BHP Billiton and Rio Tinto - Risk Assessment, Short Term Financial Policies, Capital Structure - Example

BHP BILITON & RIO TINTO COMPANIES Student’s name Code & Course Professor’s name University City Executive Summary The contemporary business environment has continued to face divergent challenges, notably in the mining industry. Of particular interest to the major players in the world and in Australia was the prolonged reduction of commodity prices. This has forced companies to fight hard to implement initiatives that help them improve free cash flow. As the top companies realized that the low prices are not temporary, they had to cut costs in order to guarantee returns in the current environment. The cost reduction strategies that started last year for many of the major players in the world began to pay off as they continued into this year (PWC, 2015). The biggest players in Australia continue to deal with cases of geopolitical turmoil, price volatility, rising costs and a general decline in grades. While there is some cause for optimism, the prospects in such markets as India and China have remained uncertain. Japan, another potential market is struggling with a bulging sovereign debt and a population that is rapidly ageing. The instability in the Russian border and the crisis in the Middle East still continue to raise concerns. The prospects for such commodities as iron ore and coal also remain weak. However, there is equally a lot of reason to rejoice as the US economy shows signs of a slow rebound, and the areas of Europe slowly showing recovery. Industry stakeholders are also becoming increasingly vocal in their demands from the major companies in the mining sector (Deloitte, 2015). However, despite all the uncertainty, mining company executives still remain focused on a return to profitability and productivity. This paper looks at two of the biggest mining companies in Australia, Rio Tinto and BHP Billiton, as they look to rebound from one of the most difficult periods for the industry. Contents Executive Summary 2 BhP Biliton & Rio Tinto Companies 4 1.0 Introduction 4 2.0Business overview 4 2.1 Rio Tinto 5 2.2BHP Billiton 5 3.0 Risk Assessment 6 3.1 Using meaningful safety indicators 6 3.2 Identification of high-risk areas 7 3.3 Sharing information 7 4.0 Short Term Financial Policies 7 4.0 Current Capital Structure 8 4.1 Asset Comparison 8 4.2 Liability Comparison 9 5.0 Current Dividend Policy 10 BhP Biliton & Rio Tinto Companies 1.0 Introduction Financial management is an imperative aspects, notably in maintain a company’s approach to business. These aspects poses significant change and influence in a company’s operation , but presents its business approach as a whole. The global business environment, notably the mining sector is faced by divergent has complexities and uncertainties. More often than not, it has been assumed that financial management should be used by financial specialist and analyze, rather than an entire corporation. However, a more appropriate emerging view suggests that all the business decisions impact the overall financial position and performance of the organization (Kepner & Wysocki, 2012). Principles of financial management consolidates divergent factors namely risks, dividend policies and capital structure, to name a few. These aspects are imperative in determining a company’s approach in a specific industry (Kepner & Wysocki, 2012). This retrospect paper seeks to analyze financial management approach of two of the biggest players in the global and Australian mining industry, Rio Tinto and BHP Billiton. It presents their overall business overview, the risks they face in the local and international business environment, short term financial initiatives they use to face these challenges and the capital and dividend structures and policies. 2.0 Business overview 2.1 Rio Tinto Rio Tinto first began business more than 140 years ago in 1873 (Rio Tinto, 2015). In Australia, the company began its operations in 1905 as the Zinc Corporation in New South Wales. It listed in the Australian Stock Exchange in 1962, and now boasts more than 200,000 shareholders. More than half of the company’s global assets are in Australia. The country produces iron ore, alumina, coal, bauxite, diamonds, salt and uranium from more than 30 operating plats across the world. The company has offices in Melbourne, Brisbane and Perth. Australia has been key to the operations of the company for long. In 2012, for instance, the company paid more than 8.7 billion in taxes to the Australian government. Despite the current industry