Comparative Analysis of Rio Tinto and BHP Billiton Limited

This report provides a comparative analysis of Rio Tinto and BHP Billiton Limited in the mining and natural resources sector. It includes performance ratios, share price movements, factors that may have influenced share price, beta values, expected rates of return, and dividend policies.

HI5002 Finance for Business Group Assignment T2
2018

TABLE OF CONTENTS
TABLE OF CONTENTS...................................................................................................................................1
CHAPTER 1 : INTRODUCTION.......................................................................................................................2
CHAPTER 2 :OPERATIONS AND COMPARATIVE ADVANTAGES....................................................................3
CHAPTER 3 :PERFORMANCE RATIOS...........................................................................................................5
3.1 Profitability Ratio..............................................................................................................................6
3.2Liquidity Ratios..................................................................................................................................7
3.3 Leverage Ratios.................................................................................................................................8
CHAPTER 4 : 2014-2017 SHARE PRICE MOVEMENT.....................................................................................9
CHAPTER 5 : FACTORS THAT MAY HAVE INFLUENCED SHARE PRICE MOVEMENT....................................11
CHAPTER 6 : BETA VALUES AND EXPECTED RATES OF RETURN.................................................................12
CHAPTER 7 : COMPANY DIVIDEND POLICIES.............................................................................................13
CHAPTER 8 : LETTER OF RECOMMENDATION............................................................................................14
CHAPTER 9 : REFERENCES..........................................................................................................................17
CHAPTER 10 : APPENDIX............................................................................................................................19
1

CHAPTER 1: INTRODUCTION
The purpose of this report is to evaluate and compare two companies. The companies we have
chosen in this report are in the mining and natural resources sector. They include Rio Tinto
Limited (RIO) and BHP Billiton Limited (BHP). The report is divided nine sections as follows:
In section two, we discuss the operations and comparative advantages of the two companies.
In section three,we calculate the performance ratios of the two companies based on liquidity,
profitability and capital structure.
In section four, we analyze the share price movement of the two companies within the last three
years.
In section five, the factors that may have influenced the share price are identified.
In section six, the beta values and expected rates of return are determined using CAPM.
In section seven, the dividend policies under the two chosen companies are compared.
In section eight, a letter of recommendation is made to the investor, based on which company
they should invest in.
2

CHAPTER 2:OPERATIONS AND COMPARATIVE ADVANTAGES
About BHP Billiton Limited
BHP Billiton Limited (BHP) is a mining company. It produces iron ore and plays a large role in
oil and gas. The company’s core areas include mineral exploration and production, exploration
of petroleum, refining and production.. BHP’s, operations and interests are divided into
Petroleum and Potash, Coal, Copper, Iron ore, and Nickel(BHP, 2018).
Comparative Advantages- BHP
BHP is currently the largest mining company in the world. Unlike its competitors, it is able to
maintain profitability even at periods when the price of commodities falls making it very
efficient.
Furthermore, BHP is well diversified across manycountries and resources, thus lowering its risk
profile. However, the company’s profitability is volatile as it is subject to movements in
commodity prices(The Australian, 2018).
About Rio Tinto
Rio Tinto Limited (RIO) is a company that is involved in metals and mineral exploration,
production and processing. Rio Tinto’s portfolio of assets is made up of four major product
groups: Aluminums, Iron Ore, Copper and Diamonds, Minerals and Energy(Rio Tinto, 2018).
Comparative Advantages- RIO
Rio Tinto is the second largest mining company in the world. It has operations in various regions
including Australia. About 80% of the company’s revenue are through its iron ore operations.
However, in addition to iron ore, Rio Tinto also produces coal, diamonds, bauxite, alumina,
aluminum, uranium, salt copper and gold.
RIO is less diversified than BHP. Therefore, it is sensitive to currency movements and price
changes in iron ore. However, similar to BHP, RIO is an efficient producer of iron ore. Hence it
3

is able to ‘withstand’ abrupt movements in iron ore prices. Furthermore, the company is able to
benefit when higher cost producers close production(The Australian, 2018).
4

