Warren Buffett famously said that he tried to be “be fearful when others are greedy, and greedy when others are fearful”.
There’s little doubt that the market is currently fearful about the earnings prospects of the big miners. Should contrarian investors be getting greedy?
Grim outlook
Over the last three months, consensus profit forecasts for BHP Billiton (LSE: BLT) (NYSE: BBL.US), Rio Tinto (LSE: RIO) (NYSE: RIO.US) and Anglo American (LSE: AAL) have all fallen dramatically:
|
Company |
2016 profit forecast March 2015 |
2016 profit forecast June 2015 |
Change |
|
BHP Billiton |
$8.6bn |
$5.7bn |
-34% |
|
Rio Tinto |
$8.2bn |
$5.8bn |
-29% |
|
Anglo American |
$2.4bn |
$1.8bn |
-24% |
These are pretty brutal downgrades. The question for investors is whether this is a buying opportunity, or a sign that the mining industry is entering a downcycle.
Is the price right?
Shares in BHP and Anglo have fallen by about 30% over the last year. Rio has fared better, losing just 8% over the same period.
However, over a five-year timeframe, it’s Anglo that’s the big loser. Shares in the South Africa-based miner have fallen by 61% since June 2010, compared to 12% for Rio and 29% for BHP.
Here’s how the three firms compare in terms of forecast P/E and yield:
|
Company |
2016 forecast P/E |
2016 prospective yield |
|
BHP Billiton |
19.2 |
6.1% |
|
Rio Tinto |
14.1 |
5.3% |
|
Anglo American |
11.6 |
5.6% |
Source: Reuters consensus forecasts
BHP Billiton
BHP’s valuation is beginning to look demanding. The firm has suffered a double blow this year, thanks to the oil market crash and the sustained fall in the price of iron ore.
As a result, earnings per share are expected to fall again next year, pushing dividend cover down to a forecast level of just 0.85.
I don’t think this will be enough to cause the payout to be cut, though. BHP has a long and proud history of maintaining a progressive dividend and has the financial strength to maintain its payout, as long as earnings start to improve in 2017.
Rio Tinto
Like BHP, Rio owns vast, low-cost iron ore mines. These will remain profitable at any foreseeable iron ore price.
The firm is cutting back on new projects and focusing on maximising returns from its core iron ore, copper and coal assets. Rio’s dividend was amply covered by free cash flow last year, and I expect a solid result this year.
As such, I see Rio as an attractive income buy at current prices, and plan to add to my own holding.
Anglo American
Anglo has fallen further than its peers, and in fairness I think it’s deserved to. The firm’s turnaround programme has lagged behind those of Rio and BHP. Anglo is still struggling to complete the restructuring or disposal of its thermal coal and platinum assets in South Africa.
At the same time, I’m beginning to get interested in Anglo. The firm’s shares now trade at 0.8 times their book value and on a price-to-sales ratio of 0.8. That compares to equivalent figures of 1.8 and 1.7 for Rio.
Anglo is also the cheapest of these three firms on a P/E basis. I plan to take a closer look.
Today’s best buy?
I don’t think global demand for iron ore, coal and copper is going to collapse and see Rio Tinto as a fairly safe income buy.
However, Anglo’s low valuation and BHP’s potential for a strong recovery make both stocks potential contrarian choices, subject to further research.