BHP vs Rio: Financial Analysis and Investment Comparison

This report provides a financial analysis and investment comparison of BHP and Rio Tinto, two giants in the field of minerals and mining. It includes liquidity ratios, profitability ratios, share price movements, calculation of beta and value, and dividend policy.

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FINANCE

BHP vs Rio
Executive Summary
Investment in a company or a rival company is a difficult task however with the aid of
financial analysis it can be done with ease. Ratio analysis and other parameters help in
providing a strong answer to the fact that whether the company is feasible to be invested in.
In this report, two giants in the field of minerals and mining that is Rio and BHP is selected.
The report initiates with the introduction and the operating model. It is then followed by the
ratios comparison of both the companies. The beta values of both the companies are
computed and the dividend policy has been highlighted so as to make the appropriate
decision.
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BHP vs Rio
Contents
Introduction...........................................................................................................................................2
1. Comparative advantage and operation model..............................................................................3
2. Computation of performance ratios..............................................................................................5
• Liquidity ratios...............................................................................................................................5
 Profitability ratios..........................................................................................................................7
 Solvency ratio................................................................................................................................8
3. Share price movements.................................................................................................................9
4. Factors that influenced the share price.......................................................................................11
5. Calculation of beta and value......................................................................................................12
6. Dividend policy of the companies................................................................................................12
Recommendation................................................................................................................................13
Conclusion...........................................................................................................................................13
References...........................................................................................................................................14
Appendix.............................................................................................................................................16
3

BHP vs Rio
Introduction
Rio Tinto is the largest mining organizations in the world and it has been established in the
year 1962. Furthermore, the company intends to provide its users with effective returns
through an appropriate portfolio. Moreover, it is made of several segments such as aluminum,
iron ore, diamond, minerals, and copper that assists it to exert its affairs globally across
various countries. This has been possible with the prevalence of sixty thousand people
operating in the organization. Nevertheless, accounting for the initial stages, Rio Tinto firstly
entered the industry as a single entity but thereafter, it changed its perspectives and theories
to become a company dually listed in nature (Rio Tinto, 2017). Moreover, the significant
areas of company’s functioning are primarily concentrated upon Canada and Australia.
Lastly, the entire business affairs of the company are operated through partly or wholly-
owned subsidiaries. Nonetheless, Rio has also been listed on the ASX and London Stock
Exchange that assists it in the fulfillment of prime objectives.
On the other hand, BHP Billiton is a pioneer in the field of metal, mining, and petroleum. The
company is dually listed with two parent companies that run on its own. The major advantage
that the business carries is the management and the Board function. Further, BHP strives to
enhance the value of the shareholder through the process of marketing, discovery and
increasing the natural resources (BHP Billiton, 2017). The formidable strategies help the
business to flourish and ensure the protection of the environment.
1. Comparative advantage and operation model
It is beneficial for the Australian government to keep charging taxes to the operations which
are of a global standard because this will increase the stakes for the same. BHP Billiton has
been seen to work on the same standards which are like exploring, mining, drilling,
extracting, processing, shipping as also marketing. It is seen that the company has been
paying the taxes from the profits division which have been generated due to the trade in
Australia. The company has also been making amounts from Singapore due to a 400-strong
marketing team which is gathered there for an operation like customer sales, freight, credit
risk and forecasting which are related to iron ore (BHP Billiton, 2017). Cleverly the team has
been set up in Asia which makes its closer to the main marketing customers like China,
Japan, and South Korea. Application of the taxes is a very important topic and has been seen
to always fall in Australia’s favor. BHP Billiton has been seen to play it fair and honest for
4

