There is no doubt on the point that commodities are among the most undervalued asset class. My view is underscored by the fact that commodities (Bloomberg Commodity Total Return Index) have delivered returns at a CAGR of 0.99% in the last 20 years. An extended bear market also implies a phase of under investment. This generally translates into a tight demand-supply scenario and makes a strong case for commodities trending higher. It’s therefore a good time to consider investing in some of the best commodity dividend income winners.
Given the extended period of relatively low commodity prices, some of the best commodity stocks trade at an attractive valuation. The fears of a recession in 2023 have also depressed valuations.
However, I believe that in a recession scenario, commodities will trend higher. First, the Federal Reserve will turn dovish, and the dollar will weaken. Further, governments are likely to pursue expansionary fiscal policy. I am therefore positive on commodities for the second half of 2023. At the same time, the best commodity dividend income stocks discussed are worth holding in the core portfolio.
Let’s discuss the reasons to be bullish on these three high-yield commodity stocks.
Rio Tinto (RIO)
Rio Tinto (NYSE:RIO) is possibly the best commodity dividend income stock to buy. RIO stock offers a dividend yield of 7.7% and trades at a forward price-earnings ratio of 7.6 times. Considering the valuation, I expect healthy capital gains besides regular dividend income.
From a fundamental perspective, Rio Tinto is a value creator. Last year, the company reported $9 billion in free cash flows. I expect FCF to remain healthy even amidst commodity price volatility. This will ensure dividends and value creation through aggressive share repurchase.
Another reason to be bullish on Rio Tinto is the fact that the company is aligning its business to benefit from energy transition demand. This includes a focus on copper, lithium, cobalt, and nickel. With an investment-grade balance sheet, Rio has ample flexibility to invest in these commodities. As a matter of fact, the company is already positioned to be the largest supplier of lithium to Europe over the next 15 years.
Vale (NYSE:VALE) is another deeply undervalued name among commodity dividend income leaders. The 7.83% dividend yield stock trades at a forward price-earnings ratio of 4.7x. Even after discounting global slowdown concerns, the stock is massively undervalued.
It’s worth noting that Vale reported an EBITDA of $3.7 billion as of Q1 2023. Even with the impact of lower iron ore price realization, Vale is positioned for an annualized EBITDA of $14.8 billion. For the quarter, the company’s EBITDA-to-cash conversion ratio was 62%. The business is therefore a cash flow machine, and dividends are secure in a low-price commodity environment.
Vale has also been exploring diversification. While the iron ore segment remains the cash cow, emerging segments include copper and nickel. With a global focus on transformation towards clean energy, the company stands to benefit from this diversification.
Vale reported net debt of $8.2 billion as of Q1 2023. With strong cash flows, debt servicing is unlikely to be a concern. On the contrary, I expect aggressive share repurchases to sustain along with dividends.
Albemarle Corporation (ALB)
Albemarle Corporation (NYSE:ALB) stock is among the best commodity dividend income names to consider. ALB stock has declined in the recent past with lithium price correction. However, the stock looks deeply undervalued at a forward price-earnings ratio of 7.9x.
For Q1 2023, Albemarle reported a healthy revenue growth of 129% on a year-on-year basis to $2.6 billion. Even with the impact of lower lithium price, the company has guided for annual revenue growth of 35% to 55%.
It’s also worth noting that Albemarle has guided for an operating cash flow of $2 billion (mid-range) for 2023. Healthy cash flows will position the company to deliver robust dividend growth. Currently, the stock offers an annualized dividend of $1.6 per share.
Between 2019 and 2022, Albemarle boosted its lithium conversion capacity from 85ktpa to 200ktpa. The company is further targeting a capacity of 550ktpa by 2027. The sustained capacity expansion makes a strong case for dividend growth, besides the point that lithium is likely to remain in a long-term uptrend.
On the date of publication, Faisal Humayun did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.