(AF7006 / AF7011) Finance assignment a critical appreciation for strategic advantage for BHP and Rio Tinto

Question

Task: In your finance assignment you are required to select two major non-financial quoted companies. Both companies should be in the same industry group, of similar size and should be working in the same market for which you will research, analyse and evaluate their consolidated financial results.

Answer

Introduction

Brief History;
Broken Hill Pproprietary’s starting can be linked to the silver, lead and zinc mine near the Broken Hill Australia. The establishment of the company considered for the finance assignment can be traced back to 1885 and is a pioneer in the development, sale and production of the natural resources like iron ore, gas, copper, silver and zinc. BHP was a top player in the value added flat steel. Its origin can be linked to the tin mine in the Indonesia Billiton Island in 1851. Billiton is a multinational when it comes to metals as well as Mining Corporation that produces aluminium, manganese and alloys (BHP 2020).

Description of Industry Membership, Main Business and Principal Locations in the finance assignment
BHP Group which was BHP Billiton Limited is an Australian public corporation that owns the element of the BHP Group and even control BHP Group Plc in the UK. The company is engaged into the research relating to minerals and energy, production as well as processing. The group has a massive workforce of 34,480 workers and contains 42,000 contractors. As per the finance assignment findings, the head is based in Melbourne and the company operates in more than 90 locations around the globe. It is a multinational resource firm that has high range of projects that is related to the production of the metals, iron ore, minerals and petroleum products. On the London stock exchange the company is listed as BHP and is a major resource corporation that contains variety of diversified resources. The business is segregated in different domain that is iron ore which is one among the biggest in the world followed by coal that helps in the generation of electricity and other industrial process (BHP 2020)

Exceptional Recent Events
Inflation might occur due to the alterations in the commodity prices which might happen due to various factors. These include shift in the prices activated by the factors of economic and geopolitical and industry demand influenced by enhanced supply because of the establishment of various productive resources or enhanced production from the resources that are existing and the change in the product substitution. It s found in this finance assignment that the impact of COVID-19 has influenced and might continue to have an influence on the price of the commodity (BHP 2020). This might lead to volatility due to the immense deterioration of demand from the impacted customer, countries and disturbance in supply from major producing region. As per the finance assignment it can particularly affect the financial performance because of the exposure to the movement in the price of oil, gas and minerals.

Competitive Environment
BHP Group success in the attainment of the position in the market is directly linked to the dedication in the creation of long term shareholder value, corporate governance, their attention on the environment and being diversified. BHP succeeded as they stress upon technology in comparison to other companies. It is positioned as a pioneer and a market leader in terms of comprising the biggest natural resource and number of workers (BHP 2020). This is being reflected in the finance assignment by having a team of employees that focuses entirely upon technology and innovation so that they can attain an edge on the market scenario as well as the future. BHP is deemed to be a dominant competitor with a huge and broad global portfolio of the natural resources. Hence, such a competitive external environment is a key when it comes to the BHP competitive position in the industry.

PESTLE analysis in the finance assignment
Political

Brief Financial Information in the finance assignment
Sales in 2020 amounted to US$42.9 billion a decline from the 2019 level of US$1.4 billion or 3 percent. The decline was manly from the lower average realised prices for coal, petroleum and copper (BHP 2020). Further, lower volume was observed due to decline in the natural field at Petroleum and lower grade at Spence and Escondida which was combined with the maintenance across a variety of assets. It is found in the finance assignment that the same was offset due to higher prices of iron ore, upbeat production at WAIO and better stability of the operations. In the past five years the sales have consistently increased which was owing to the higher coal and copper prices followed by better operational performance. The total assets of the company declined in the last five years. The group has a massive workforce of 34,480 workers and contains 42,000 contractors which is the reason for its widespread network and performance (BHP 2020)

Evaluation of Financial Statements: A Comparative Analysis in the finance assignment

