Financial Analysis of BHP Billiton and Rio Tinto: A Comparison

This report provides a detailed financial analysis of BHP Billiton, a major mining company formed through the merger of BHP and Billiton. The analysis covers the company's financial reporting, focusing on the needs of various stakeholders including shareholders, lenders, government, and cont...Read More

Slide 2– BHP Billiton was formed in the year 2001 when there was a merger between two
mining groups i.e. BHP from Australia and also Anglo Dutch Billiton Plc from UK. Owing to
the roots in both UK and Australia, the company is listed on both the exchanges i.e. LSX and
ASX. The existing market capitalization of the company stands at $ 111 billion with a
revenue of $ 31 billion (which has declined in the recent years) and $ 3 billion PAT (FY2015).
The company is a mining behemoth as is apparent from the wide segments which clearly
reflects a diversified portfolio led by iron ore & coal. The mines of the company are
geographically distributed with Australia hosting most of the mines but the mines are also
found in North America (US, Canada, Mexico), South America (Brazil, Chile, Peru, Colombia)
along with Africa (Algeria).
Slide 3- Financial reporting is aimed at fulfilling the information needs of the various
stakeholders. Shareholders and lenders are two critical stakeholders. The shareholders have
to take decision if the underlying stock is investment worthy at current price levels or not. In
this context, Earnings per Share or EPS is critical as Price/EPS multiple typically depends the
fair price of the share. Additionally, the leverage is also significant particularly in the context
of future growth as business is capex driven. Dividends are also crucial as reflected from
cash flow statement. With regards to lenders, enough operating profits need to be
generated so as to honour interest obligations. Further, the ratios in context of liquidity and
solvency should be healthy based on which the extent of exposure is fixed and also the
security is demanded.
Slide 4 – Another vital stakeholder is the government along with regulators. The financial
statements reflect the level of adherence to various disclosure and accounting standards.
This is critical as it is a public listed company. Further, in adverse times such as the ongoing
time, there is increased risk of window dressing in accounts and misreporting which
regulators need to be vigilant about. For mining business, a pivotal role is played by
contractors which render a host of service. The revenue of the company is imperative as it
hints at the prevailing commodity prices. Further, the short term liquidity ratios would be
imperative as it affects the short term ability of the company to meet payment obligations
for contractors.

Slide 5 – For a mining business, one of most critical statements is the income statement.
This is because the revenue essentially tends to drive the financial health of the company.
For instance, if the price of commodities is high, the revenue realised would be higher and
hence profit generation would improve which would ensure a healthy financial position
reflected in the balance sheet. A drop in commodity prices which is being currently
witnessed has reduced the profits and can adversely impact the financial strength. On the
expense side, the only noticeable expense relates to cost of revenue.
Slide 6- The balance sheet reflects the financial position of the company. Since the business
requires high capex, hence about (3/4)th of the assets of the company would be found in
the form of PP&E. Also, debt financing is critical due to the capital requirements of the
business. Considering the long gestation period of various capital projects, long term debt
funding is required which is why these borrowings reflect 40% of the overall liabilities.
However, 10% of the liabilities is in the form of current borrowings required for working
capital. In relation to equity, imperative aspect would be the number of share issued
coupled with internal accruals captured through retained earnings.
Slide 7 – In relation to measurement of assets , the use of accounting conventions coupled
with management judgement is imperative especially for mining where inherent subjectivity
is involved. The role of these aspects can be witnessed when the material or ore which can
be recovered from a mine needs to be determined which besides technical report also
requires management insight and fair judgement. With regards to expenditure on
exploration, the likelihood of future benefit arising is driven by management judgement
which essentially drives the accounting treatment extended. Similarly, impairment and
depreciation computation besides determination of fair value also are influenced by the
ongoing accounting conventions and management judgement.
Slide 8 – A ratio analysis has been carried out for BHP Billiton and the competitor firm has
been selected as Rio Tinto. This analysis has been carried out taking the financial statements
from FY2012 to FY2016 into consideration. The various ratios considered in this endeavour
are profitability, efficiency, liquidity and solvency. The profit generating ability of the
business is captured by the profitability ratios. Further, the operational efficiency
particularly with regards to turning inventory into sales and sales into cash is captured

through efficiency ratios. Liquidity and solvency ratios tend to focus on short term and long
term liquidity of the company respectively which is critical so that debt funding can be
availed in the future.
Slide 9 – The gross profit margin of the company shows high variation owing to the changes
in the commodity prices. From 2012-2014, there was a firming of prices which is reflected in
the form of higher gross margins but in 2015-2016, there is a trend reversal. For the
competitor even though, the performance at gross level is worse than BHP, but the pre-tax
margins are significantly superior in comparison with BHP. One positive aspect for BHP is in
the form of improving liquidity which continues even in FY2015 and FY2016. However,
despite the improvement in liquidity ratios, these continue to be worse than the
corresponding values for Rio Tinto which highlights the need to improve these further.
Slide 10 – The solvency ratios for BHP are essentially driven by the business performance
which in turn depends on the prevailing commodity prices. During 2012-2014, there was a
rise in the commodity prices leading to improvement in solvency ratios. However, in 2015-
2016, as the commodity prices plummeted, the solvency ratios have following suit.
However, the competitor Rio Tinto has superior ratios in terms of solvency in comparison
with BHP which provides a better future growth platform for Rio in terms of debt financing.
The falling trend in efficiency ratios for BHP is clearly appalling especially considering Rio’s
performance. It has led to an increase in the working capital requirement for BHP owing to
higher cash cycle.
Slide 11- This slides summarises the implications of the information collected from ratio
analysis for the various stakeholders. For the shareholders, falling profitability ratios is an
indication that the share price would underperform as the price is a function of EPS. Further,
the dividend payout can potentially be adversely impacted. For the lenders, deteriorating
solvency and efficiency ratios are concern for long term and short term lending respectively.
Further, the interest cover would also be adversely impacted. For the government, lowering
commodity prices imply greater risks of misreporting and higher vigilance on the part of the
regulators. For the contractors, lower commodity prices mean delay in projects which
implies lesser work.