Investment on BHP - Essay Example

Financials Investment on BHP BHP is a large corporate entity which is having its hold on a diversified fields such as mineral,oil, gas and steel. Renowned for its continuous developing structure and operations, is known as one of the Australia's oldest and biggest companies and was listed NYSE and LSE. It developed a good brand value from the years of experience. It diversified its operations across number of countries concentrating on petroleum business. Its operations are more than 100 in 25 countries. Its cash flow is stable from number of years indicating that its record of Accounts Receivable and Accounts Payable was good in spite of developing fixed assets. This tells us about the company's efficiency in using current assets as the ones that generate income. The stable cash flow from the years also tells us that the current liabilities are in control, which is within the limits of the company's assets and cash flows. The operational income of the company in the year 2005 is US$8.5billion. This gives reliable earnings per share. Due to the largest market capitalisation of the company one can recommend that not only investing he can hold the shares or debentures of the company for long time as the market capitalisation was being increased constantly from the past years. It is listed on LSE, Australian stock exchange, Johannesburg stock exchange and American Depository receipts listings and New York stock exchange. The Customer sector groups, to which the company gives more importance than its operations concentrate on Aluminium, Base Metals, Carbon Steel Materials, Energy Coal, Stainless Steel Materials, Petroleum, Diamonds and Specialty Products, At first let us examine the return/risk characteristics of the investment in the company, which is a indicator of past performance. The returns for the company are at a high stake as the company generated turnover of US$31.8 billion, earnings before interest and tax (EBIT) of US$9.3 billion, and net income was at US$6.5. The available cash flow after Accounts Payable was US$8.7. This implies that the net income of the company was almost 20% of the turnover which is a sound fundamental for any corporate entity. As the net income decides the future expansion, earning per share, available cash for the coming financial year, capacity to invest in new projects and R&D it is considered as a fundamental which assures return on the investment. The cash flow was just above the net income. This implies that the cash flow was in proportion to the assets of the company which tells us that the share price increase in the market can be justified. The fluctuation of the prices of the company's shares were around 30% of the maximum price. The maximum price was 19$ and minimum price was around 12$ in 2005. This fluctuation and the maximum price, the share enjoys in the market can be justified due to the substantial percentage of net income and recorded growth of 29.5 percent in operational income of the company in 2005. The increase of operational income and net income of over 20% of the turnover implies good return for the investment and security for the money invested. The operational income, net profit, and earnings per share were growing continuously in the past years. The turnover in 2004 and 2005 is US$ 29649 million and 22887 million. The turnover was increased by almost 33 percent but the costs increased only from 17084 to 20697 which indicates good management of operational activities which control cost factor and thereby plays a key role in increasing the net income. The earnings per share had increased by more than 80 percent in 2005 when compared to 2004 earnings. The total current assets stand at staggering US$7822 million which is more than the net income of the company. It is considered as a sound fundamental as the current liabilities of the company were lesser amounting to US$7659 million. The total non current assets stand at US$34288million and total non current liabilities atUS$16087million. This tells us that the domination of current assets over the current liabilities was not at the cost of the long term future of the company. The cash flows statement of the company states that the operational costs, exploration costs, purchase of property was done from the cash available from the income after taxes paid. This is the indication of the sound financial condition of the company which makes it increase the fixed and non current assets with the help of income after taxes paid. As the assets of the company are at substantial amounts the increase of the share price in the market can be justified up to reasonable extent. The cash and cash equivalents at the end of the 2005 are at US$1407 million which indicates a comfortable cash flow for the coming financial year. After having a macro analysis about the financial fundamentals of the company let us have look at the Ratio analysis which appraises the company about its performance at various points. Ratio analysis: Along with the above analyses the indicators of past performance in terms of critical success factors were taken and must be observed for investment. Using liquidity ratios let us measure the capacity of the company in meeting the short term financial needs. Current Ratio: It is taken that the capacity of the company meeting its financial requirements will be healthy if C.R is 2. Current Ratio = Current assets /Current liabilities. =7822/7659 =1.02, 6654/5027 =1.32 in 2004, 5329/4710= 1.13 in 2003, 5527/5041 = 0.95 in 2002, 10997/10739 =1.02 in 2001 < 2, which is taken as safe