Managerial Accounting- The Recent Performance of a BHP Billiton - Case Study Example

Managerial Accounting: To analyze the recent performance of a major UK company and give advice to an investor based on their findings Contents Managerial Accounting: To analyze the recent performance of a major UK company and give advice to an investor based on their findings 1 Contents 2 Introduction 3 The Investor’s Objective 3 BHP Billiton 4 Analysis of the Strategies 4 Financial Statement Analysis 6 Liquidity Analysis 7 Solvency Analysis 8 Profitability Analysis 9 Operating Activity Analysis 10 Investment Activity Analysis 11 Comparison from the Industry Perspective 12 Recommendation 15 Conclusion 16 References 17 Appendices 18 BHP Billiton Chairman’s Review: 18 BHP Billiton Income Statement 19 BHP Billiton Balance Sheet 20 Rio Tinto Balance Sheet 22 Introduction To suggest an investor about his further association with a company, a researcher needs to analyze the performance of the company for the past few years. Along with this, the analyst also has to analyze the current trends in the industry and the company’s position with respect to the industry. An investor would invest in the company when he finds it profitable for the long term or the short-term period. A company is profitable for the long term or the short term if it uses the available resources efficiently. To find that whether a company is using the resources efficiently or not, a researcher has to analyze the financial statements of the company. Along with this, the strategies taken by the company will also need to analyze. The vision, mission and goals of the company tell about the strategies that they are going to take in the future. Analyzing the financial position and the strategies taken by the company, an analyst can suggest the investor about his investing strategies in future. For investing in a company, the investor has to check the current trends in the industry. If the industry average is better than the company’s condition or the growth rate, then the analyst has to check the policies taken by the company management to solve the dispute. This paper is an attempt to analyze a company, which is among the top 200 companies of the United Kingdom based on market capitalization and suggest the investor about the investing strategies that should take by the investor. The researcher will analyze the performance of the company of past few years, the strategies taken by the company and the company’s performance from the industry perspective. The Investor’s Objective There are many types of investors in the market and their objectives are not same all the time. Some investors only aim for the short-term growth. For short-term gain the investors may trade inside a single day, i.e. they may buy and sell the stock in a single day. They can trade the stocks monthly basis. Their decision mainly based upon the movement of the stocks prices in a short term and the decision of the mass. When a huge number of investors sell a stock then these type of investors speculate that the stock price is likely to decrease and he also sells the stock. However, there are also other types of investors, who invest in a company for the long term. The objective of the investors is growth of the stock. They invest in a company for the long term. In this case, the client of the researcher is the second type of investor. He prefers to invest for the long term. The researcher has selected the company BHP Billiton for analyze whether to invest more in the company or not. The researcher will analyze two situations i.e. the investor already holds the share of the company and the investor has not invested in the company until now. It will be recommend to the investor whether or not to invest in the company. BHP Billiton BHP Billiton is a company, which has formed in the year 2001, headquartered in Melbourne, Australia. The company was the merger of Anglo-Dutch Billiton Plc and the Australian Broken Hill Proprietary Company Limited. The company has a major office in the United Kingdom for the management purpose. The company is in the metals and mining industry. BHP Billiton Plc is a registered company in the United Kingdom and listed in the London stock exchange. The stock is also the constituent of the FTSE 100 index. The merged company is the third largest company in the industry from the market capitalization point of view and the largest company in the industry based on revenue. The company is a dual listed company. BHP Billiton Plc traded in the stock exchanges of the United Kingdom, the United States and South Africa. The other part of the company, BHP Billiton Limited, trade in the United States and Australian stock markets. BHP Billiton has involved in many merger and acquisitions still the inception of the company. The company has acquired WMC Resources in the year 2005, which was a mining company and mainly operated in South Australia. The company has tried to acquire one of the major competitors in the industry Rio Tinto through a hostile takeover process. Eventually the effort did not have the success due to the global recession. After that, the company has acquired several companies like Athabasca Potash, Petrohawk energy etc. Currently, the company is operating in 25 countries and approximately 41,000 people are working with the company. Analysis of the Strategies BHP Billiton is the company of mining and metals industry. The portfolio of the company is diversified. They