Profitability Analysis in the finance assignment
Gross Profit Margin

As per the finance assignment findings, the gross profit of BHP was 10% in 2016 and it was predicted to reach 34% by 2020. The group has a massive workforce of 34,480 workers and contains 42,000 contractors. The gross profit of BHP and Rio was equally competitive because some year was dominated by Rio while some was dominated by BHP. The revenue of BHP decline from 2018 and hence the GP declined in 2019 and 2020. The decline was mainly due to the lower average price realized for petroleum, coal and copper followed by lower volumes that happened owing to the decline at Petroleum. Further, the planned maintenance at different assets led to the lowering of the revenue and hence the gross profit.

The trend of BHP Billiton in terms of gross profit as per the finance assignment is declining which means the sales of the company are not sufficient. However, if compared to the Rio’s gross profit margin it can be seen that BHP has a steady performance in all the years and less fluctuations is observed.

Net Profit Margin analysis in the finance assignment

As per the finance assignment the net profit margin is the measurement of the net income generated as a percentage of the revenues received. BHP net profit increased from the year 2018 however in 2019 and 2020 the ratio remained stagnant. It is due to the increment in the total expenses by 3%. The decline in the revenue could have caused a problem however the reduction of the taxation expenses by US$755 from year 2019 led to the stagnant profit. The decline was mainly due to the tax disputes and the net reduction in the credits of US tax in link to Chilean taxes.

In comparison to BHP, Rio considered in the finance assignment posted better net profit margin. The reason why Rio produced better net profit was owing to the Pilbara operations that produced 333.4 million tonnes which was 2% more than 2019 (Rio 2020). The improvement in the mine and asset health was the major reason of better performance by Rio Tinto Return on equity analysis in the finance assignment

ROE ascertains the profitability of the company by measuring how much the company earned for the company’s investment (Blecke & Gotthilf 2019). BHP ROE fell short of the Rio ROE indicated by the above table. The reason why BHP failed to deliver better ROE as per the finance assignment was the failure to use the equity in an optimum manner. Henceforth, the company could not post better number while Rio was able to utilize the equity and hence a better result was observed.

Liquidity Ratios analysis in the finance assignment
Current ratio

Current ratio depicts the excess of current assets over current liabilities (Nuhu 2014). As seen from the computation and the graph the current ratio of BHP has witnessed a falling trend since 2018. However, the company still manage to have more than $1 of current assets in comparison to $1 of current liabilities. The reason for the decline in the current ratio as per the finance assignment is the decline in the current assets. Similarly the same has been observed in the case of Rio Tinto however in 2020 Rio Tinto current ratio enhanced which was by dint of an increment in the current assets (Rio Tinto 2020). Both the company are sound in terms of liquidity. However, BHP carries an advantage in this scenario because of the massive presence.

Quick ratio analysis in the finance assignment

Quick ratio is a better representation of liquidity as it eliminates the inventory (Nuhu 2014). Hence, it projects the actual liquidity of the business with which the business can pay off the liabilities. BHP quick ratio has declined from 2018 but still the ratio is above 1:1 which means the business is having sufficient quick assets for meeting the obligations. In comparison to Rio, it is found in the finance assignment that the quick ratio of BHP is better because the quick ratio of BHP has outperformed Rio from 2016 to 2019. This means the liquidity of BHP ranks better in comparison to Rio.
BHP is in a better position to repay the obligations. Hence, it will be easier for the business to repay the obligations.

Efficiency Ratios analysis in the finance assignment
Inventory days

Higher number of days is being taken by BHP before releasing an inventory. The ratio indicates that BHP funds are tied up in inventory. Hence, BHP is taking more number of days in converting the stock into sales which indicates trouble for the company. Thereby it is important for the company as per the finance assignment to forecast the demand and optimize the logistics. Similarly, Rio is taking more number of days when it comes to holding the inventory before the sales. Rio is taking 86 days to convert the stock into sales which is higher and company’s funds are locked up in inventory (Rio Tinto 2020). This indicates BHP is taking lesser number of days in comparison to Rio but the trend is showing higher number of days which is leading to loss of opportunity for the company.