for meeting the short term financial liabilities. It is clear that if any sudden financial requirement comes in the way the BHP can manage efficiently. The company was being able to meet its short tem financial requirements efficiently since last three years as was evident by the financial reports of the company. Asset Management/Activity Ratios When a business does not use its assets properly investors find it to take money to a safer place. High turnover is needed to use its assets effectively. If the business does not continue to generate high turnover, assets will be idle. It is not possible to buy and sell assets continuously. Using Activity ratios there is a need to assess how active various assets are in the business in case of BHP. Increased turnover may be also as dangerous as decreased turnover if the establishment does not have sufficient working capital to cope up with the turnover increase. With the increase of turnover increase of working capital and cash is inevitable. In absence of these there is a danger of overtrading. But in the case of BHP the working capital, cash flows are maintained at a safer level making it a company capable of increasing its turnover cost effectively. Average Collection Period The average collection period is the ratio which estimates the quality of debtors as it denotes the efficacy of their collection. This is measured with: short average collection period, as long collection period tells us about the bad quality of debtors. Even too low collection period also is not advisable as it affects the profit making and turnover of company due to restricted credit policy. Average collection period = Accounts receivable/annual credit sales x 365 days. This is not calculated as annual credit sales are not available in the statements. But the substantial percentage of net income states that the company is maintaining not only cost effective techniques but also recovering the credit given to the customers in time. Inventory Turnover This ratio measures the stock with respect to turnover to determine how frequently the stock is turned over in the business. It indicates the capacity of the company in selling its products. It can be calculated by ratio between the costs of goods sold to the average inventory. Inventory turnover = Cost of Sales /Average inventory = 20697/2542 =8.14, 17084/1715=9.96 in 2004 11730/1320 =8.83 in 2003, 12433/1509 =8.24 in 2002, 17549/2138 =8.21 in 2001which indicates that the inventory was at low as the goods is moving fast. Stock Period = Average Stock /Sales of COGS x 365 days The average stock was not provided in the financial statements, which implies very less stock period. This tells the investor that the stock period was very less and the company is turning the stock too frequently which brings cost effectiveness and more net income for the company. Total Assets Turnover The relation ship between Sales and assets is Asset turnover. To maximise the sales the company should manage its assets efficiently. The firm should manage its assets efficiently to maximise sales. The efficiency of the company using its assets to produce sales is indicated by total asset turnover. It can be calculated by dividing the firm's sales by its total assets. Total Asset Turnover = Sales /total assets 29648/7822 =3.79 in 2005, 23513/6654 =3.53, in 2004, 16549/5329 =3.11 in 2003, 17062/5527=3.09 in 2002, 12070/5576 =2.18 in 2001. The above values imply that BHP is at its best in utilising the assets to increase its turnover. It is observed from the financial statements that the capacity of BHP in utilising the assets to enhance turnover increased in last five years. Fixed Asset Turnover The capacity of the company to produce sales using its fixed assets is measured by the fixed assets turnover. It is calculated by dividing the firm's sales by its net fixed assets as follows: Fixed asset turnover = Sales /net fixed assets 29649/18364=1.61 in 2005, 23513/24525 =0.96 in 2004, 16549/23546=0.70 in 2003, 17062/24335 =0.70 in 2002, 12070/22640 = 0.53 in 2001. This indicates the ratio is increasing in last 5 years which denotes the increase in the capacity of the company to produce sales using fixed assets. The ration is greater than 1.This tells that BHP was efficient in using its fixed assets to increase turnover. Equity Ratio The equity ratio is calculated as Equity ratio = Ordinary shareholder's interest/ total assets 1500/7822=0.19 in 2005, 1330/6654=0.20 in 2004, 898/5329 =0.17 in 2003, 1797/5428=0.33 in 2002, 1807/5576=0.32 in 2001.This tells us that the company's dependence on share holders money is decreasing since 5 years, though there is one exception. This is a good trend which indicates the increase in business activities with out the need of increase in capital. Multiplying the above value with 100 we get 19, which indicate that the ordinary share holder supplied only 19% of the company's needs. Still the company is cost affective and profit earning. So the less payment for towards share holder's interest is actually a negative aspect but here the company is doing that in spite of cost effective operational activities. This makes company to have good fundamentals. Gross Profit Margin Gross profit is directly proportional to sales in case of normal conditions. It is even used to compare this ratio between similar companies. Gross profit Margin = Sales-cost of sales /Sales 29649-20697/29649 =0.30 This ratio is lesser than the previous year. This tells investor that rate in increase in cost of goods is less than the rates of increase in sales, hence the increased efficiency. Net