CHAPTER 3:PERFORMANCE RATIOS
Performance ratios can provide investors with information on the company’sliquidity,
profitability and/or capital structure. Table 3-1 shows liquidity, profitability and/or capital
structurefor BHP Billiton Limited over the past three years. Similarly, Table 3-2 shows the same
ratios as above underRio Tinto Limited over the past three years.
Profitability Ratios
2017 2016 2015
Return on Equity 21.03% 18.52% 27.63%
Return on Assets 9.61% 7.34% 8.37%
Return on Capital 16.39% 11.96% 12.08%
Leverage or Capital Structure
2017 2016 2015
Debt to Equity Ratio 0.95 1.08 0.83
Liquidity
2017 2016 2015
Current Ratio 1.85 1.44 1.27
Quick Ratio 1.53 1.16 0.94
Table 3-1: Financial Ratios- BHP Billiton Limited
Profitability Ratios
2017 2016 2015
Return on Equity 22.02% 15.10% 15.87%
Return on Assets 10.53% 7.1% 7.14%
Return on Capital 19.12% 12.76% 10.44%
Leverage or Capital Structure
2017 2016 2015
Debt to Equity Ratio 1.00 1.11 1.27
Liquidity
5

2017 2016 2015
Current Ratio 1.69 1.60 1.53
Quick Ratio 1.38 1.29 1.22
Table 3-2: Financial Ratios- Rio Tinto Limited
3.1 Profitability Ratio
Profitability ratios are used to assess a firm’s ability to use its assets or capital to generate profits.
Examples of profitability ratio are return on assets (ROA), return on equity (roe) and return on
invested capital (ROIC).
Return on Assets (ROA)
ROA measures how efficiently the company's assets have been used to generate profits.
ROA = Net Income+ Interest Expense∗(1−Tax rate)
Average Total Assets
A large ratio suggests that the company has a good return on assets and hence is properly
managed.
The ROA for BHP and Rio increased in 2017. However, Rio Tinto had a higher ROA in 2017
compared to BHP indicating that Rio Tinto was operating more efficiently.
Return on Equity- DuPont
The ROE ratio analyses the ability of a company to realize an adequate return on the capital
invested by the owners or shareholder of the company. A large ratio shows efficiency.
However, it is important to note that the ROE alone does not say anything about the capital
structure. As a result, analysts have split the ratio into three which is the basis of the DuPont
Model(Ro, 2015)
Return on Equity = Net Income
Sales x Sales
Total Assets x Total Assets
Shareholde r ' sEquity
6

The ROE for BHP and Rio increased in 2017. However, Rio Tinto had a higher ROE in 2017
compared to BHP indicating that Rio Tinto is utilizing its capital successfully.
Return on Capital
The ROIC analyses the return an investment releases to its contributors of capital. In other
words, it indicates the efficiency of how a firm turns its contributor’s capital into profits
(Investing Answers, 2017).
Return on Capital = Net Income−D ividends
Invested Capital
The ROIC for both companies increased in 2017. However, Rio Tinto had a higher ROIC in
2017 compared to BHP indicating that the company is convertingits invested capital into profits.
3.2Liquidity Ratios
Liquidity ratios assess the liquidity risk for the company i.e. the company’s ability or inability to
pay its obligations in the short term. Examples of liquidity ratios are the quick (also known as the
acid test ratio) and current ratio (Subramanya & Wild, 2009). A company that has a liquidity
ratio above 1 suggests that there is a greater assurance that the company’s current short term
obligations can be settled by their current assets. Hence, such a company company does not have
a problem of liquidity.
Current ratio = Current assets/current liabilities
Quick ratio = (cash and cash equivalents + marketable securities + accounts receivable) / current
liabilities
In 2017, BHP and RIO showed a current ratio of 1.85 and 1.69 respectively. In the same year,
they showed a quick ratio of 1.53 and 1.38 respectively. Both companies do not have a risk in
liquidity.
7

3.3 Leverage Ratios
These ratios analyse whether a company can meets their long term liabilities. An example of a
ratio is the debt to equity ratio. In 2015-2017, the debt to equity ratio for both companies has
been high (in some cases above 1). This suggests the companies have a lot of debt and hence
presents a solvency risk.
8

CHAPTER 4: 2014-2017 SHARE PRICE MOVEMENT
The graph below shows the movements in the monthly share price over the last three years for
Rio Tinto and BHP.
From the graph, we observe the following
 The share prices for BHP Billiton Limited and Rio Tinto Limited are positively
correlated with each other. Hence both share prices move in the same direction.
 Generally, movement of prices has been closely correlated.
 Returns have reached up to 23% in respect to BHP, and 21% in respect to Rio.
The graph below shows the two company’s share price movements, including movements inthe
All Ordinaries Index.
9

