2 Reasons Big Miners Are Attractive Again

06/15/2012 9:45 am EST

Focus: STOCKS

When the developing world slows, it can put a damper on commodity prices, and the big miners are the first to feel the hit…but things are turning around, and as they do, these miners will have some compelling features for income investors, reports the staff at Motley Fool UK.

One sector that I’ve been reluctant to invest in over the last few years is big miners—giants like BHP Billiton (BHP), Rio Tinto (RIO), and Anglo American (London: AAL).

These behemoths of the resource industry have been supremely profitable, but a little expensive for my taste, thanks to booming global demand for their commodities. However, slowing growth in China means that is all starting to change, and these shares are starting to show me two key buying signals. Let me explain.

Thanks, China
China’s growth rate has slowed slightly this year, causing widespread falls in the share prices of the world’s biggest mining companies. Despite this, China’s GDP is still expected to grow by about 7% this year—and from a much larger base than in previous years.

This means that global demand for commodities like coal and iron ore will remain strong, but it does mean that the commodities industry is likely to move from flat-out expansion into a more mature, "cash cow" phase.

The big miners seem to have anticipated this quite sensibly, with Rio and BHP both announcing scaled-back, more focused investment plans over the last few months. I reckon this is good news, and will give investors who didn’t get on board before the commodities boom got started a second chance to gain access to these companies’ earnings at an attractive price.

Covet Thy Earnings
Earlier this year, the world’s third-richest man, Warren Buffett, ignored market sentiment and increased his holding in one of the UK’s biggest companies to more than 5%.

Buffett did this because he thought it looked cheap, and he wanted greater access to its strong, long-term earnings. Buffett’s logic is the reason I am currently so attracted to big mining shares; access to cheap, long-term earnings.

In 2011, BHP Billiton made operating profits of £19 billion on turnover of £44 billion. Most of the big mining projects BHP and its peers undertake have lifespans measured in decades, virtually guaranteeing a strong, reliable stream of earnings.

As the table below shows, access to mining companies’ earnings has got a lot cheaper over the last year, falling much further than the FTSE 100. This mouth-watering cheapness is my first buying signal.

Company Price-to-earnings ratio 12-month change
BHP Billiton 7.1 -23%
Anglo American 6.6 -27%
Rio Tinto 5.5 -31%
FTSE 100 14.2 -5.5%

My second buying signal is income. BHP, Rio, and Anglo American are all expected to start paying out a greater share of their earnings in dividends over the next few years. They all have a much higher level of dividend cover than the FTSE 100 average, and can easily afford to give shareholders a pay rise.

These figures suggest that a 4%-plus yield will soon be within the reach of shareholders in BHP and Rio, taking their yields above the average for the FTSE 100—one of my criteria for buying. Indeed, as I write, BHP offers a 4.1% yield based on its current share price and forecast total dividend for the current financial year.

Ready to Buy?
Shares in Rio and Anglo American have now fallen to 2006 levels, and while BHP remains a little more expensive, I believe that all three now offer very good value.

My choice will be BHP or Rio, probably the latter, but I’ve got a feeling they might all be cheaper still later this year, so I’m going to keep my powder dry for a little longer yet.

Read more from Motley Fool UK here…

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