RIO TINTO Financial Analysis in the Period from 2011 to 2014 - Case Study Example

Executive summary This report presents Rio Tinto company Limited’s financial analysis. The company mainly deals with metals and mining and is headquartered in the UK though it has a management office in Australia. The report analyses the company’s financial reports for the financial years 2010-2014 by conducting both a trend analysis and a ratio analysis. It is hoped that the users of financial statements will find the report useful in making informed investment related decisions. The trend analysis indicates that the company’s performance in terms of sales revenue, EBIT and profit attributable to equity holders of the parent entity have all declined indicating a declining financial performance for the company. Similarly, the company’s balance sheet items with respect to total assets, liabilities and owners’ equity have all declined over the financial period under review. This shows declining size of business operations. The ratio analysis conducted in the report indicates declining company’s performance in terms of profitability (ROE and ROA) during the period 2010-2014. The company’s efficiency, liquidity, capital structure and market performance all declined during the period under review. The declining performance of the company resulted from the tough operating environment resulting in declining prices for the company’s products thus leading to declining company sales and hence overall performance. Table of Contents Executive summary 1 Table of Contents 2 Introduction 3 Rio Tinto 3 Trend analysis 4 Income statement 4 Statement of financial position 6 Ratio analysis 8 Profitability analysis 8 Efficiency 9 Liquidity 10 Capital structure 10 Market performance 11 Conclusion 12 References: 12 Appendix 13 Introduction Financial statements of companies are deemed important to decision makers as they provide various users with information to help them make decisions. However, in their raw form, financial statements may not help the decision makers to make proper decisions and hence the need to analyze them using various means such as financial ratios analysis and trend analysis. In this regard, this report conducts a financial statements analysis of a leading metals and mining company known as Rio Tinto. The financial statement analysis will be based on the company’s financial reports from the year 2011-2014. The report is divided into three parts. The first part briefly analyzes Rio Tinto’s background information while the second part conducts a trend analysis on the company’s balance sheet and income statements for the four years period. The third part conducts a ratio analysis on the company’s financial statements in a bid to determine the company’s profitability, efficiency, liquidity, and capital structure and market performance. The report then summarizes the findings of the above analysis with the hope that decision makers can find this analysis useful in making various types of investment decisions. Rio Tinto As stated above, this report analyzes Rio Tinto Company limited which is a British-Australia multinational that deals with metals and mining. The company is dual listed in both the London stock exchange and the Australian stock exchange. The company’s UK headquarters are in London with a management office in Melbourne, Australia. The company was founded in 1873 and since then, it has witnessed solid performance where it has been involved in many strategic mergers in a bid to strengthen its performance. Its goods performance is also supported by the quality of goods it produces as well as its good capital base. From its founding, the company has grown to becoming a leading global mining company. In 2014, the company achieved consolidated sales revenue of $47.7 billion which was actually a decline from the 2013 figures as a result of decline in prices of its products. The company’s net earnings had declined 9% from the 2013 figures to $9.3 billion as a result. As such, it can be concluded that the company’s performance in the mining industry has been successful although it has been affected by price fluctuations globally of late. Trend analysis In this regard, the company’s financial performance over the four years will be compared in a bid to identify any consistent results or trends. This is important in helping both the management and other users how the business has performed and even in predicting where the company’s current business operations and practices are likely to take it. In this regard, it will help the management in making decisions that will move the company in the right direction and hence improve business performance. In this report, it is noted that there has been a general decline in the company’s income statement parameters including sales, EBIT and profit attributable to equity holders of the parent company. However, there is a mixed trend since the company’s worst performance is recorded in the year 2012 when the company’s performance starts to improve again. Similarly, the company’s statement of financial position also depicts a general declining trend over the five years period where the company’s total assets, total liabilities and owners’ equity are noted to have declined from the 2010 level. This can be attributed to the difficult operating environment for the company characterized by declining commodity prices. Income statement As can be depicted from the chart above, the trend analysis of Rio Tinto’s income statements for the period between the financial year 2010 and 2014 show a steep decline in the company’s performance as far as its business performance as well as profits are concerned. As the diagram shows, the company’s sales revenue declined by 14% between the year 2010 and 2014. Similarly, both the company’s earnings before tax and items (EBIT) and the profit attributable to equity holders of the parent company declined by 39% and 72% respectively. It should however be noted that the worst performance by the company in the two aspects was recorded in 2012 when the company’s EBIT and profit attributable to equity holders of the parent company had both declined by 