From the graph, we observe the following:
 The share prices for BHP Billiton Limited and Rio Tinto Limited are positively
correlated with the All ordinary index. Hence both share prices move in the same
direction as the All ordinary index.
 However, both company’s price movements are above that of the All ordinary index
 Hence their price movements are more volatile than the All ordinary index.
10

CHAPTER 5: FACTORS THAT MAY HAVE INFLUENCED SHARE PRICE
MOVEMENT
BHP Billiton Ltd
In 2016, BHP Billiton announced that its first-half results would include write-downs worth
US$911m relating to closures and redundancies within the group, including the revaluation of its
copper business and iron ore production. Following this announcement, share prices in BHP
Billiton droppedby over 4% (Australian Associated Press, 2016).
In 2015, following a dam collapse in Brazil that resulted in the country’s worst environmental
disaster, BHP’s share price fell across all markets, falling 22 per cent in Sydney and 23 per cent
in both London and Johannesburg between 5 November 2015 and 30 November 2015. The falls
wiped $25bn off the company’s value(Independent, 2018).
Rio Tinto Ltd
In 2017, Rio Tinto announced that it will buy back another $US 2.5 billion of shares. As a result,
due to the announcement, share prices increased despite the drop in iron ore prices(Gray, 2017).
In 2014, Rio Tinto issued a statement that it had rejected to enter a takeover approach from
Glencore Plc. This merger would have created a $160 billion mining giant. Following this
announcement, Rio’s share price increased as much as 4.7 percent to a 9-day high. Glencore was
down 2.1 percent (Reuters, 2014).
11

CHAPTER 6: BETA VALUES AND EXPECTED RATES OF RETURN
BHP Billiton Ltd
According to Reuters, BHP Billiton has a Beta of 1.26. This means that its share price is more
volatile than the market index(Reuters, 2018).
Using the CAPM model, the required rate of return is determined as follows:
Re = risk free rate + beta*(rm-rf)
Where rm-rf is the market premium.
In other words, return on equity is calculated using the risk free rate, market premium and a beta
which shows correlation between the market returns and stock returns.
If the risk free rate is given as 5% and the market risk premium is given as 6%, then the required
rate of return for BHP’s shares is calculated as 0.063%
Rio Tinto Ltd
According to Reuters, Rio Tinto has a Beta of 0.96. This means that its share price is less volatile
than the market index(Reuters, 2018).
Using the CAPM model, the required rate of return is determined as follows:
Re = rf + beta*(rm-rf)
If the risk free rate of return was 5% and the market risk premium is 6%, then the required rate of
return for the companies’ shares is calculated as 0.048%.
12

CHAPTER 7: COMPANY DIVIDEND POLICIES
A dividend policy sets the guidelines for which a company uses to determine the proportion of
profits it will pay out to shareholders as dividends (Investopedia, 2018).
BHP dividend’s policy states that it will provide a minimum 50% pay out of its earnings at all
reporting periods. Furthermore, , in accordance with the company’s capital structure , the Board
will assess the ability to pay an amount in addition to the minimum paymen (BHP, 2018).
Rio Tinto’s dividend policy will provided between 40% to 60% pay out of its earnings at all
reporting periods. The board will take into account the results for the financial year, the outlook
for its major commodities, the company’s the long-term growth prospects of the business and
maintaining a strong balance sheetFurthermore, at the end of each financial period, the board will
determine an appropriate total level of ordinary dividend per share,. The intention is that the
balance between the interim and final dividend will be weighted towards the final dividend.
Rio is focused on generating cash and returning as much of it as possible to investors.
Consequently, the company is committed to maximising shareholder value by maintaining a
balance between cash returns to shareholders and investment into the business.
Taking into consideration the cyclical nature of the commodities industry, the board may include
additional returns in periods of profitability and cash generation, (Rio Tinto, 2018).
Both companies have a constant pay out policy. This means dividends payment is a fixed
proportion of the company’s earnings. Hence, the amount of dividend paid will move in direct
proportion of the company’s earnings.
This policy is preferred to many companies since it is related to a company’s ability to pay out as
opposed to the progressive dividend policy where dividend amounts are maintained every
year(Dhaval, 2018).
13