BHP vs Rio
the last 15 years by presenting all the tax payments publicly and this has resulted in it to be
selected as the company which has been the most transparent company in terms of legal talks.
When it comes to Rio, the major advantage can be witnessed is the competitiveness in terms
of industry and condition. The strategy of the company is clear and enables to perform in a
formidable manner in the industry environment. The goal is to provide maximum benefits
and hence it follows four Ps that is the portfolio, performance, people, and partners. Further,
the company is strongly positioned to address the increment in the environment and cost
pressure (Rio Tinto, 2017). The marketing function is centralized and works in tandem with
the operations to enhance the value from the activities and keep the resources management in
tune to the overall market.
Operating model
The four foundations of the BHBP associated with their business field work areas - Iron Ore,
Petroleum, Copper and Coal. All these priorities are held strong by maintained centers
(Group functions) and the marketing system (marketing division). all the above centers have
their own sets of administrative and executive departments and the CEO of each of the center
is the one who sits in the final meeting of the Group Management Committee which consists
of all the senior members (BHP Billiton, 2017).
All the above-mentioned centers are structured in such a way so that they keep their priorities
like the member’s safety, maximum production and minimum costs at the top of the list. All
the centers are independent and believe in the instantaneous decision. All the centers have
different working associated with the sales, marketing, corporate support and this is why all
the centers are free to take advantages of the policies set up in the company which will help
to avoid the macroeconomics hindrance. This also helps the company to execute things in a
more systematic way with association with the portfolio which will increase the reputation of
the company. The type of business that has been stated above, it should be noted that the
income from the product is never in the hand of the company. The international market
decides the mark of profits as per the supply and demand rate. BHP is clever enough to select
only Tier-1 projects so that their standards are set up globally.
Perceiving long-term view is the key to mining operations and the lower costs plan cannot be
achieved only by strategic developments and portfolios. Tier-1 is the main area that decides
5

BHP vs Rio
that the workings will be of lower cost or not. It should be noted that the time lapse between
production and the starting of the business ranges from 10 to 20 years.
Rio Tinto has an effective plan by which it can guarantee such values which it will be able to
achieve easily in the future without increasing its overall costs. The operating model of Rio
rests on the investment of people and partnership with the stakeholder who is external. The
company invests in huge in the development of technical, as well as commercial capabilities
that enables to unleash the maximum value from the assets (Rio Tinto, 2017). The
fundamentals of operations dwell on the value chain, trusted relationship and reputation.
6

BHP vs Rio
2. Computation of performance ratios
• Liquidity ratios
This ratio assists in highlighting the company’s ability to repay its short-term debt
obligations. Further, this ratio also determines the funds that are associated with short-term
tenure and how it can allow in a smoother flow of operations. Therefore, if a company does
not have a proper liquidity ratio, it signifies failure or ineffectiveness on the part of the
company to repay their short-term debt obligations (Leo, 2011). Nevertheless, on the other
side, efficiency ratios play an important part in highlighting the fact whether it can manage its
resources or assets in an efficient way or not. Moreover, efficiency ratios are almost like that
of liquidity ratios and the reason behind this can be attributed to the fact that it assists in
measuring the processes by which an organization can generate revenues from its present
available funds. Further, it the management of the company is not capable of subduing its
resources, it signifies that the generated profits will be declined (Marsh, 2009).
Current ratio can play a key role in depicting the rotation of resources through the business
affairs so that both stock and debtors can be easily converted into cash for the payment to
creditors (Petersen & Plenborg, 2012). This can be undertaken by dividing a company’s
current assets with their current liabilities. Nevertheless, in relation to the company, it can be
observed that its current ratio has been very efficient in nature, thereby reflecting that it has
been able to maximize its current assets when compared to the current liabilities (Laux,
2014). Therefore, the company can easily cater to all its future short-term debt obligations in
an efficient way and its current ratio is the prime witness of this fact. However, in contrast to
this, when it comes to quick ratio, the same plays a key role in highlighting the fact that the
company can repay its short-term debt obligations. Besides, it can facilitate serving as an
effective reflection of current ratio as stocks are not incorporated in this ratio. Moreover, the
organization’s quick ratio is greater than the usual rate of 1:1, thereby shedding light on its
liquidity strength to address the future obligations (Merchant, 2012). Furthermore, in relation
to fixed assets ratio, the company’s ratio has been stagnant that depicts utilization of assets in
all the years. The current ratio of BHP is formidable as compared to Rio Tinto because it is
near to the standard ratio of 2:1 indicating the presence of more current assets to meet the
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BHP vs Rio
obligations. Rio is above the ratio of 1:1, however, stands low in comparison to BHP.
2015 2016 2017
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
2
Rio Current Ratio (Current
Assets/Current Liabilities)
Current Ratio (Current
Assets/Current Liabilities)
The acid test ratio is a better indicator of liquidity and from the graph it is noted that BHP has
high presence of liquidity as the ratio exceeds 1:1 and this opportunity can be considered by
BHP to invest the funds elsewhere to reap profit. The growth in the acid test ratio of BHP has
been formidable in the past three years. On the other hand, Rio is better placed as in all the
three years, the ratio remained above 1 indicating a strong momentum (Porter & Norton,
2014).
2015 2016 2017
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1.60
1.80
Rio Acid Test [(Current
Assets-Inventory+Prepaid
exp)/Current Liabilities)]
BHP Acid Test [(Current
Assets-Inventory+Prepaid
exp)/Current Liabilities)]
8