112% and 121% respectively. This is attributed to the fact that the company made losses during the year. However, the company has since returned profitability though its performance is still far below the 2010 level. It should be noted that the company’s declining performance is to be attributed to its operating environment where though costs have been increasing; the prices of the commodities it deals with have generally declined. It should however be noted that measures undertaken by the management to bring the company back to profitability have started to bore fruits. Such measures include increasing the company’s volumes which offsets the declining prices as well as putting into place cost cutting measures. The company has also welcomed on board a strategic investor thus alleviating the threat of hostile takeover by BHP Billiton and seeing the company on the road to recovery. Statement of financial position Just like the income statement analysis, Rio Tinto’s balance sheet analysis for the period between the financial year 2010 and 2014 shows a decline as far as the company’s performance in its various balance sheet parameters are concerned. As depicted from the chart above, the company’s total assets declined by 4.39% over the five years period from $112,773 million in the year 2010 to $107,827 in the year 2014. The decline has been attributed to depreciation as well as divesture of the company’s non-core assets over the five years period. It is however worth noting that the company’s liabilities have increased by 10% over the period from the 2010 levels. In 2010, the company’s total liabilities were $48,261 million compared to $53,233 million. It is however noting that the 2014 liability levels have greatly declined from the 2011 levels of $60,337 million. The decline has resulted from the company’s efforts to reduce debts and hence debt related costs. On the other hand, the company’s owner’s equity has declined by 15.37% over the four years. The company’s owners’ equity declined from $64512 million in 2010 to $54,594 million in 2014. It is to be noted that the decline in the company’s balance sheet performance is to be attributed to the company’s declining profitability over the five years period. In addition, the company’s efforts to bring the company back to profitability have also helped to shape its balance sheet. Such measures include maintaining lower levels of inventories and receivables which in turn means declining levels of assets. The company also decreased its net debt over the period hence leading to lower levels of liabilities. The company’s capital divesture, reduced capital expenditure and capital return to shareholders can explain the reason behind declining levels of equity for the company. 2010 2011 2012 2013 2014 Current assets 100% 102% 89.58% 99.4% 96.99% Non-current assets 100% 106.94% 107.71% 98.23% 95.29% Total assets 100% 106% 104.26% 98.45% 95.61% Current liabilities 100% 116.23% 107.34% 117.97% 94.91% Non-Current liabilities 100% 135% 134.96% 125.53% 121.11% Total liabilities 100% 125.02% 123.4% 119.19% 110.30% Owner’s equity 100% 91.78% 89.84% 82.93% 84.63% From the table below comparing the various aspects of the balance sheet, it can be seen that the greatest changes have taken place in the company’s long-term assets in comparison to current assets. It can thus be depicted that the decline in long-term assets has had the greatest effect on the declining of the company’s total assets. On the other hand, it can be seen that long-term liabilities have increased more than the increase in current liabilities. It can thus be concluded that the company’s non-current liabilities have greatly affected the increase in its total liabilities. Ratio analysis From the financial ratios in the attached excel sheet, it is clear that the company’s profitability over the five years period from 2010 to 2015 has been on the decline. In fact, all the company’s profitability indicators including returns on assets and returns on equity have all declined between 2010 and 2014. The company’s asset efficiency ratios as indicated by asset turnover ratios, inventory and debtors turnover ratios between 2010 and 2015 have also declined mainly due to the decline in the amount of assets over the years. The company’s liquidity however depicts an improvement during the period. It should be noted that both the company’s current and quick ratio are slightly high over the period. This means that the company is under no liquidity threat at the moment. The analysis also shows that the company’s capital structure and leverage has improved over the period with the company’s main source of funds being its assets. This depicts a good picture of the company’s long term financial stability with the company’s total assets being greater than its liabilities and more than double its equity throughout the five years period. It should be noted that despite the company’s overall declining performance, an improving performance can be identified from the year 2013. This is seen in the company’s price to earnings ratio which is an indication of improving customer confidence on Rio Tinto Company limited. Profitability analysis 2010 2011 2012 2013 2014 ROE 26.53 6.67 -6.75 7.11 9.34 ROA 18.36 11.75 -2.04 7.13 11.65 Profit margin 27.37 11.17 -5.94 2.11 13.64 Cashflow to sales ratio 0.33 0.33 0.19 0.29 0.3 From the table above, it can be seen that Rio Tinto’s level of profitability reduced as depicted by the various ratios. For instance, both the company’s ROE and ROA declined significantly between the year 2010 and 2014. The company’s ROE declined from 26.53% in 2010 to 9.34% in 2014. This is an implication that the company’s ability to generate profits for every dollar of equity declined to $0.934 from$ 0.2653. Similarly, the company’s ROA declined significantly from 18.36% to 11.65% implying that every dollar of the company’s assets earned $0.671 less. It should be noted that this has resulted from the declining amount of revenue for the company which has result in significant declines in the amounts of profit reported. This has resulted from the tough economic environment that the company currently faces including