situation and the volatility of the global economy, the company continues to invest in long term projects worth billions of dollars. Rio Tinto employs up to 23,000 Australians directly, and is one of the largest employers of indigenous Australians in the private sector. Rio Tinto is also heavily involved in the technology, research and innovation field (Rio Tinto, 2014). Despite the tough operating environment, Rio Tinto has delivered a robust set of financial results. The company has delivered stable half year earnings of 2.9 billion dollars. The operating cash flows before tax were 4.4 billion dollars, covering the capital expenditure of 1.2 billion and the 2.2 billion required for dividend payments. The company continues to focus on financial and operational discipline, which saw it deliver cost savings of 641 million dollars for the half year. This was 85 per cent of the overall targets for the year, a target which was then subsequently readjusted to 1.0 billion given the optimistic results (Rio Tinto, 2015). 2.2 BHP Billiton BHP Billiton has also been in operation for more than 100 years, with its roots tracing back to mining operations in 1851 on a small Indonesian island. Broken Hill Proprietary began as a silver, zinc and lead mining company in Broken Hill Australia. Incorporated in 1885, it has grown to become one of the world’s biggest mining companies. The company is among the biggest producers of major commodities like iron ore, copper, uranium and metallurgical coal. The company is also invested in oil and gas, as well as conventional and unconventional energy coal. The company has its coal, iron ore and global headquarters all located in different locations around Australia (BHP Billiton, 2015). The company’s performance for the financial year 2015 was a mixture of optimistic growth and disappointing reductions in key areas. The company recorded a two percent reduction in total recordable injury frequency. The market capitalization as at June 2015 was 108 billion dollars, while the revenue from continuing operation stood at 44.6 billion. The net operating cash flow reduced 24 per cent at 19.3 billion. The total dividend per share also increased by two cents to stand at 124 US cents. On the other hand, the basic earnings per share reduced by 86 cents at 35.9 US cents (BHP Billiton, 2015). 3.0 Risk Assessment 3.1 Using meaningful safety indicators Safety records yields significant benefits to the companies. The BhP Biliton is well known for its global safety programs like ‘Zero Harm’. As such, the mining companies not only benefit from safety but also financial benefits. This is because of company increases their access to external capital, attracting more investors, reduced cost through litigation, production delays, and accidents (Ekevall, 2012). 3.2 Identification of high-risk areas Use of detailed incident reports assists in the identification of high-risk areas during assessment. As such, it allows users to take any action or to make inferences. To improve the quality of the system, the companies use it through consistent application of taxonomies. Additionally, the system might be used to apply innovative analysis methods. 3.3 Sharing information Improving safety performance in mining industry requires sharing of information. The companies increase the awareness of information in the database. To asses the risk, it requires the reviewing of the database annually to identify the improvement opportunities. 4.0 Short Term Financial Policies Restrictive (Aggressive Policy) Both BhP & Rio Tinto shows restrictive kind of short-term financial policies. The companies keep low levels of inventory due to low shortage costs including low productivity level. As such, the companies have the below elements to manage the short term financial policies a) Disciplined investments The companies research on investments opportunities, which pose the possibilities of highest returns. The investments focus on assets that offer higher returns are when rated, the results indicated are above the company cost of capital (Rio Tinto, 2014). Additionally, the company tries to keep checks and balances ensuring that the assets run according to the strategies of the company. b) Cash Return to Shareholders The companies use progressive dividend policy to manage the short-term financial issues. The main agenda of using dividend is to increase the America dollar value over time & return surplus cash to shareholders within short time (The Rio Tinto Company, 2012). c) Prudent Balance Sheet Management Aggressive policy mainly focuses on strict