Average receivable days analysis in the finance assignment

It is the average time taken by the customer for repaying the business for the products and services (Gerhard 2017). BHP average receivable days are between 26 to 40 days indicating better collection of debt. On the other hand, Rio considered in the finance assignment has a strong average receivable days ranging from 14 to 30. This means the company is able to recover debt faster. Hence, it has a prudent management. Both the companies have a strong collection policy and thereby able to recover the debt earlier.

Solvency / Gearing Ratios
Debt to equity

The debt to equity ratio projects the composition of debt and equity in the company. The debt to equity in 2020 is 1 which means the presence of debt and equity in proportion. The debt of BHP as per the finance assignment has increased steadily which means the company is looking towards expansion. With a strong current and quick ratio, the company is balanced and hence can pay the liabilities (Kim 2013).

Hence, for a company like BHP it need not worry about the debt because of the presence of strong liquidity. As per the findings in the finance assignment the debt has increased because of the IFRS 16 lease application and return to shareholders amounting to $6.9 million. In the case of Rio, the debt to equity is near to 1 from 2018 to 2020 meaning the company is having high debts and the same can be justified because it has strong current and quick ratio.

Debt ratio

Debt ratio is a financial ratio that enables to know the percentage of company’s assets funded by debt (Carlon 2019). As per the computation, it is signified that the debt ratio of BHP is between 45-50%. This ratio is an indicator of the company’s credit worthiness. From the comparison in the finance assignment it is imperative that Rio debt is less as compared to BHP. However, the debt of BHP is supported by strong liquidity where the current ratio stands at 1.44 and quick ratio at 1.17.

Moreover, the ratio is near to 50% which indicates that the debt procurement is under control and hence the business is adequately using the debt and equity in proportion.

Stock Market (Investment)
PE ratio

The PE ratio can be defined as the ratio of the market price of the stock in link to the earning per share of the company (Mersland & Urgeghe 2013). As per the finance assignment the present PE of BHP stands at 34 while for Rio it is 11. This indicates that there is a major difference when it comes to valuation depending on the PE ratio for both the industry average as well as peer value that implies that the valuation of BHP is overstated.

Dividend Yield

The dividend yield indicate how much the company has paid when it comes to dividend over the course of year (Atril 2014). Both BHP and Rio has ensured that the shareholder receive better percentage when it comes to the investment. The graph in the finance assignment indicate that both the companies have provided strong yield and further the shareholder can expect better return for the money invested.

Revenue Growth => Year after Year (Horizontal Analysis)

As projected from the horizontal analysis, the revenue of BHP declined by 3% from 2019. The decline can be cited in the finance assignment mainly due to the lower average realized prices for coal, copper and lower volumes when it comes to the natural field decline happening at Petroleum. Further, grades were lowered at Escondida and Spence which was in combination with the planned maintenance across different assets (BHP 2020). This has been offset by the price of iron ore which was higher

Conclusions
Overview of Performance
BHP has strong fundamentals and is performing reasonably well. The Company has experienced a slight decline in sales however in 2020; the gross profit and net profit remained strong even after the pandemic. As per the finance assignment the gross profit stood at 34% while net profit at 19%. The liquidity of the company is strong as BHP has current and quick ratio more than 1 indicating presence of more current assets. The debt collection by the company is prudent and is done quickly while it take a longer frame when it comes to the holding of inventory before the sales. Hence, the overall performance indicates that BHP is strongly placed and has quoted strong numbers which makes it the best in the business.

Implications for Potential Investment
BHP is strongly positioned to take the advantage from the sell off in the market. The business of iron ore, nickel and copper are surging ahead strongly. Iron ore demand will be high when it comes to medium term because India, Brazil and China grow their middle class populations. Moreover, nickel and copper will grow because he renewable will be more widely deployed. Hence, considering the fundamentals of the company followed by the future requirement, it is found in the finance assignment that BHP is a strong player and hence a must in the portfolio. Therefore, investment must be done in BHP as future opportunities are high.