BHP vs Rio
 Profitability ratios
Profitability ratios can be used to assess how an organization can generate revenues when
compared to other costs that incur in the general scenarios. In addition, it must be taken into
consideration that the profitability ratios must be extreme in nature as it reflects a company’s
significance when compared to the competitors. However, when the profitability ratio of an
organization in relation to the present tenure is compared to the past year, the ratio must be
greater in nature (Parrino et. al, 2012). The reason behind this can be attributed to the fact that
it reflects a positive working scenario on the company’s profit. Furthermore, in relation to the
company, its profitability ratios that have been calculated are gross profit margin, net profit
margin, return on assets, and return on equity respectively (Douma & Hein, 2013).
In association with the net profit margin of the company, the same is called as a profitability
ratio that can be utilized to reflect how efficiently an organization is able to manage its
expenses. Besides, the board or management calculates such a ratio to determine how
efficiently the organization has been performing to convert its costs into revenues (Davies &
Crawford, 2012). In addition, the return on equity and return on assets of the organization
have also experienced a positive trend, thereby reflecting that the organization has used its
resources or assets in an appropriate way.
The return on Assets indicates that Rio is better placed as compared to BHP owing to better
utilization of the assets. Though a negative ratio was witnessed in 2015 however, it bounced
back and shown high performing results.
2015 2016 2017
-8
-6
-4
-2
0
2
4
6
8
10
12
Rio Return on Assets [(Net
Income/Average
Assets)*100]
BHP Return on Assets [(Net
Income/Average
Assets)*100]
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BHP vs Rio
2015 2016 2017
-25.00
-20.00
-15.00
-10.00
-5.00
0.00
5.00
10.00
15.00
20.00
25.00
Rio Net Profit Margin [(Net
Profit after tax/Sales
Revenue)*100]
BHP Net Profit Margin
[(Net Profit after tax/Sales
Revenue)*100]
Similarly, the net profit margin of Rio is better placed because the growth of the company’s
profit has been formidable. After a drop in the year 2015, it projected high results however,
BHP had a massive fall in 2016 and therefore, a disturbance can be noted in the graph.
 Solvency ratio
2015 2016 2017
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
Rio Debt Equity Ratio
BHP Debt Equity Ratio
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BHP vs Rio
2015 2016 2017
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
Rio Debt ratio
BHP Debt ratio
This ratio plays a benevolent part in reflecting the company’s long-term sustainability. In
addition, the solvency ratio highlights that the overall debt remained constant and more than
1. This means that there is higher dependence on debt financing on the part of company. Both
the companies have a huge reliance on debt and that is obvious from the strong business both
contains (Choi & Meek, 2011).
3. Share price movements
(Rio Tinto, 2017)
11

BHP vs Rio
(Market index, 2018)
BHP Billiton
12

BHP vs Rio
(Market index, 2018)
From the comparison with the all ordinary index it can be commented that both the
companies that is Rio and BHP follows the All ordinary index. In the case of Rio, the All
ordinary index graph remained above the share price of the company while in the case of
BHP the share price remained above the All ordinary index.
4. Factors that influenced the share price
The recovery of iron ore prices was a massive motivation for BHP. Besides, the news related
to the revamping of a trillion dollars of infrastructure has resulted in the increment of copper
prices. The company’s announcement in association with its mines has played a primary part
in influencing the share prices on a whole. Hence, such a step has a major hand in the
creation of upwards pattern in stock prices (BHP Billiton, 2017). The decrease in production
expenses paved a path for another significant alteration in the company’s stock prices.
Further, it paved a way for the organization to carry out all profitable events to diversify its
business to an effective stage.
On the other hand in the year 2016, the company had observed stagnancy in its iron ore prices
after an important gap of two years. Further, such decrease remained stagnant until 2015 and
afterward, the same increased with due course of time. The company’s coal mine based in
Zululand has been sold in South Africa and the announcement of the rationalization of coal
played a primary role in creating a significant reduction in the shipment of coal (Rio Tinto,
13