CHAPTER 8: LETTER OF RECOMMENDATION
<<Company Letterhead>>
<<Address>>
<<Date>>
Dear Sir
Recommendation of Selected Company to include in Investment Portfolio
We have recently analyzed the performance of two firms, namely Rio Tinto Ltd and BHP
Billiton Ltd in the same industry.
In this letter we explain which of the two selected companies should be included in your
investment portfolio based on ratio analysis and other trends.
Results from our review
The table below summarizes the results from an analysis of the liquidity, profitability and capital
structure ratio. The period under analysis was from 2014 to 2017.
Financial Ratios 2017 2016 2015
Return on Equity 21.03% 18.52% 27.63%
Return on Assets 9.61% 7.34% 8.37%
Return on Capital 16.39% 11.96% 12.08%
Debt to Equity Ratio 0.95 1.08 0.83
Current Ratio 1.85 1.44 1.27
Quick Ratio 1.53 1.16 0.94
Table 3: Financial Ratios- BHP Billiton Limited
Financial Ratios 2017 2016 2015
Return on Equity 22.02% 15.10% 15.87%
Return on Assets 10.53% 7.1% 7.14%
Return on Capital 19.12% 12.76% 10.44%
Debt to Equity Ratio 1.00 1.11 1.27
14

Current Ratio 1.69 1.60 1.53
Quick Ratio 1.38 1.29 1.22
Table 4: Financial Ratios- Rio Tinto Limited
Focus of review
The review sampled 2 mining firms .The key focus of the review was to assess suitability of the
two shares for investment against the clients risk profile, which includes, but is not limited to,
their knowledge and experience, investment objectives and financial situation.
Results of Review
1. Profitability Analysis
The ROA, ROE and ROIC for Rio Tinto Ltd and BHP Billiton Ltd increased in 2017. However,
Rio Tinto had a higher ROA in 2017 compared to BHP indicating that the company was
operating more successfully.
2. Liquidity Analysis
In 2017, BHP and RIO showed a current ratio of 1.85 and 1.69 respectively. In the same year,
they showed a quick ratio of 1.53 and 1.38 respectively. Both companies do not have a risk in
liquidity. However, BHP appeared more liquid than RIO.
3. Capital Structure
In 2015-2017, the debt to equity ratio for both companies increased (in some cases above 1).
This suggests the companies have a lot of debt and hence presents a solvency risk. The risk is
higher with Rio Tinto than BHP.
Summary
While we believe both companies are good investments, our preference is in investment of BHP
Billiton. This is because of their diverse operations, its positive outlook for the commodities it
produces has positioned it to outperform, and its undemanding valuation, over the next years.
Furthermore, the risk of solvency and liquidity appears to be lower than Rio. Therefore, we
recommend that the client should invest in BHP Billiton Ltd
15

Please feel free to contact us should you want to discuss further.
Yours Faithfully,
John
Investment Analyst
16

CHAPTER 9 : REFERENCES
Australian Associated Press. (2016, January 20). BHP Billiton shares fall to lowest point in decade after
announcing write-downs. Retrieved from The Guardian:
https://www.theguardian.com/business/2016/jan/20/bhp-billiton-shares-fall-to-lowest-point-
in-decade-after-announcing-write-downs
BHP. (2018). About Us. Retrieved from BHP: https://www.bhp.com
BHP. (2018). Shareholder Information. Retrieved from BHP:
https://www.bhp.com/investor-centre/shareholder-information/faqs
Dhaval, S. (2018). Meaning and Type of Dividend Policies. Retrieved from Financial Management:
http://www.businessmanagementideas.com/financial-management/dividends/meaning-and-
types-of-dividend-policy-financial-management/3968
Gray, D. (2017, September 22). Rio Tinto to buy back another $US2.5b of shares. Retrieved from The
Sydney Morning Herald: https://www.smh.com.au/business/companies/rio-tinto-to-buy-back-
another-us25b-of-shares-20170922-gymlxl.html
Independent. (2018, May 16). BHP Billiton to be sued by investors over dam collapse that caused Brazil's
worst ever environmental disaster. Retrieved from Independent:
https://www.independent.co.uk/news/business/news/bhp-billiton-samarcoi-dam-collapse-
legal-action-brazil-environmental-disaster-a8354126.html
Investing Answers. (2017). Return on Capital. Retrieved from Investing Answers:
http://www.investinganswers.com/financial-dictionary/ratio-analysis/return-capital-3054
Investopedia. (2018). Dividends Policy. Retrieved from Investopedia:
https://www.investopedia.com/walkthrough/corporate-finance/5/dividends/policy.aspx
Reuters. (2014, October 7). Bruised Rio Tinto rebuffs Glencore takeover approach. Retrieved from
Reuters: https://uk.reuters.com/article/uk-rio-tinto-glencore-approach/bruised-rio-tinto-
rebuffs-glencore-takeover-approach-idUKKCN0HV27020141007
Reuters. (2018). BHP Billiton Ltd (BHP.AX). Retrieved from Reuters:
https://www.reuters.com/finance/stocks/overview/BHP.AX
Reuters. (2018). Rio Tinto Ltd (RIO.AX). Retrieved from Reuters:
https://www.reuters.com/finance/stocks/overview/RIO.AX
Rio Tinto. (2018). About Us. Retrieved from Rio Tinto: https://www.riotinto.com
17

