It's been a disappointing year for three of Australia's largest mining stocks: Fortescue Metals Group Limited (ASX: FMG), Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX: BHP), with shares in all three lagging the ASX.
While all three companies could have bright futures, could the smallest of the three, Fortescue Metals Group, prove to be the best performer moving forward? Or are Aussie investors better off sticking to its larger peers, Rio Tinto and BHP?
Iron ore weakness
All three companies are due to report a fall in earnings in the current year. The main reason for this is a continued weak iron ore price and while BHP Billiton relies on iron ore to the smallest extent of the three, it still makes up a significant amount of its revenue.
So, while BHP does offer investors the most diversification of the three, even it is not immune to a prolonged period of weakness in the price of iron ore.
Discounted shares
To reflect the expected fall in earnings in the current year, all three companies trade at a discount to the wider index. However, Fortescue seems to offer the biggest margin of safety in this respect. While BHP and Rio Tinto's price-earnings (P/E) ratios of 13.5 and 9.9 respectively appeal when the ASX has a P/E of 15.6, Fortescue's current rating of 7.4 times 2016's projected earnings screams value.
That's because it takes into account the expected fall in earnings over the next two years and still leaves Fortescue trading on less than half the wider market's P/E.
Looking ahead
While the next couple of years could prove to be slightly frustrating for shareholders in Fortescue, Rio and BHP there is compensation in terms of the strong, fully franked yields on offer. For example, Rio and BHP yield 3.6% and 3.8% respectively, but it's Fortescue that really has the potential as an income play.
That's because it yields an incredible 5.5% from a dividend that even with the anticipated fall in earnings taken into account, is 2.5 times covered by profit. For this reason, as well as its low valuation and wide margin of safety, Fortescue appears to be a better buy than Rio and BHP in my opinion.
