Whatsapp stores its cache of profile pictures of your friends in the whatsapp folder of sdcard. But this is by default hidden from gallery.
To make them appear in gallery, run a file manager application like ES file explorer, and navigate to /sdcard/whatsapp/profile pictures
Here, you can see all the images (and copy if you want). Now go down and delete the file ".nomedia"
If the file is not visible, go to Settings in es file explorer, and in file Settings check show hidden files. You can find and delete the ".nomedia" file now.
And now you can set these images as contact icons by following the normal steps.
Extra tip: you can create a ".nomedia" file in any folder of your choice and the audio, video and image files of that folder will be hidden from the Android system.
