The Financial Position and Financial Performance of BHP Billiton and Santos Ltd - Research Paper Example

Student Name: Tutor: Title: Financial Analysis Course: Institution: Executive summary The strength of a company is determined by how well it uses its capital assets in the day to day operations for the purpose of achieving its long term activities. Financial performance of a company shows how well it can turn available resources into profits. Financial position shows the strength of the company in settling its debts on time and its ability to expand. This report looks at the financial position and financial performance of BHP Billiton and Santos Ltd over the period commencing from 2009 to 2011. The various results of the company in terms of their financial position and performance have been compared and contrasted. Various strategies to improve the allocated company which is BHP Billiton have been explored. The credibility of the suggestions has been demonstrated in the last part of this report through an evaluation. The report is made complete with a list of references and an appendix at the end. Financial Analysis Part A Question 1 Financial performance of the companies The financial performance of the companies for the past three years indicates small profits for Santos Ltd as compared to previous performance. BHP Billiton has posted progressive high profit margins since 2009. Santos Ltd shows instability in profit growth with the year 2010 witnessing a drop from the previous year. Their Gross profit margins trend from 2009 to 2011 is shown below: Gross profit margin 2009(million $) 2010(million $) 2011(million $) BHP Billiton 72.06 76.96 79.72 Santos Ltd 37.75 34.38 38.26 Santos Ltd has posted low profit margins year after year. Its profit margin seems to stagnate at around 36. Its profit margin is half of that of BHP Billiton. Despite 2011 profit margin showing an improvement from the previous year, it still remains close to the value that was posted in 2009. This statistics shows dwindling fortunes for Santos Ltd and the management has to search deeper and find the problem affecting the company’s performance (Bodie, Kane & Marcus, 2004, p. 459). Contrary to Santos Ltd financial performance, BHP Billiton on the other hand has shown positive improvement in its margins since 2009. The growth is steady and progressive. The company has to continue investing in its excellent performance and avoid things that will lead to dwindling profits. The profit margin is calculated by dividing the gross profit with the total revenues and then multiplying by 100% (Williams et al, 2008, p.266). From this case it can be seen that the gross profit for BHP Billiton has shown an increasing trend while Santos Ltd has shown reducing trend as indicated below: BHP Billiton 2009(million $) 2010(million $) 2011(million $) Gross profit 45,137 48,210 53,548 Total revenue 62,641 62,644 67,168 From the table above it can be seen that BHP Billiton has realized growth in gross profit and total revenue since 2009 to 2011. Santos Ltd 2009(million $) 2010(million $) 2011(million $) Gross Profit 2181 2,228 2530 Total Revenue 758 766 968 The gross profit of Santos Ltd has been increasing since 2009 but a very small margin. The increasing trend is also indicated in the total revenue but also with a small margin. This behavior in gross profit and total revenue is replicated in the trend in the gross profit margin. Santos Ltd shows slow growth rate in profitability while BHP Billiton shows high growth rate in profitability. Return on Equity The return on equity ratio for the two companies is as follows: 2009 2010 2011 BHP Billiton 15.89 28.9 44.72 Santos Ltd 7.58 6.84 9.07 Santos has performed dismally according to the return on equity ratio although in the past three years it has shown growth. The single digit ratio posted by Santos Ltd shows that the company profit does not measure up to the kind of investment done in terms of owner’s equity. The equity invested has not given the returns anticipated. The return on equity ratio was very small (Houston & Brigham, 2009, p. 90). In 2010, it was 6.84 while that of that of 2011 was 9.07. Although the ratio is improving, it is still very low. The financial position of BHP Billiton and Santos Ltd The financial position of the companies are accurately captured in the gearing ratios which calculated by dividing total debt by equity. Debt/Equity ratio 2009(million $) 2010(million $) 2011(million $) BHP Billiton 40.33 32.88 27.63 Santos Ltd 26.04 41.54 36.38 The financial positions of both companies show that they have reduced debt indicated by borrowed capital over the three year period. However, from the ratios it can be seen that BHP Billiton has lower level of debt as compared to Santos Ltd. Santos Ltd has been