BHP vs Rio
2017). Nevertheless, the potential factor in relation to the company was associated with
Pilbara iron.
5. Calculation of beta and value
a. It can be observed from the calculation that the beta of Rio showed at 1.64 that signifies
higher volatility in the stock of the company. Further, it means that the stock can proceed at a
greater pace than the overall industry (Carmichael & Gragam, 2012). Moreover, when the
company’s beta for its stock is greater than 1, it means potential movements in stock when
compared to the overall market.
b. CAPM:
E(R) = RFR + βstock (Rmarket – RFR)
Hence, CAPM= 0.04+1.64(6-5) = 1.68
c. Rio cannot be regarded as a proper investment zone because its beta has reported at being
greater than one and the same is witnessed in the case of BHP where beta is 1.28. Further,
stocks that are having more than one beta are considered risky because there is immense
volatility in such stock. This means that the stock will proceed rapidly than the overall
market.
CAPM (BHP)
E(R) = RFR + βstock (Rmarket – RFR)
Hence, CAPM= 0.04+1.28 (6-5) = 1.32
6. Dividend policy of the companies
The company’s dividend policy can be determined after knowing the real financial results.
Besides, it also relies on the decision of the board to retain profits for expansion and
diversification and whether they are keen on portraying an effective financial statement.
Furthermore, the motive behind the formulation of the company’s dividend policy can be
attributed to the balance betwixt the interim and final dividend that assists in weighing the
final dividend (Petty et. al, 2012). Moreover, the procedure is undertaken in a way that there
is a proper balance betwixt the company’s investment and a return of cash to the shareholders
(Needles & Powers, 2013). This is because the company is liable for maximizing the
shareholders’ wealth. Nevertheless, it must witness specific tests owing to the cyclical nature
14

BHP vs Rio
of the market and because of unspecific variations in earnings and generation of cash.
Overall, the dividend policy of company helps in relation to extra dividend and the ordinary
dividend that can be offered to the shareholders (Peirson et. al, 2015).
Recommendation
If the prices of shares of BHP Billiton increase, Rio Tinto will experience lesser capital gain
on the part of investors. The profitability of both organizations has witnessed significant
alterations. The reason behind this can be attributed to the fact that both the organizations are
primarily from the mineral resource group. In addition to this finding, the external
environment plays a key role in affecting the overall situation of the company very heavily.
The capability of a company to retain its position in the long-run can be witnessed in the case
of BHP Billiton and the reason behind this can be attributed to the fact that the company has
more powerful financial fundamentals when compared to Rio Tinto (BHP Billiton, 2017).
Both BHP Billiton and Rio Tinto are powerful organizations that are heavily dependent on
debt financing. Hence, investment in both the companies is risky for the investors because the
company is under an obligation to pay a huge amount as interest for the loan that has been
obtained.
Conclusion
Under the investment topic of Rio and BHP it is seen that the returns as as not as expected.
The highest expectations are never fulfilled by the BHP because it is capital return is
somewhat weak in nature whereas Rio Tinto’s priority is to give maximum benefits to the
shareholders. BHP the capital expenditure charts of the BHP are soaring high above Rio
Tinto. IN case of BHP, the rating of “A” is the main priority whereas for Rio Tinto growth
strategy is the main foundation. 80% of the capital of the company is generated through the
working operations of iron ore and the decrease in price of the same will maintain the status
and the capital of the company. The production centers along with the weakness in the local
currency acts as a boon to the company. It is also noted that the petroleum works of the BHP
are providing extra boost to the share price of the same.
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BHP vs Rio
References
BHP Billiton. (2017). BHP 2017 Annual report and accounts. https://www.bhp.com/media-
and-insights/reports-and-presentations [Accessed 31 August 2018]
Carmichael, D.R. and Graham, L. (2012) Accountants Handbook. Financial Accounting and
General Topics, John Wiley & Sons.
Choi, R.D. and Meek, G.K. (2011) International accounting. Pearson .
Davies, T. and Crawford, I. (2012) Financial accounting. Harlow, England: Pearson.
Douma, S., & Hein, S. (2013) Economic Approaches to Organizations. London
Laux, B. (2014) Discussion of The role of revenue recognition in performance reporting.
Accounting and Business Research. [online]. 44(4), 380-382. Available from:
https://doi.org/10.1080/00014788.2014.897867
Leo, K. J. (2011). Company Accounting. Boston:McGraw Hill
Merchant, K. A. (2012) Making Management Accounting Research More Useful. Pacific
Accounting Review. [online]. 24(3), 1-34. Available from:
https://pdfs.semanticscholar.org/6ccf/f78a452763f17ed5e4f4ddc6b96703801403.pdf
Marsh, C. (2009) Mastering financial management. Harlow: Financial Times Prentice Hall.
Market index. (2018) BHP Billiton market index. Available from:
https://www.marketindex.com.au/asx/bhp
Needles, B.E. & Powers, M. (2013) Principles of Financial Accounting. Financial
Accounting Series: Cengage Learning.
Parrino, R, Kidwell, D. and Bates, T. (2012) Fundamentals of corporate finance. Hoboken,
NJ: Wiley
Petty, J. W, Titman, S., Keown, A. J., Martin, J. D., Burrow, M. and Nguyen, H. (2012)
Financial Management: Principles and Applications, 6th ed. Australia: Pearson Education
Australia.
Peirson, G, Brown, R., Easton, S, Howard, P. and Pinder, S. (2015) Business Finance, 12th
ed. North Ryde: McGraw-Hill Australia.
Petersen, C. and Plenborg, T. (2012) Financial statement analysis. Harlow, England:
Financial Times/Prentice Hall.
Porter, G. and Norton, C. (2014) Financial Accounting: The Impact on Decision Maker.
Texas: Cengage Learning
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BHP vs Rio
Rio Tinto. (2017) Rio Tinto Annual Report and accounts 2017 [online]. Available from:
http://www.riotinto.com/documents/RT_2017_Annual_Report.pdf [Accessed 19 May 2018]
Vaitilingam, R. (2014) The Financial Times Guide to Using the Financial Pages. London: FT
Prentice Hall.
Williams, J. (2012) Financial accounting. New York: McGraw-Hill/Irwin.
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BHP vs Rio
Appendix
BHP Billiton ratios
Profitability
Return on Assets
2015 2016 2017
Net Income 1910 -6385 5890
Average Assets
11866
4
10472
5
98594.
5
Return on Assets [(Net Income/Average Assets)*100] 1.61 -6.10 5.97
Net Profit Margin
2015 2016 2017
Net Income 1910 -6385 5890
Sales Revenue 44636 30912 38285
Net Profit Margin [(Net Profit after tax/Sales Revenue)*100] 4.28 -20.66 15.38
Solvency
Debt Equity Ratio
2015 2016 2017
Total Debt 59812 64663 59748
Total Equity 64768 54290 57258
Debt Equity Ratio 0.92 1.19 1.04
Debt Ratio
2015 2016 2017
Total liabilities 59812 64663 59748
Total assets 124580 118953 117006
Debt ratio 0.48 0.54 0.51
Liquidity
Current Ratio
18

