Digging for high yields among the market's biggest mining stocks

Shares in a number of large and mid-cap mining stocks have been on a strong run over the past two years. In fact, we’ve seen several of them break-out sharply in the first quarter of 2019. And according to the latest figures, it’s not just price growth we’re seeing from the miners – it’s impressive dividend growth too. So is this a sector we should all be taking more seriously?

Not so fast. Mining of course is one of those highly cyclical sectors that has a habit of catching us unaware. As recently as 2015 and 2016 the whole sector fell out of favour and drastically underperformed the market. But while holding those stocks might have felt daft at the time, they’ve come racing back in the years since.

You can see this in a 10-year chart which shows the wide drawdown of the FTSE 350 mining index (blue line – consisting of 12 large-cap stocks) against the main FTSE 350 index (green line). It looks pretty brutal…

…but then over the past two years there’s clear outperformance by the big mining stocks against the index:

The causes of these swings are varied. Share prices are naturally sensitive to commodity prices, and the prices of products like coal and metals are driven by global supply and demand. Then you have to consider how individual companies are being run. Many were guilty of over-leveraging and over-expanding in the mining boom early this century. When supply fell away and uncertainty swept in, it took years to unwind those mistakes.

A recovering sector

What we’ve seen over the past few years is the end of that cyclical swing. Some of the largest companies have stripped back their businesses. Assets have been sold, balance sheets have been strengthened and commodity prices have (in some cases) been rising.

The first signs of this kind of move come when deep value investors start smiling. After years of being out of favour, mining stocks can move very rapidly and it’s the brave long-term holders that benefit first. Indeed, the moves in very large mining stocks can be swift and spectacular.

Take Anglo American. Just two years ago, the diamonds and precious metals group was worth around £7 billion. Its shares had actually been rising over the previous 12 months, so it had already moved off its cyclical low. But in the two years since then, Anglo American has doubled in value to more like £30 billion. You don’t often see such sizeable moves in large stocks.

Yet, it’s partly because of their cyclical nature that investors are generally wary of miners. Even after this strong run we’ve seen, many still attract fairly low ratings. Anglo American, for instance, trades on a price-earnings ratio of 13 times, which is forecast to fall to just 9 times next year. Evraz, which has been one of the biggest winners over the past year, trades on a PE of 5, rising to 7 times next year. That doesn’t shout these are hugely popular stocks.

Price gains and high yields

According to the latest dividend data from Link Asset Services, mining has also been the source of the greatest dividend growth in 2019 so far. Asset sales triggered a massive £1.7bn special payout from BHP, and another is expected from its fellow mining blue chip Rio Tinto. But special payouts aside, mining still managed to outpace most other sectors in Q1 when it came to dividend growth.

And while growth rates are expected to settle down as the year progresses, Link are still forecasting that the market yield will remain well above its long term average this year – and that payouts will remain strong.

So where are the biggest yields in the mining sector at the moment? Here’s a screen that goes in search of the highest 1-year forecast yields in mining amp; metals stocks across the FTSE 350. It includes the StockRank, which scores the overall quality, value and momentum of each stock – from zero (poor) to 100 (excellent).

On top of that, this table shows the number of dividend increases from each company over the past 10 years. It also includes the dividend cover for these stocks – most of which are well ahead of the 1.5-times that’s generally accepted as a reasonable level.

As you can see, the valuations of these stocks – even after a tearing run for many of them in recent months – are still fairly tame for the most part. While companies like Evraz, BHP, Rio Tinto and Polymetal offer some attractive numbers in terms of yield and StockRank scores, there’s a definite sense here that the market is cool on the cyclical ups and downs of the mining sector.

This year some of the biggest equity market uncertainties are likely to be around Brexit and its impact on domestic economics and the value of sterling. In these kinds of conditions it could be worth considering the diversification benefits of a sector that is quite separate from the home market. And while mining stocks come with their own challenges, the price performance and yields on offer are a reminder why many find them appealing.

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