unstable in its borrowing behavior hence the fluctuating trend. Santos Ltd has more of borrowed capital in its capital structure as compared to BHP Billiton save for 2009. Santos Ltd has tried to reduce its dependency on borrowed capital over the years except in 2010 when the level of borrowed capital. Although both companies have shown an effort of reducing borrowed capital, BHP Billiton has shown an aggressive move of reducing debt/equity ratio from 41.54 in 2010 to 32.38 in 2011. BHP Billiton has reduced its debt/equity ratio from 40.33 in 2009 to 27.63 in 2011. The deviation posted by Santos Ltd is 12.7 while that of BHP Billiton is 18.44. BHP Billiton Equity 2009(million $) 2010(million $) 2011(million $) Total Equity 50,463 58,250 53,831 Equity capital for BHP Billiton has seen fluctuating level of total equity. The level increased in 2009 from 50,463M to 58,250M in 2010. In 2011, the level equity decreased slightly to $53,831M; however this did not affect the trend in debt/equity ratio. Increase in equity leads to decrease in the debt/equity ratio or the gearing ratio. Santos Ltd Equity 2009(million $) 2010(million $) 2011(million $) Total equity 6967 7,603 8,963 Santos Equity capital has increased gradually and steadily from 2009 to 2011. It increased from $6967M in 2009 to 8,963 in 2011. The increase in equity has likewise led to decrease in the debt/equity ratio all other things remaining constant. Both issued capital and retained earnings increased over the period of the three years. This is also the case of BHP Billiton where retained earnings have increased over the period of the last three years. Current ratio 2009(million $) 2010(million $) 2011(million $) BHP Billiton 1.9 1.93 1.28 Santos Ltd 3.26 3.26 3.12 The current ratio shows that Santos Ltd had more current assets to liabilities as compared BHP Billiton. BHP Billiton current ratio has dropped from 1.9 in 2009 to 1.28 in 2011. The many current assets in Santos Ltd have not been exploited fully by the company hence the high ratio of current asset to current liabilities. The ideal current ratio should be 2:1 (Groppelli & Ehsan, 2000, p.433). The current ratio posted by Santos Ltd of above 3 is very high. This means that there are far to more current assets as compared to liabilities. Having a lot of cash being tied up in current assets is not the best thing for Santos Ltd. The daily operations of the company can be affected by the low liquidity in the company. Question 2 Cash Inflows over the past three years BHP Billiton portion of the cash flows 2009(million $) 2010(million $) 2011(million $) Cash from operations 22,131 19,945 28,036 Capital Expenditure -13,307 -12,583 -11,545 Cash from investing -12,448 -11,791 -15,345 Cash from financing -1,463 -6,267 -14,930 Net change in cash 8,253 1,918 -2,214 The cash flow for BHP Billiton shows increase in operation activities which leads to a lot of cash being spent. As a result of this, the cash at hand by the end of the operating period is negative. The cash from operating activities has increased over the years leading to deficiency of cash in hand. On the other hand, capital expenditure has reduced over the same period. Investing and financing activities have both reduced over the three year period (Bodie, Kane & Marcus, 2004, p. 459). Cash in hand has been reduced over the three year period. Santos Ltd cash flow portion of the cash flow for the past three years 2009 (million $) 2010 (million $) 2011(million $) Cash from operations 1155 1273 1253 Capital Expenditure -1,117 -1,700 -2,820 Cash from investing -2411 -1,017 -2,142 Cash from financing 1954 1830 -90 Net change in cash 687 2,079 -987 Cash at hand has fluctuated over the period under analysis. There was plenty of cash in 2010 but the amount declined in the year 2011 to negative. This means that the company is operating on an overdraft. Operation activities have fluctuated over the years. Capital expenditure has increased over the period of the three years. The capital expenditure has greatly increased the asset level in the company. Cash from investing activities has fluctuated over the three years. Cash from financing activities has decreased due to low investment in the company. PART B Question 1 Strategies for BHP to improve financial position, performance and cash flows BHP Billiton has increase its current assets and hence its current ratio. Increasing current assets as compared to current liabilities will lead to stability of the company. Liquidity in the company is important. Cases of massive losses emanating from operating activities are avoided through this means. The company has to increase capital expenditure and other investing activities while reducing the operating activities. BHP Billiton will be more stable financial if it undertake this