are currently operating in different types of natural resources. The strategy of the company is to enhance the value of the shareholders. They want to increase the value of the shareholders through discovering new opportunities, by developing their existing business, acquire some companies to make the portfolio more diversified and market the resources as available to them. When a company is in a business, then the managers have to decide between two options. These are shareholders’ wealth maximization and the profit maximization. The analysts opine that a company should always have the objective of shareholders’ wealth maximization. If the company has the objective of profit maximization, then they can earn profit for a short-term period. However, the objective of shareholders’ wealth maximization ensures the long-term profit for the company as well as the short-term profit also. The objective of BHP Billiton is the right one, and they are moving to the right way. They have also taken the strategies, which are in accordance to their vision. The modern era is the era of globalization. In this era of globalization, each country has the connectivity with other countries of the world economically. When the economic condition of a country is bad, then it hampers the economic conditions of other countries. The economic and political conditions of a country are not always favourable for a company to operate. Because of these reasons, a company has to diversify their business geographically and sector wise. BHP Billiton is the company, which is operating in 25 countries of the world including Brazil, Australia, the United States, the United Kingdom, Pakistan, Iraq and Peru. The company is doing business in many sectors including Aluminium, energy coal, iron ore, stainless Steel materials, base metals, and diamond and speciality products. The vast operation of the company increases the diversification of the company. The diversification of the company ensures that the company will be able to face the different economic situations efficiently. The vision of the company is to own and operate on the low-cost, expandable, large and upstream assets. Operating with the low cost assets assures higher margin of profit for the company. The company has mainly targeted the expandable assets, which will assure the future growth for the company. Targeting the large and expandable assets means the future growth of the company, which is profitable for the company management as well as the stakeholders of the company. The stakeholders of the company is not only the shareholders or the prospective investors of the company, but also the customers, employees, the local government and the creditors are also the shareholders. The strategy of the company is to value the customers, employees as well as the communities associated with the company. Valuing the employees will help to increase the motivation of them and as a result, the productivity of the employees increase. If the company is able to manage the employees efficiently, then it becomes able to earn profit for the long-term. Valuing the customer means to value the opinion of the clients and provide them quality product and services. If a company value the opinions of the customers, the customers will also assure the long-term association with the company. As per the view of the chairman, Jacques Nasser AO, the main strength of the company is the diversified portfolio. The company has performed well from as per the industry average, as the chairman has said. The strength of the company is the current economic condition of the world. There are a numbers of developing countries in the world like India, China, where the industrialization and the urbanization is fast. For the improvement of the infrastructure, the transport and the buildings, the importance of the mining industry is huge and BHP Billiton is among the top three companies in the industry. When a company wants to do business for a long-term, it has to take the responsibilities for the society and the environment in which they are operating. The corporate social responsibility structure of BHP Billiton is significant. The company management provide one percent of their pre tax profit to the community programs. Along with this, they used to take care for the society. The company used to create jobs for the local people, support the local industry with their diversified business and invest in the local projects. In an industry like mining, where the company is one of the top companies in the world, and the long-term vision of the company would certainly encourage the existing or the prospective investors to enhance their association with the company. Financial Statement Analysis The analysis of the financial statements of an organization helps one to examine its financial performance and well-being. The financial statements of a company can be assessed with the help of ratio analysis, so as to evaluate the company’s position in terms of liquidity, profitability, and solvency among others. This section of the paper would focus on the analysis of BHP Billiton’s last three years’ financial statements. The financial statement analysis would comprise of liquidity analysis, profitability analysis, long-term debt and solvency analysis in addition to the analysis of the operating as well as the investing activities of BHP Billiton. Liquidity Analysis The liquidity position of a company can be assessed with the help of its