credit sales. This indicates reduce in sale level; reduce in cash cycle and how to restart new financing procedures. The companies retain a single credit rating. The policy provides the flexibility in the investment planning hence boosting a robust business that easily performs well in all business phases (Rio Tinto Company, 2012). Ideally, the policies though not always feasible, the company might choose to finance the short-term assets with a short debt involving equity. With concerns on relative interest rates, the companies prefer short-term borrowing since its not costly. d) Cash reserves & Maturity hedging Cash reserves works best for Rio Tinto & BhP Billiton especially when it involves surplus cash & borrowing. This policy reduces the possibility of the firm to experience financial complications. The availability of the recurring short-run obligations are easily met. Assets and liabilities strongly focus on maturity hedging. The policy finances the short-term bank loans. 4.0 Current Capital Structure 4.1 Asset Comparison The asset base for both companies is remarkably similar. The differences arise only when the percentile of other fixed assets is observed since it holds goodwill after paying a premium acquisition of other companies. Currently the Rio Tinto balance sheets holds at 33% of total assets which is $ 14 Billion goodwill, due to the acquisition of Alcan in 2007 (Shadforth Financial Group 2012). Such an acquisition of over $ 38Billion brought challenges to the company by increasing the depts. Level. The company almost face a recession by being acquired by BhP Billiton but got stability from the deteriorating market crisis and its strong performance in the iron sector. The current leverage of Rio Tinto is at 33% with a 25% dept/75% equity hence the cash conditions is not at stable situation hence inhibiting the capital expenditure in years to come (Rio Tinto, 2014) The Bhp Billiton has managed to maintain a stable a stable asset base. Currently the company holds its assets at 14% that is $ 12 billion as per the records, which easily signals excess cash held for potential acquisition (The Business of Mining, 2013). With a comparison to Rio Tinto, which holds the cash flow at 4% of the asset value, indicates neither the week flexibility for the company capital projects in the short run nor much capabilities for acquisitions. The current fixed assets from both company includes, real estates, machinery plant of the company and the current assets like inventory, marketable securities and cash. 4.2 Liability Comparison In capital liability, BhP Billiton shows a strong position. The company has an 86% equity involved in the financing mix with a combined value of $12 Billion in cash. As such, the company has an enormous financial flexibility during the decision making process. Rio Tinto tries to keep up with a struggle with 50 % equity in financial mix. The current total liabilities from the company is 50.67Billion which is inclusive of loans, mortgages, accrued expenses, account payable and deferred revenues (Ingram, 2015). Additionally, both the companies face the commodity slide in prices. The challenges arise due to a rallied of $ US 65.10 a tonne of iron ore and the slow growth pace of capability summing up especially in Pilbara hence low improvement spendings (Janda, 2015). In opinion, the findings indicate that the companies face the possibility of after duration, fall in grades due to the expected lower prices especially on nickel, hard metal and iron ore U.S Dollar per tonne. 5.0 Current Dividend Policy BhP Billiton & Rio Tinto Company is committed to progressive dividend policies, which must rise in conjunction with earnings per share. Currently, Rio Tinto reduced the expected dividend policy growth annually from 4% to 2% for the next three years to almost a similar policy of BhP Bilton generating $ 1.68 and $ 1.44 respectively (Cauchi, 2015). However, with dividend policy in place, both companies fail to generate enough free cash flow in place to cover the dividend payment. As such, it is important for the companies to utilise the all department’s balance sheets to fund the dividend. More challenges as per dividend policy shows BhP Billiton dividends in a worse situation with the current commodity price persist. By 2020, the cash flows at BHP will shortfall rise to over $US 10 Billion due to it’s unsustainably of below dividend payment requirements (The Australian, 2014) The commitments to maintain the level of dividends proves challenging though the companies struggle to live on the policy. Among the challenges, the