step. Absence of cash to deal with emergencies that may come up is reckless for the company (Stickney et al, 2009). The company can also borrow more money to invest in other activities that are profitable. The trend of long term debt shows that the company has reduced borrowing. This is indicated in the trend in the gearing ratio or debt/equity ratio which shows the reduction in debt. The company should increase its retained earning without negatively affecting earning per share. Earning per share attracts potential investors and increases the level of capital stock. However, paying high amounts of dividends may affect the growth of the company in terms of low levels of earning per share (Williams et al, 2008, p.266). The company has to play back the profit into the available investments without only resorting to increasing dividends. Instead of giving out dividends in form of cash, the company can pay dividends in form of dividend stock and therefore increasing the amount available for investing activities. The company has to look for ways of diversifying its activities so that the risk involved is spread out. The high profit margins can only be maintained by looking for additional investment activities to boost cash returns. The internal control systems have to be strengthened. Question 2 Evaluation of the strategies in both qualitative and quantitative terms The current ratio posted by BHP Billiton is below the ideal ratio of 2:1, consequently it can be attained through the company its operating activities which are noted to be on high level from the cash flows. The current ratio has to be increased so that there is enough liquidity to deal with the day to day operations in the company. The company runs the risk of falling short of cash to deal with day to day operating activities (Groppelli & Ehsan, 2000, p.433) Increasing the amount to be borrowed will widen the income of the company when the money is invested. The current trend shows reducing in borrowing which is witnessed in the debt/equity ratio. The company is increasing equity value. It is also prudent to increase debt as money is borrowed for investing the amount realized by the owner. 2009 2010 2011 Debt/equity ratio 40.33 32.88 27.63 Total Equity 50,463 58,250 53,831 The debt/equity ratio dropped from 40.33 in 2009 to 27.63 in 2011. From this ratio it can be seen that BHP Billiton has reduced debt to a great length. Borrowed capital has to be used in financing activities which bring returns to the company. The company can issue more stock to the public for the purpose of raising additional capital. Other activities like financing and investing have to be increased to increase current ratio of the company (Houston & Brigham, 2009, p. 90) The company has indicated high return on equity, and consequently it would be wise to borrow more and continue investing in those activities that are realizing high returns for the company. Earning per share (basic) 2009 2010 2011 EPS 1.31 2.7 4 Retained earnings 45,654 52,903 49,521 Earning per share has increased drastically from 2.7 in 2010 to 4 in 2011. The retained earnings on the other hand have fluctuated. Where as retained earnings was high in 2010 as compared to 2009, it dropped in 2011. This can be attributed to the company paying more in terms of dividend and reducing retained earnings (Gupta, A., 2008). More money has to be retained so that more investments are made. The move to pay more from 2.7 in 2010m to 4 in 2011 affected the amount that was left in the business or the company as retained earnings. References Williams, JR.; Haka, SF., Mark S. & Bettner, JVC., 2008, Financial & Managerial Accounting. McGraw-Hill Irwin, New Jersey. Groppelli, A. A, & Ehsan, N., 2000, Finance, 4th ed. Barron's Educational Series, Inc., London. p433. Bodie, Z. ; Kane, A. & Marcus, A.J., 2004, Essentials of Investments, 5th ed. McGraw-Hill Irwin, New Jersey. Houston, J.F & Brigham, E.F., 2009, Fundamentals of Financial Management. [Cincinnati, Ohio]: South-Western College Pub. Gupta, A., 2008, Financial Accounting for Management: An Analytical Perspective. Pearson Education India, New Delhi. Stickney, C.P., Weil, R.L., Schipper, K., & Francis, J., 2009, Financial Accounting: An Introduction to Concepts, Methods, and Uses, Cengage Learning, New York. Appendix Debt/equity ratio = Total Debt/Total Equity Gross profit margin = Gross profit/sales BHP Billiton gross profit margin 2009 2010 2011 Gross profit 45,137 48,210 53,548 sales 62,641 62,644 67,168 G. Profit margin = G. profit/sales 72.06 76.96 79.72 Current ratio = current Assets /Current liabilities BHP Billiton current ratio 2009 2010 2011 Current assets 27,873 29,679 23,562 Current liabilities 14,689 15,401 18,392 Current ratio = current assets/current liabilities 1.9 1.93 1.28 Read More