BHP vs Rio
2015 2016 2017
Current Assets
1636
9
1771
4
2105
6
Current Liabilities
1285
3
1234
0
1136
6
Current Ratio (Current Assets/Current Liabilities) 1.33 1.85 1.85
Acid Test Ratio
2015 2016 2017
Current Assets
1636
9
1771
4
2105
6
Inventory 4292 3411 3673
Current Liabilities
1285
3
1234
0
1136
6
Acid Test [(Current Assets-Inventory+Prepaid exp)/Current Liabilities)] 0.94 1.16 1.53
Rio Tinto Ratios
Return on Assets
2015 2016 2017
Net Income -866 4617 8762
Average Assets
99695.
5
90413.
5
92494.
5
Return on Assets [(Net Income/Average Assets)*100] -0.87 5.11 9.47
Net Profit Margin
2015 2016 2017
Net Income -866 4617 8762
Sales Revenue 34829 33781 40030
Net Profit Margin [(Net Profit after tax/Sales Revenue)*100] -2.49 13.67 21.89
19

BHP vs Rio
Debt Equity Ratio
2015 2016 2017
Total Debt 54215 49973 51015
Total Equity 37349 39290 44711
Debt Equity Ratio 1.45 1.27 1.14
Debt Ratio
2015 2016 2017
Total liabilities 54215 49973 51015
Total assets 91564 89263 95726
Debt ratio 0.59 0.56 0.53
Current Ratio
2015 2016 2017
Current Assets
1555
4
1508
6
1917
2
Current Liabilities
1015
7 9400
1134
9
Current Ratio (Current Assets/Current Liabilities) 1.65 1.69 1.69
Acid Test Ratio
2015 2016 2017
Current Assets
1555
4
1508
6
1917
2
Inventory 3168 2937 3472
Current Liabilities
1015
7 9400
1134
9
Acid Test [(Current Assets-Inventory+ Prepaid exp)/Current
Liabilities)] 1.22 1.29 1.38
20