payouts rates are currently flat rather than being progressive. As such, both the companies face dividend challenges, which are expected to consume 50% of the companies operating cash flows. It therefore justifies that all capital and dept service commitments have to be met from the remaining 50% (Investec, 2015). Theoretically, on the current situation, BhP Billiton & Rio Tinto might be forced to use depts. purposefully to pay dividends. The internal cash flow is not enough hence cannot fund the dividend. The theoretical aspects indicate the approach to be weak & rather to increase the value of debt and purchase distressed assets rather than just paying for dividends. Criticism are in place pointing out that it is wrong using debt to pay current dividends, especially if the tactics is used in a longer duration (ker, 2015). Pulling out from the current dividend policy depends on the shareholders returns from the cash flows in years to come. The ultimate determinant of solving such a problem is the commodity prices in place. The current initiative involved is to cut the operating costs and capital expenditure too much than its own target to improve on dividend policy towards flexibility. This is due to the limited flexibility seen in the ratings of BhP (A+) and Rio Tinto’s (A-) (Kip, 2015). Conclusively, both the mining countries is likely to trim the dividends in the coming years due to diminishing commodity market prices though currently Rio Tinto is a better dividend performer compared to BhP Billiton (Cauchi, 2015). 6.0 Conclusion and Recommendation Conclusively, BHP Billiton and Rio Tinto stocks are down, showing a 40% and 30% for the past 123 months (Jones, 2015). The stokes are down due to intensifying crisis at China market. The companies get motivated from the land of opportunities. As such, the companies have come up with research reports claiming the demand of Ore is steel growing despite the economy crisis worldwide. Such a statement is a flash of spot to gloom the Mining industry. Additionally, BhP Billiton sees greater demand market beyond the current winning shareholders Chinese, whereby the mining company expects steel to rise by 65% by 2030. BhP Billiton & Rio Tinto show the possibility of increased financial returns.. Purchasing the current market stokes by Rio Tinto and BhP pose a significant advantages owing to the competitive market in the industry. Whereas there is no indicators that suggested a fall back in both companies, low commodity pricing are increasing by the day. In the event that such occurrence takes place, the companies will be compelled to recover from the ground up. Reference List BHP Billiton, 2015. Resourcing global growth Strategic Report 2015. [Online] Available at: . [Accessed 2 October 2015]. Cauchi, S. (2015) Rio Tinto & BhP Billiton to keep Dividend pressure. The Sidney Morning Herald. Business Day. Deloitte, 2015. Tracking the Trends 2015, Deloitte. [Online] . [Accessed 1 October 2015]. Ekevall, E. (2012) Improving Safety Performance in Australia Mining Industry through Enhanced reporting. PWC Investec. (2015) Diversified Miners Janda, M. (2015) BHP Billiton, Rio Tinto credit ratings on negative outlook. ABC News. Kepner, K. & Wysocki, A., 2012. Financial Management: Some Important Generalizations. IFAS Extension, pp. 1-3. Ker, P. (2015) Big Miners’ Dividends a little to ‘progressive’ for the times. The Sydney Morning Herald. Business Day. Kip, K. (2015) Fitch comes down hard on BhP, Rio Dividends. Mining Finance & Investments. Ingram, T. (2015) BHP Billiton and Rio Tinto Face Choice between Dept and Dividends. The Sydney Morning Herald. Business Day PWC, 2015.Mine 2015: The Gloves are off. [Online] Available at https://www.pwc.com/ee/et/publications/pub/pwc-e-and-m-mining-report.pdf[Accessed 1 October 2015]. Rio Tinto, 2014. Rio Tinto in Australia. [Online] Available at: . [Accessed 1 October 2015]. Rio Tinto, 2015. History. [Online] . Rio Tinto, 2015. Rio Tinto delivers first half underlying earnings of $2.9 billion. [Online] . [Accessed 2 October 2015]. Rio Tinto. (2014) Delivering Sustainable Shareholders Returns. Strategic Report Rio Tinto. (2014) Financial Strategy The Australian. (2014) BlackRock urges miners to hold firm on dividend policy. The Australian Business Review. The Business of Mining. (2013) Connecting Mining & Business World. Capital Structure after Crisis The Rio Tinto Company. (2012) An Economic History of Leading Mining Companies. Shadforth Financial Group. (2012) Investor Edge. BHP Billiton versus Rio Tinto- The Battle of Titans. Available from . Read More