Are the big diversified mining stocks outstanding value or giant value traps?
Few questions are more important for the Australian sharemarket - given BHP Billiton and Rio Tinto have a combined 15 per cent weighting in the S&P/ASX 200 index and are a portfolio mainstay for many investors.
Fears of a so-called hard landing for China's economy and lower commodity prices have wiped billions off BHP and Rio's market capitalisations this year.
BHP Billiton has fallen from a 52-week high of $45.09 to $33.86; Rio has tumbled from a 52-week high of $84.53 to $60.31.
Both stocks have badly underperformed in the sharemarket - each has a total one-year shareholder loss of more than 20 per cent.
Contrarian investors might see this share price weakness as a buying opportunity.
BHP Billiton is on a price-earnings (PE) multiple of about eight times 2012-13 earnings, consensus forecasts show.
BHP's average annual PE over the past five financial years is closer to 13. Rio Tinto is on an expected 2012-13 PE of about seven times, compared to a five-year average annual PE of 11.
BHP Billiton and Rio are trading at a substantial discount to the market's average PE of about 12 times, even though they own some of the resource sector's best assets and are superbly leveraged to long-term economic growth in the BRIC economies of Brazil, Russia, India and China.
Of course, those PE forecasts depend on the E (earnings) part of the equation being met.
A contagion of the European sovereign debt crisis, from Greece to larger economies, would reduce demand for Chinese exports and threaten the stability of its economy.
That, in turn, would lower demand for commodities, further weaken their prices and crunch Australia's resource sector.
Against that, China appears to have considerable scope to boost its economy should problems in Europe and a weaker-than-expected US recovery increase the prospects of a sharper global slowdown.
Long-term portfolio investors who believe the global economy will strengthen later this year, and higher-risk appetite will lead to a stabilisation of commodity prices, might consider BHP and Rio at current prices or wait until the latest bout of market volatility subsides.
Good judges, such as MyClime and Morningstar, believe BHP Billiton and Rio offer value.
MyClime's valuation for BHP shares rises from $54.45 in 2011-12 to $65.59 in 2012-13.
Its Rio Tinto valuation rises from $83.98 this financial year to $100.89.
On MyClime's forecasts, BHP is trading at a 37 per cent discount to its intrinsic value this financial year; Rio Tinto is 28 per cent.
MyClime is not as bullish on energy stocks.
It valuation for Woodside Petroleum rises from $31.39 in 2011-12 to $34.12 in 2012-13 (the current share price is $32.80).
MyClime sees better value in mining service stocks, such as Mineral Resources, Forge Group and Maca.
Mineral Resources is trading at 25 per cent discount to MyClime's 2011-12 valuation of $14.
Morningstar also favours BHP Billiton and Rio.
It has a buy recommendation on BHP and a fair value of $51 for its shares. Morningstar's fair value for Rio shares is $88.
It said in a research note: "Of the diversified blue chips, we retain our preference for BHP. It is at the largest discount to fair value and its more diversified asset portfolio leaves it less exposed to the price vagaries of any one commodity."
