Rio Tinto Limited (ASX: RIO) shares are currently trading on a trailing dividend yield of 4.3% fully franked.
That's a big yield for a capital intensive mining stock.
And with the official Reserve Bank of Australia (RBA) interest rate currently sitting at a record low of 2.25%, it appears to be a no brainer: Drop term deposits, buy Rio shares.
However buying shares of Rio Tinto – or any of the miners – for income purposes could be a one-way ticket to the poor house.
Whilst Rio is one of the world's premier diversified mining companies, its exposure to iron ore and a number of other commodities could call its capital management policy into question – especially if (as expected) China's demand for raw materials continues to wane.
Indeed, for this exact reason, mining companies rarely (if ever) make good income stocks.
After spending years on design, then billions of dollars on construction, few miners are able to generate a sustainable competitive advantage.
Without high barriers to entry new competitors can enter the market and produce the same product. Many producers will undercut their rivals to guarantee a sale. Whilst Rio Tinto has an exceptionally low cost base, it has no demand-side competitive advantage (i.e. it cannot control market prices).
Therefore unless there's a big demand from customers, the market price which miners receive for their products will fall, profit margins will get squeezed and, ultimately, less money will be returned to shareholders.
Accounting for over 80% of Rio Tinto's 2014 revenues, the prices for iron ore, aluminium and copper are currently depressed. Meanwhile the group's payout ratio (the amount of money it pays in dividends versus what it earns in profit) is forecast to reach 81% next year.
Personally, I think 81% is very high for a mining outfit regardless of whether or not it will cut future capital expenditure.
2 dividend stocks I'd buy instead
I think fellow ASX stocks, Coca-Cola Amatil Ltd (ASX: CCL) and Credit Corp Group Limited (ASX: CCP), appear much better alternatives for income-seeking investors today.
Coca-Cola Amatil, Australia's bottler and distributor of Coca-Cola and Beam-branded products has received mixed reviews from analysts lately as its SPC Ardmona, Indonesian, and flavoured milk businesses have failed to fire on all cylinders.
However, aside from offering a 4.1% partially franked dividend, the company is now focused on reinvigorating its brand and delivering new product lines. Whilst its turnaround mightn't be smooth, I'm confident it'll return to modest profit growth in coming years.
Credit Corp is Australia's leading receivables management business specialising in debt purchase and collection. The company's share price has appreciated strongly in recent times but could still hold value for investors focused on the long term (five years or more). Its forecast to pay a 3.6% fully franked dividend.
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