current ratio, quick ratio and cash ratio. These ratios determine the organization’s capability to fulfill their short-term liabilities. The current ratio can be computed as the ratio of the current assets to the current liabilities of the company, while the quick ratio is calculated as the quick assets divided by the current liabilities. In this context, the quick asset of an organization comprises of its cash, receivables and short term marketable investments. On the other hand, cash ratio is calculated by dividing the sum of cash and short term marketable investments by the current liabilities (Brigham & Ehrhardt, 2010). The current ratio for BHP Billiton for the year ending June 2011 was, Current Assets 25280 Current Liabilities 19733 Current Ratio 1.2811 (Bloomberg Businessweek (a), 2012). The quick ratio of BHP Billiton has been computed as follows, Cash and cash equivalents 10084 Trade receivables 6068 Other receivables 2129 Total quick Assets 18281 Current Liabilities 19733 Quick Ratio 0.92642 (Bloomberg Businessweek (a), 2012). BHP Billiton’s cash ratio can be calculated as follows, Cash and cash equivalents 10084 Current Liabilities 19733 Cash Ratio 0.51102 (Bloomberg Businessweek (a), 2012). Solvency Analysis The solvency position of an organization can be measured by means of its long-term debt ratios, such as the debt to equity, debt to capital, and the interest coverage ratios. These ratios assess the ability of the firm to meet its long-term commitments. The debt to equity ratio of a firm is computed by dividing its total debt by its total shareholders’ equity, while its debt to capital ratio is derived by dividing its total debt by the sum of its shareholders’ equity and its total debt. The interest coverage of a company is calculated as the ratio of its earnings before interest and tax (EBIT) and its interest payables (Brigham & Ehrhardt, 2010). The computation of BHP Billiton’s debt to equity and debt to capital ratios are provided below, Current interest bearing liabilities 3519 Non-current interest bearing liabilities 12388 Total debt 15907 Equity attributable to members of BHP Billiton Group 56762 Debt to Equity 0.28024 Total debt 15907 Total Capital 72669 Debt to Capital 0.2189 (Bloomberg Businessweek (a), 2012). The interest coverage ratio of BHP Billiton was, EBIT 31501 Interest on borrowing 246 Interest Coverage Ratio 128.053 (Bloomberg Businessweek (a), 2012). Profitability Analysis The analysis of a firm’s capacity to produce cost-effective sales by means of its resources can be determined with the help of the profitability ratios. These ratios consist of the operating profit margin, the net profit margin in addition to the returns on equity and assets of the company. The operating profit margin of a firm is the ratio of its operating income to revenue, while net profit margin is the ratio of net income to revenue. On the other hand, return on equity (ROE) is the value of net income as a percentage of total shareholders’ equity while the return on asset is the value of net income as a percentage of total assets (Brigham & Ehrhardt, 2010). Accordingly, the values of the profitability ratios of BHP Billiton have been presented below: Profit from operations 31816 Profit after taxation attributable to members of BHP Billiton Group 23648 Equity attributable to members of BHP Billiton Group 56762 Revenue 71739 Total assets 102891 Operating profit margin 44.35% Net profit margin 32.96% ROE 41.66% ROA 22.98% (Bloomberg Businessweek (a), 2012). Operating Activity Analysis In order to assess the company’s competence in its day-to-day activities, for instance inventory management and receivable collection, ratios like the inventory turnover, payable turnover, working capital turnover, and cash conversion turnover among others are used. The inventory turnover of BHP Billiton was: Revenue 71739 Current inventories 6154 Inventory Turnover 11.6573 (Bloomberg Businessweek, 2012). This implies that the average inventory processing period of the company was (365/ 11.66) = 31 days. The receivable turnover of the company for the year 2011 was, Revenue 71739 Trade receivables 6068 Receivables Turnover 11.8225 (Bloomberg Businessweek, 2012). Accordingly, the average receivable collection period was found to be 31 days. Thus, the operating cycle of BHP Billiton was 62 days (sum of average inventory period and average receivable collection period). The payable turnover of BHP Billiton was as follows: Revenue 71739 Trade creditors 6667 Payables turnover 10.7603 (Bloomberg Businessweek, 2012). As a result, the average payable payment period for the company was 34 days, which was derived by dividing the number of days in the year by the payable turnover of the company. Thus, it takes BHP Billiton around 34 days to pay its suppliers. The cash conversion cycle of a company quantifies the period to time necessary for a firm to convert the cash invested in operational activities into cash obtained from operations. It is equal to the difference between the company’s operating cycle and its average payable payment period. Consequently, the cash conversion period of BHP Billiton for the year ending June 2011, was 28 days. Working capital turnover of BHP Billiton for 2011 was, Revenue 71739 Working capital 5555 Working Capital Turnover 12.9143 (Bloomberg Businessweek, 2012). Investment Activity Analysis The long-term investment position of a company can be determined with ratios like the net fixed asset