Credit Assessment
As per the annual report, the company has undertaken long term debt that amounts to $32.01 billion. The company even have a total equity that amounts to US$ 52,246 million that results from share capital, reserves and retained earnings (BHP 2020). As per the finance assignment the leverage policy of the company is set so that the practises help in the investors safeguard. The leverage has helped the clients in trading without putting the entire sum of money. Hence, the overall scenario reflect a stability in the finances.

Limitations of the finance assignment Analysis
Though the financial statements undergo audit yet they are not full proof. At times they fail to project the correct picture of the company’s financial position (Laux 2014). This might happen for few reasons such as maintenance of specific position or to impress the investors or bankers.

When this happens, no matters how effective might be the method there cannot be accurate finance assignment analysis
Financial statement in the finance assignment is the documentation that relates to the past performance of the company. Hence, the analysis depends on the assumptions which are done considering the past data which might not serve the purpose (Melicher & Norton 2016). Evaluation is done depending on the specific situation that exists while the analysis is done. If the situation changes then the evaluation will have no relevance

Recommendations
For having the best return, it is advisable in the finance assignment that the share of the company should be purchased for long term. This will help in providing the maximum benefit as the opportunities are high in the upcoming future. Moreover, it will help the investors to be away from the market volatility as they can target the price and invest. Thereby, investment for long term will provide the best result.

References
Atril, P 2014, Financial Ratios. In: Financial Management for Decision Makers, (7th Edition). Pearson Education Limited, p. 70.
Beaver, W.H., Correia, M., McNichols, M.F 2012, Do differences in financial reporting attributes impair the predictive ability of financial ratios for bankruptcy? Review of Accounting Studies, vol. 17, no. 4
BHP Group, (2019). 2019 Annual Report. viewed 9 October 2022, from https://www.bhp.com/investor centre/annual-report-2019/
BHP Group 2020, BHP annual report & accounts, viewed 9 October 2022 https://www.bhp.com/-/media/documents/investors/annual-reports/2020/200915_bhpannualreport2020.pdf BHP Group Share Price Trends 2020, viewed 9 October 2022, from https://finance.yahoo.com/quote/BHP/historyp=BHP
Blecke, C. J, & Gotthilf, D. L 2019, Financial analysis for decision making. 4th ed. Englewood Cliffs, N.J, Prentice-Hall
Carlon, S. 2019, Financial accounting: reporting, analysis and decision making (6th ed). Milton, QLD John Wiley and Sons Australia, Ltd
Gerhard, S 2017, Creativity research in Management accounting: A Commentary. Journal of management accounting research, vol. 29, no. 3, pp. 49-54.
Kim, S 2013, Accounting quality, corporate acquisition, and financing decisions, The University of North Carolina,
Laux, B 2014, Discussion of The role of revenue recognition in performance reporting. Accounting and Business Research. vol. 44, no. 4, pp. 380-382
Melicher, R.W. and Norton, E.A 2016, Introduction to Finance: Markets, Investments, and Financial Management, 16th ed. Wiley Publishers
Mersland, R., & Urgeghe, L 2013, International Debt Financing and Performance of Microfinance Institutions, Strategic Change. vol. 22, pp. 36-47
Nuhu, M. 2014. Role of Ratio Analysis in Business Decisions: A Case Study NBC Maiduguri Plant. Journal of educational and social research, vol. 4, no. 5, pp.105-118
Rio Tinto 2020, Rio Tinto 2020 annual report & accounts, viewed 9 October https://www.riotinto.com/-/media/Content/Documents/Invest/Reports/Annual-reports/RT-Annual-report-2020.pdf

Appendix

Ratios

RIO TINTO

Horizontal analysis