It's been a tough year to be an investor in Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX: BHP). That's because shares in the two biggest Aussie mining companies have underperformed the ASX by a large amount.
While the ASX is up 1.5% over the last year, Rio Tinto is down 4.5% and shares in BHP Billiton have fallen by 4% over the same time period. However, the future could be much brighter for investors in both stocks and now could be the perfect time to buy them for these three reasons.
- A key reason for Rio and BHP's share price fall is a weaker iron ore price. Indeed, both companies are heavily focused on iron ore, with it accounting for over 90% of Rio's profits last year and representing a sizeable minority of BHP's. This means that the current year's earnings forecasts are disappointing for both companies, with EPS set to fall by 25.9% (Rio) and 5.3% (BHP). However, next year is set to show an improvement as both companies cut costs and become more efficient. For example, Rio's bottom line is forecast to grow by 2.5% and BHP's by 22.6%. Although Rio's growth is far below that of its peer, the key thing is that both stocks are set to bounce back quickly from this year's disappointment and are becoming more efficient businesses in the process. This bodes well for their long-run returns.
- With earnings set to fall this year, investor sentiment is weak. This is highlighted by the two companies' low valuation multiples, with Rio having a P/E ratio of just 9.6 and BHP's being 13.4. Both are well below the ASX's P/E of 15.7, and this shows that there is considerable scope for an upward re-rating over the medium term.
- A consequence of low valuation multiples is high yields. Indeed, Rio and BHP both offer investors fully franked yields that are perhaps higher than you'd normally expect from mining stocks. For example, Rio's yield of 3.7% and BHP's yield of 3.8% are very attractive – especially with interest rates set to remain at 2.5% for the foreseeable future. And, despite earnings falls being expected this year, dividends are comfortably covered for both stocks. This means that they could increase at a brisk pace moving forward, thereby making Rio and BHP even more appealing as income plays.