MENU

Are BHP Billiton plc, Anglo American plc & Rio Tinto plc Becoming Value Traps?

FTSE 100 mining heavyweights BHP Billiton (LSE: BLT) (NYSE: BBL.US), Rio Tinto (LSE: RIO) (NYSE: RIO.US) and Anglo American (LSE: AAL) all look cheap — if you believe the miners’ story, which is that their low-cost production will force less profitable competitors out of business.

This, in turn, will bring the markets for iron ore and other key commodities back into balance, despite slowing growth in China, and fairly flat demand elsewhere.

The only trouble is that this is a long-term gamble. If the miners have judged the situation wrongly, their profits could gradually crumble over the next few years, pushing down their share prices even further.

The miners could become a classic value trap: stocks that are cheap, but could get much cheaper, due to external forces beyond the companies’ control.

What do the numbers say?

There are signs that the miners’ strategy to flood the iron ore market with cheap production is beginning to drive out higher-cost competitors. Atlas Iron, Australia’s fifth-largest iron ore producer, is suspending production at its mines, as it is losing too much money at current iron ore prices to continue operating.

Australia’s third-largest iron ore miner, Fortescue, is also feeling the pressure, and cancelled a planned bond issue and refinancing deal last month.

However, even if successful, the big miners’ strategy isn’t going to work quickly. City analysts have cut earnings forecasts for BHP, Rio and Anglo over the last three months:

Current year post-tax profit forecast

BHP Billiton

Rio Tinto

Anglo American

Feb 2015

$10.37bn

$8.06bn

$2.19bn

April 2015

$8.07bn

$6.31bn

$1.75bn

% change

-22%

-22%

-21%

However, these forecasts will undoubtedly change again over the coming months, and could rise.

Perhaps it’s best to judge to take a more traditional value-investing approach, and judge the appeal of each company by its historic performance:

 

BHP Billiton

Rio Tinto

Anglo American

Trailing P/E

10.6

9.9

9.1

Trailing yield

5.7%

5.0%

5.4%

Dividend covered by free cash flow?

Yes

Yes

No

The choice between BHP and Rio depends on whether you want exposure to oil as well as iron ore: Rio is very much an iron ore play, while for BHP, oil and iron ore are both key to profitability.

Anglo’s mix of iron ore, coal, copper, diamonds and platinum makes it unique, but it remains the riskiest stock, in my view, as it has lagged behind BHP and Rio in terms of restructuring and debt reduction.

Today’s best buy?

It’s hard to ignore the generous yields on offer from all three of these stocks, which should add useful diversity to a traditional income portfolio.

I believe these dividends will be maintained, especially at Rio Tinto, which I rate as the best buy for exposure to iron ore.

If you're looking for more cheap stocks to add to a long-term portfolio, I strongly recommend the 7-step stock picking strategy described in "7 Simple Steps For Seeking Serious Wealth".

This free, no-obligation report contains details of an investment strategy developed by the Motley Fool's Share Advisor analysts, whose tips have beaten the market since the service was launched.

Best of all, this approach could take you as little as 20 minutes per month.

To receive your copy of this report today, simply click here now.

Roland Head owns shares in Rio Tinto and BHP Billiton. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.