Are BHP Billiton plc, Rio Tinto And Anglo American plc A Contrarian Buy?

Are mega-miners BHP Billiton (LSE: BLT) (NYSE: BBL.US), Rio Tinto (LSE: RIO) (NYSE: RIO.US) and Anglo American (LSE: AAL) becoming genuine contrarian value buys — or is there worse to come?

I’m beginning to think that despite the negative sentiment around the mining sector, now might be a good time to buy at least two of these companies.

In this article I’ll explain why — and which two I’d buy.

Down, down, down

Investors have certainly had a rough ride over the last year. Shares in all three firms have fallen heavily, despite the FTSE 100 has broken through the 7,000 barrier to a new record high:

The picture isn’t quite as bad as it seems for BHP shareholders, as they will shortly receive one share in spin-off miner South32 for every BHP share they own. South32 shares currently trade at about 116p, meaning that BHP shareholders are effectively down by only 21% over the last year.

There was also good news for Rio Tinto shareholders on Tuesday morning. The firm said it has now agreed a development plan for the next, underground, stage of its giant Oyu Tolgoi copper mine in Mongolia, which should help drive long-term earnings growth.

Earnings collapse

However, it’s still a grim picture, especially as City analysts have been cutting earnings forecasts for each of these firms. This means they no longer look particularly cheap on a P/E basis.

Here’s a snapshot showing how expectations have changed over the last three months, together with the latest forecast P/E ratios:

The problem is that the price of these companies’ most important product, iron ore, has fallen dramatically. Demand growth from China is slowing, but supply is rising.

Companies with high costs or high debt levels are already suffering, but Rio and BHP do not have these problems. Their debt costs are manageable and their operating costs are amongst the lowest in the world. They can afford to wait for the market to return to balance, without being forced to cut production.

Anglo should also cope without major problems, but the South Africa-based firm has higher gearing and still faces a number of restructuring challenges elsewhere in its business.

However, all three companies offer a generous yield that should reward patient shareholders:

For income seekers, I believe these are attractive yields. BHP has said that it won’t cut its dividend payout following the spin-off of South32, but the firm’s dividend cover is the lowest of the three firms.

Indeed, current forecasts suggest that the firm’s 2015/16 forecast payout of $1.28 may not be covered by earnings, which are forecast to fall to $1.17 per share next year. BHP could afford an uncovered dividend for a short time, but a cut might become likely if earnings did not rebound in 2016/17.

Today’s contrarian pick?

In my view, BHP and Rio are slightly more attractive than Anglo American as contrarian buys.

Anglo has more unresolved problems and was unable to capitalise on last year’s strong prices to reduce its debt levels, as Rio and BHP did. However, Anglo’s price-book ratio of 0.9 might make it most attractive to value investors seeking asset backing: ultimately, it’s your decision.