turnover, total asset turnover and the equity turnover. The computation of these ratios has been shown below: Revenue 71739 Property, Plant and Machinery 68468 Net Fixed Asset Turnover 1.04777 Revenue 71739 Total assets 102891 Total Asset Turnover 0.69723 Revenue 71739 Equity attributable to members of BHP Billiton Group 56762 Equity Turnover 1.26386 (Bloomberg Businessweek (a), 2012). Comparison from the Industry Perspective The comparison of the financial position of an organization with one or more companies in the same sector assists in the development of an investment outlook from the industry point of view. The business of BHP Billiton Ltd. falls under the materials sector and the company operates in the metals and mining industry. Hence, for an apt understanding of the investment viability of BHP Billiton, it is imperative to compare its financial performance with another company in the same sector and industry. In this section of the paper, we would evaluate the last three year performance of BHP Billiton against that of Rio Tinto Ltd, which also operates in the mining and metal business. For this, the latest three year annual reports of both BHP Billiton and Rio Tinto were analyzed to assess their state in terms of liquidity, solvency, and liquidity. Such an evaluation would be beneficial to ascertain the most suitable course of action that should be taken by the investors regarding the shares of BHP Billiton. The liquidity ratios of BHP Billiton and Rio Tinto for the last three years have been computed as follows: BHP Billiton RioTinto Year 2011 2010 2009   2010 2009 2008 Current Ratio 1.28 1.93 1.90 1.70 1.82 0.83 Quick Ratio 0.93 1.46 1.35 1.16 0.86 0.30 Cash Ratio 0.51 0.96 0.91 0.73 0.39 0.05 (Bloomberg Businessweek (a), 2012; Bloomberg Businessweek (b), 2012). The liquidity ratios of BHP Billiton increased in the year 2010 as against that of 2009, however, it declined considerably during the past year. A similar trend can be observed for Rio Tinto Ltd. as well. However, Rio Tinto’s latest liquidity ratios are significantly higher than that of BHP Billiton. This indicates that BHP Billiton holds a lower percentage of current assets and cash as compared to its current liabilities. In other words, it can be said that BHP Billiton is comparatively less competent than Rio Tinto in the context of meeting its near-term obligations. The long-term debt or solvency positions of BHP Billiton as well as Rio Tinto for the last three years were as follows: BHP Billiton RioTinto Year 2011 2010 2009   2010 2009 2008 Debt to Equity 0.28 0.32 0.41 0.25 0.52 1.93 Debt to Capital 0.22 0.25 0.29 0.20 0.34 0.66 Interest Coverage Ratio 128.05 100.35 27.40 27.32 8.98 6.16 (Bloomberg Businessweek (a), 2012; Bloomberg Businessweek (b), 2012). The debt ratios of the two companies depict that their solvency position got better in the past years. The comparative analysis of Rio Tinto and BHP Billiton reveals that the latter is in a more comfortable position in terms of long-term solvency. Moreover, BHP Billiton’s ability to pay its interest on debt is significantly higher than that of Rio Tinto. The last three years’ profitability margins of BHP Billiton and Rio Tinto were as follows: BHP Billiton RioTinto Year 2011 2010 2009   2010 2009 2008 Operating profit margin 44.35% 37.94% 24.22% 34.13% 18.21% 27.85% Net profit margin 32.96% 24.10% 11.70% 25.32% 11.65% 6.77% ROE 41.66% 26.22% 14.71% 24.56% 11.12% 17.81% ROA 22.98% 14.32% 7.46% 12.74% 5.01% 4.10% (Bloomberg Businessweek (a), 2012; Bloomberg Businessweek (b), 2012). The profit margins as well as the returns generated from its assets and equity have consistently improved for BHP Billiton. Furthermore, BHP Billiton had generated significantly higher returns than Rio Tinto. This implies that BHP Billiton has been able to utilize its assets and equity optimally to generate superior returns throughout the years. The short-term activity turnover ratios of the two companies are computed as follows: BHP Billiton RioTinto Year 2011 2010 2009   2010 2009 2008 Inventory Turnover 11.66 9.90 10.42 11.90 8.55 9.68 Receivables Turnover 11.82 10.68 13.55 14.50 12.37 14.58 Payables turnover 10.76 11.81 13.35 27.36 21.35 18.87 Working capital Turnover 12.91 9.09 10.54 8.59 6.63 8.41 (Bloomberg Businessweek (a), 2012; Bloomberg Businessweek (b), 2012). The average inventory processing period and the receivable collection period for BHP Billiton during the year 2011 were 31 days each, implying that its operating cycle during the period was equivalent to 62 days. The inventory processing period and receivable collection period for Rio Tinto were 31 days and 25 days respectively. Therefore, the operating cycle for Rio Tinto during the last financial year was 56 days. The average payable payment period of BHP Billiton and Rio Tinto during the same period was 34 days and 13 days respectively. Hence, the cash conversion cycle of BHP Billiton was 28 days, while that of Rio Tinto was 43 days. Consequently, it can be observed that BHP Billiton took much less number of days to turn its resources into cash inflows. The asset turnover ratios of the two companies for the last three financial years are as follows: BHP Billiton RioTinto Year 2011 2010 2009   2010 2009 2008 Fixed Asset Turnover 1.05 0.95 1.02 1.01 0.91 1.30 Total asset turnover 0.70 0.59 0.64 0.50 0.43 0.61 Equity Turnover 1.26 1.09 1.26 0.97 0.95 2.63 (Bloomberg Businessweek (a), 2012; Bloomberg Businessweek (b), 2012). These ratios