Rio Tinto. (2018). Dividends. Retrieved from Rio Tinto: https://www.riotinto.com/investors/dividends-
7988.aspx
Ro, S. (2015, April 17). Goldman Sachs eplains the 'return on equity' formula that every CFA test taker
must know. Retrieved from Business Insider: http://www.businessinsider.com/cfa-dupont-roe-
model-2015-4?r=UK&IR=T
Subramanya, K., & Wild, J. (2009). Financial Statement Analysis. New York: McGraw-Hill Irwin.
The Australian. (2018). BHP BILLITON LIMITED. Retrieved from The Australian:
https://markets.theaustralian.com.au/shares/BHP/bhp-billiton-limited
The Australian. (2018). Rio Tinto Limited. Retrieved from The Australian:
https://markets.theaustralian.com.au/shares/RIO/rio-tinto-limited
18

Chapter 10 : APPENDIX
Monthly prices & returns on BHP, RIO AORD
BHP AORD RIO
Date Close Return Close Return Close Return
5/31/2017 23.28 -3% 5764 0% 63.27 1%
4/30/2017 23.9 1% 5761.3 -3% 62.81 4%
3/31/2017 23.72 -1% 5947.6 1% 60.44 0%
2/28/2017 24.04 -4% 5903.8 2% 60.46 -2%
1/31/2017 25 -6% 5761 2% 61.99 -7%
12/31/201
6 26.64 6% 5675 -1% 66.68 11%
11/30/201
6 25.06 3% 5719.1 4% 59.9 4%
10/31/201
6 24.41 6% 5502.4 2% 57.75 7%
9/30/2016 23.07 3% 5402.4 -2% 54.18 5%
8/31/2016 22.38 10% 5525.2 0% 51.61 8%
7/31/2016 20.43 5% 5529.4 -2% 47.6 -4%
6/30/2016 19.52 5% 5644 6% 49.56 9%
5/31/2016 18.65 -2% 5310.4 -3% 45.5 2%
4/30/2016 19.08 -8% 5447.8 2% 44.69 -13%
3/31/2016 20.68 23% 5316 3% 51.55 21%
2/29/2016 16.86 8% 5151.8 4% 42.69 6%
1/31/2016 15.57 1% 4947.9 -2% 40.28 3%
12/31/201
5 15.35 -14% 5056.6 -5% 39.13 -12%
11/30/201
5 17.86 -1% 5344.6 2% 44.71 -3%
10/31/201
5 18.09 -21% 5218.2 -1% 45.91 -9%
9/30/2015 23.02 4% 5288.6 5% 50.65 4%
8/31/2015 22.22 -13% 5058.6 -3% 48.6 -3%
7/31/2015 25.49 -4% 5222.1 -8% 50.29 -5%
6/30/2015 26.45 -2% 5681.7 4% 52.86 -2%
5/31/2015 27.05 -9% 5451.2 -6% 53.75 -8%
4/30/2015 29.59 -1% 5774.9 0% 58.2 2%
3/31/2015 29.8741 3% 5773.7 -2% 57.15 0%
2/28/2015 28.9957 -8% 5861.9 -1% 57.23 -11%
1/31/2015 31.444 15% 5898.5 6% 64.41 12%
12/31/201
4 27.3418 0% 5551.6 3% 57.56 -1%
11/30/201 27.4445 -5% 5388.6 2% 58 -2%
19

4
10/31/201
4 28.8929 -9% 5298.1 -4% 59.1 -2%
9/30/2014 31.7336 0% 5505 4% 60.41 1%
8/31/2014 31.6495 -8% 5296.8 -6% 59.58 -5%
7/31/2014 34.266 -5% 5624.6 0% 62.63 -6%
6/30/2014 36.1442 5623.1 66.38
5/31/2014
20