declining prices of its products. Efficiency 2010 2011 2012 2013 2014 Asset turnover ratio 0.49 0.51 0.43 0.46 0.44 Days inventory 49.23 53.42 59.67 58 46.82 Days debtors 36.93 36.53 38.11 33.29 27.74 As depicted in the above table, the company’s efficiency indicators declined significantly between 2010 and 2014. This means that the company’s efficiency in using its assets to generate sales revenue improved. Over the five years period the company’s asset turnover declined from 0.49 to 0.44. This is attributed from the decline in the company’s sales revenue over the period that was relatively higher than the decline in the company’s assets. The company’s day’s inventory ratio also declined from 49.23 days in 2010 to 46.82 days in 2014. The decline is attributed to a higher decline in the company’s inventory than the decline in the cost of sales. In addition, the company’s days debtors significantly declined from 36.93 days in 2010 to 27.74 days in 2014. The decline is attributed to the large decline in the company’s debtors over the period that was relatively more than the decline in sales revenue over the same period. It means that the portion of the company’s sales made on credit also declined. Liquidity 2010 2011 2012 2013 2014 Current ratio 1.67 1.46 1.39 1.40 1.70 Quick ratio 1.30 1.11 0.95 1.03 1.35 The table above shows that Rio Tinto’s liquidity has improved over the five years period. The company’s current ratio increased slightly from 1.67 in the financial year 2010 to 1.70 in financial year 2014. This means that the company’s ability to meet its current liabilities slightly improved by $0.03 for every dollar of current liabilities over the period. The improvement in liquidity is attributed to the reduction in the company’s current liabilities which is aimed at reducing interest expenses. The company’s quick ratio has also improved slightly from 1.30 in 2010 to 1.35 in 2014. The slight improvement is attributed to the decline in current liabilities as well as the fact that the company’s inventory forms a significant part of the company’s current assets. With both the current ratio and quick ratio being above 1, it is an indication that the company is financially sound as far as its liquidity is concerned. The company does not face any liquidity threats at the moment since it can be able to pay all its current obligations and still have some current assets remain for its operations. Capital structure 2010 2011 2012 2013 2014 Debt ratio 42.79 50.47 50.65 51.81 49.37 Debt coverage ratio 1.84 2.26 4.81 2.80 2.85 Interest coverage 95 16.77 -66.53 1.80 4.18 Debt to equity ratio 74.81 101.91 102.64 107.52 97.51 From the table above, it can be seen that the company’s debt ratio increased from 42.79% in 2010 to 49.37% in 2014. The increase is attributed to the relatively more decline in the company’s assets in comparison to the decline in the company’s total liabilities. It should be noted that the company’s profitability declined as stated above and hence the increase in its debt to equity ratio. This is because the amount of retained earnings declined over the period hence leading to lower equity. Furthermore, the company could not finance its capital expenditures using retained earnings but through debt and hence the increase in the debt ratio and debt to equity ratio. It is also worth noting that the company’s interest coverage ratio greatly declined from 95 times in 2010 to 4.18 times in 2014. Similarly, this decline is attributed to the decline in the company’s profitability over the year despite the sharp increase in the company’s finance costs from $218 million in 2010 to $3,008 million in 2014. The increase is associated with increasing long-term loans. Market performance 2010 2011 2012 2013 2014 Earnings per share $7.26 $3.029 -1.64 1.97 3.51 Price 69.73 50.19 58.2 54.04 44.22 Price to earnings 9.60 16.56 -35.54 27.39 12.59 As can be seen above, the company’s earnings per share and share price declined from $7.26 and $69.73 respectively in 2010 to $3.51 and $44.22 respectively in 2014. On the other hand, the price to earnings ratio increased from 9.60 in 2010 to 12.59 in 2014. The decline in earnings per share is attributed to the decline in the company’s earnings over the five years period. On the other hand, the increase in the price to earnings ratio is attributed to the huge decline in earnings per share relative to the company’s earnings per share. As such, it can be concluded that the company is not performing well in the market as depicted by its declining share price. The declining performance is attributed to the company’s declining profitability as stated above. Conclusion Resulting from the above trend and ratio analysis, it has been found that the company’s profitability has greatly declined. All the aspects of profitability including sales revenue, EBIT and profit attributable to shareholders declined thus indicating a decline in the company’s financial performance. On the other hand, the company’s balance sheet items including assets, liabilities and owners’ equity declined during the 2010-2014 financial years. The company’s efficiency in terms of ROA and ROE was also noted to have declined during the period under review indicating declining ability of the company to use its assets efficiently to generate returns for shareholders. The company’s liquidity in terms of current ratio and quick ratio was however noted to have improved over the financial periods under review indicating that the company does not face any serious liquidity threats in the short run. As a result of declining profitability, the company’s capital structure and hence leverage is also noted to have declined during the period under review thus increasing the threat of takeover. Owing to the declining performance as noted above, the company’s market performance declined as indicated by declining share prices and earnings per share. References: Rio Tinto 2014 Annual Report Rio Tinto 2013 Annual Report Rio Tinto 2012 Annual Report Rio Tinto 2011 Annual Report Rio Tinto 2010 Annual Report Jared, B2010, Financial accounting simplified, London, Rutledge. Appendix Find in the attached excel sheet. Read More