determine how well a company had been able to utilize its assets and equity. It can be inferred from the turnover ratios of both the companies that BHP Billiton had managed its assets and equity better than Rio Tinto. Recommendation When a company is good from both financial point and non-financial point of view, then an analyst can recommend the investor to invest in the company. From the strategic point of view, the suggestion of the investor is to invest in the company. The vision of the company is to maximize the shareholders’ wealth. The steps taken by the company is according to the vision of the company. The portfolio of the company is diversified, so it can conclude by the researcher that the management has managed the risk well. They are among the top three companies in the world and their diversified portfolio attracts the investors to invest in the company. Along with this, the economic condition of the world is also favourable for the company. There are certain developing countries like China and India, where the role of mining industry is very important for the improvement of the infrastructure, transport system of the company. By analyzing the financial statements, it has concluded by the researcher, that the company should invest in the company. The solvency position of the company is not attractable for the investors. The liquidity ratio of the company has decreased over the year, when the liquidity position of the competitor of the company has improved. However, when the researcher analyzes the return on assets and return on equity, it has found that the management is efficient in managing the investments they got from the investors. They are also utilizing the assets at the best. The company has been efficient to manage the receivables i.e. their credit policy to the customers are effective for their business. The net profit margin of the company has improved by the years, which implicates the operating efficiency of the company. The net profit margin of BHP Billiton is better than the competitors. The price earnings ratio of the company is also attractable for the existing shareholders or the prospective shareholders. The price earnings ratio of BHP Billiton is 8.6 when the price earnings ratio for the Rio Tinto is 23. It means that the stock price of Rio Tinto is above average and the stock of BHP Billiton is undervalued. Therefore, it can suggest to the investors to buy the stocks of BHP Billiton as the stock is undervalued and this is likely to increase for the long-term period as well as the short-term period. Analyzing the strategies and financial condition of the company and comparing with the competitors, the researcher can recommend that the investor should invest in the company, whether he has already invested in the company or not. The stock price is likely to rise and the company is likely to perform well in their business for the long-term period. Conclusion BHP Billiton is a merger between two companies, one is from Australia and the other is from the United Kingdom. Therefore, the company is a dual listed company. The financial and strategic analysis of BHP Billiton has done by the researcher. The latest annual report of the company has used by the researcher for reference. The company analysis has also done from the industry point of view. Rio Tinto is one of the major competitors of BHP Billiton. From the strategic viewpoint, the performance of the company was well in past few years and the vision of the company is perfect for the shareholders’ wealth maximization. The company has taken steps according to their vision, which encourage the people to invest in the company. From the financial analysis, the researcher has found that though the liquidity position of the company is not so attractive for the past years but the management has been able to manage the investments and the assets efficiently. From the analysis, it has also found that the stock price of the company is likely to increase, as the stock is undervalued. The stock price of the competitors of the company is overvalued, so it would be good to invest further in the company who has not invested in the company and it would be good to invest more, which investors have invested already in the company. References Bloomberg Businessweek (a), (2012). BHP Billiton Ltd. Financial Statements. [Online] Available at: http://investing.businessweek.com/research/stocks/financials/financials.asp?ticker=BHP:AU [Accessed on March 15, 2012]. Bloomberg Businessweek (b), (2012). Rio Tinto Ltd. Financial Statements. [Online] Available at: http://investing.businessweek.com/research/stocks/financials/financials.asp?ticker=RIO:AU [Accessed on March 15, 2012]. Brigham, E. F., & Ehrhardt, M. C., (2010). Financial Management Theory and Practice. Cengage Learning. BHP Billiton, (2012). Annual Report. [Pdf]. Available at: http://www.bhpbilliton.com/home/investors/reports/Documents/2011/BHPBillitonAnnualReport2011.pdf. [Accessed on: March 15, 2012]. Rio Tinto, (2011). Annual Report. [Pdf]. Available at: http://www.riotinto.com/annualreport2010/downloads/riotinto_2010_ara.pdf. [Accessed on: March 15, 2012]. Appendices BHP Billiton Chairman’s Review: Source: (BHP Billiton, 2012, p.4) BHP Billiton Income Statement Source: (BHP Billiton, 2012, p.161) BHP Billiton Balance Sheet Source: (BHP Billiton, 2012, p.163) Rio Tinto Income Statement Source: (Rio Tinto, 2011, p.157) Rio Tinto Balance Sheet Source: (Rio Tinto, 2011, p.160) Read More