The aluminum industry is a tough one for income investors. That's because aluminum production is a time-consuming process requiring companies to operate mines, refiners, and smelters that turn bauxite to alumina to aluminum. It's also a costly process, which when metal prices are down, can cause producers to lose money as has been the case for many in recent years.
Because of that, it's probably no surprise to see the following chart on the dividend yields of the top publicly traded aluminum producers:
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As that chart shows, other than Rio Tinto, no other aluminum producer pays a dividend. Here's a look at what enables it to not only pay one but do so very generously.
A look at their portfolios
Rio Tinto was the world's third-largest aluminum producer last year behind privately held Chinese producer China Hongqiao Group and Russian producer UC Rusal. The company's integrated operations span the globe, including bauxite mines in Australia, Brazil, and Guinea, alumina refineries in Australia, Brazil, and Canada, and aluminum smelters in Australia, New Zealand, France, the U.K., Iceland, and Oman. One thing that's worth pointing out is that Rio Tinto's operates the world's largest share of first-quartile refining capacity, which means its costs are lower than those of most rivals.
Alcoa also operates top-quartile alumina refineries as well as top-quartile bauxite mines, though it's only in the mid-second quartile for smelting. Meanwhile, Century Aluminum operates several smelters in the U.S. and one in Iceland. That said, aluminum is the only commodity those two rivals produce. Contrast that with Rio Tinto, which is also one of the world's top iron ore producers, a leading global copper producer, and it produces large volumes of energy coal, diamonds, and other minerals. That diversification is a key ingredient for Rio's dividend.
Digging into profitability
Because of its low-cost operations, Rio Tinto's aluminum business generated nearly $2.5 billion of underlying EBITDA last year, though that was down 10% from the prior year. However, the company's overall earnings rose 7% thanks to robust results from its iron ore and energy and minerals segments. In fact, Rio generated $13.5 billion of underlying EBITDA last year, along with $8.5 billion of operating cash flow.
Contrast that with Alcoa, which reported a 40% drop in adjusted EBITDA last year, which fell to $1.1 billion due to lower alumina and aluminum pricing as well as higher costs. Furthermore, it recorded several costs associated with restructuring its portfolio, including closing its Warrick smelter and Suralco refinery and mines, which resulted in it reporting a net loss of $400 million. Worse yet, the company used $311 million in cash from operations and spent another $404 million on capex. Given that cash burn, the company simply doesn't have the cash flow to support a dividend right now.
Likewise, Century Aluminum also reported a steep loss last year of $252.4 million, due to a combination of weak prices and an impairment charge. That said, the company did generate about $38 million in cash from operations last year, though half went toward capex and the other half to bolster its balance sheet, which meant it had nothing left to pay a dividend.
Adding it all up
As those comparable results show, Rio Tinto's diversified business model proved to be a significant competitive advantage over its aluminum-focused rivals because it was able to overcome weaker results in its aluminum business with the stronger performance of its iron ore and energy and minerals segments. Consequently, the company generated healthy cash flow, which it had the flexibility to use for dividends since it boasts the best balance sheet among large miners. In fact, due to its balance sheet strength, the company plans to pay out 40%-60% of its annual cash flows to investors each year, using the rest to finance growth projects. Given that neither Alcoa nor Century Aluminum generated any free cash flow last year, and both have weaker balance sheets, those companies don't have the financial flexibility to pay dividends anywhere near Rio Tinto's rate for the foreseeable future.
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