plays a significant role in its ability to pay a compelling dividend because it helps offset volatility when one commodity is under pressure. Last year, for example, the company more than overcame the impact of declining copper production thanks to strong results from its iron ore group. Meanwhile, the company further supports its ability to return cash to shareholders by maintaining a rock-solid balance sheet, anchored by a low leverage ratio of just 1.2 times net debt-to-EBITDA.

Aside from those factors, what makes BHP Billiton a top stock for income investors is its dividend policy, which is to return at least 50% of its free cash flow to investors each year. On the one hand, that plan means that the payout can go down if cash flow declines due to weak commodity prices. However, the dividend can go meaningfully higher when prices are on the rise because the company has the flexibility to pay well above that minimum level. It's that policy and the company's conservative financial position that makes BHP Billiton an excellent core holding for long-term investors looking for a resources-backed income stream.

Image source: Getty Images.

A copper driven future

Rio Tinto, like BHP Billiton, is a diversified global mining company, producing iron ore, copper, aluminum, and coal. Currently, Rio Tinto is the seventh largest copper producer in the world. However, it's in the process of developing one of the world's largest known copper deposits in Mongolia. While that underground mine won't be fully operational until 2020, it will eventually produce 500,000 tonnes of copper per year, which is more than double its current annual output of 175,000 to 200,000 tonnes per year.

Meanwhile, when it comes to paying a dividend, Rio Tinto is one of the top stocks in the entire metals and mining industry. That's because the company pays out a high percentage of its total cash generated, which includes asset sales. In 2016, for example, Rio paid out 28% of cash generated, more than double its closest rival, which only paid out 12%. One reason Rio pays out such a high percentage of its cash is due to its pristine balance sheet, with it boasting the lowest leverage ratio in the sector at 0.7 times net debt-to-EBITDA. Because of that, it doesn't need to allocate as much cash toward paying down debt as its higher levered rivals, freeing it to return more to investors. Meanwhile, with a plan to generate an incremental $5 billion in free cash flow over the next few years just through productivity gains, Rio's dividend has the potential to lead the pack for years to come even if commodity prices remain in a rut.

Investor takeaway

While copper is a crucial metal to the global economy, companies need to produce more than just that one metal to deliver big dividends for investors. It also helps to have a top-notch balance sheet and a pro-dividend policy, which is the case for both Rio Tinto and BHP Billiton. It's that total package that makes them the top copper producers for income investors.

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Matt DiLallo owns shares of BHP Billiton. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. The Motley Fool has a disclosure policy.