Profit Margin The same type of businesses run by companies was estimated by this ratio if the businesses are similar. This ration is widely used by number of analysts. The important thing in any trend is the margin and whether it compares well with similar businesses. Net Profit Margin =After Tax Earnings/Sales 6241/29649=0.21 in 2005, 3499/23513 =0.15 in 2004, 1900/16549 =0.11 in 2003, 1695/17062=0.10 in 2002, 853/12070 = 0.07 in 2001. These increasing values tell us that the percentage of net profit to sales was increasing in last 5 years which denotes the increase of profitability. As the returns were linked with profits the increase in margin of the profit makes the investment on the company having a chance of more return and less risk. Debt analysis The debt analysis of a company is done by its debt ratio and debt to equity ratio. This is the measure of the capital funded by debt. The ratio is calculated by total debt /total assets. 16087/34288=0.47. Here the debt ratio is lesser than one which indicates that the company would find it relatively easy to raise additional financial support from external sources if it needed. The lesser the debt ratio the more easily it becomes for the firm to raise debt. The ratio is lesser than 1 in 2005 and it is lesser than that of 2004. This indicates the company's high credit rating and investor's trust. Debt to Equity ratio This ratio indicates the extent to which debt is covered by shareholders' funds. It reflects the relative position of the equity holders and the lenders and indicates the company's policy on the mix of capital funds. The debt to equity ratio is calculated as Debt to equity ratio = Total debt / Total equity. 16087/18364=0.88 The value is lesser than 1 indicates that the company is making as much more profit as possible with each available unit of currency. The complete estimation of success of a company is the profitability which is a result of using its resources effectively. After the estimation of the past and nature of the performance of the company the investor deserves to have a word about future. Generally the past performance reflects and controls the future operations regarding the cash flow, assets and credit rating. These things which were used effectively in the past operations will give an estimation of the future of the company when both external and internal factors were considered. Table of Ratios of five years for BHP Inventory turnover Total asset turnover Fixed asset turnover Equity ratio 2005 8.14, 3.79 1.61 0.19 2004 9.96 3.53 0.96 0.2 2003 8.83 3.11 0.7 0.17 2002 8.24 3.09 0.7 0.33 2001 8.21 2.18 0.53 0.32 From the above table the one can know that the company's profitability, creating sales with its fixed and current assets, using its capital to a maximum extent of rotating in business a number of times were done efficiently and that increased in last 5 years though having one or two exceptions. As this tells us about the past performance of the company the SWOT analysis tells us about its future predictions. Ratio table for BSL Inventory turnover Total asset turnover Fixed asset turnover Equity ratio 2005 4.07 1.75 0.8 0.05 2004 4.8 1.75 0.5 0.1 2003 4.4 1.6 0.35 0.05 2002 4 2 0.28 0.18 2001 4 1.5 0.26 0.19 The above ratios of BSL indicate that though Blue scope steel was showing the same type of results as that of BHP, the scale and measure of BHP is more which tells gives consistency to investment in that company. SWOT analysis audits its environment and is the first stage of planning and helps investors to concentrate on critical issues. SWOT stands for strengths, weaknesses, opportunities, and threats. Strengths and weaknesses can be considered as internal factors and Opportunities and threats are generally considered as external factors. SWOT Analysis Strengths Weaknesses Opportunities Threats One of the strengths of a company is its marketing expertise. As BHP is diversified over a range of products and developed value added brand name the marketing is considered as strength. The products may not be innovative but they are the part of the commodities that find unlimited consumption in present day life. The location of the business of the company is diversified over 25 countries, which adds strength considering marketing that depends upon location. The company has expertise in maintaining quality of the diversified commodity suite it maintains. The company is time tested for its quality and it developed its own R&D for mining and refining the minerals and oil. The transportation facilities it provide for delivering the goods to the customers and giving more important for CSG over operations is also a strength. There is no evidence which points out on the company's lack of marketing expertise. As it produces a range of products like Aluminium, Base Metals, Carbon Steel Materials, Energy Coal, Stainless Steel Materials, Petroleum, Diamonds and Specialty Products, the need of marketing expertise is limited to organisational capability only. No weakness can be spotted in this section. Though there are number of competitors producing the above commodities, there is lack of companies which produce all under one brand name. This gives an edge to the company over its competitors in marketing the products to different users and industries located in different areas. It may face stiff competition from the competitors in case of commodities like oil, gas, liquefied natural gas and diamonds but it can be controlled and maintained in overall performance as the business of the company does not depend only on those items. There is no record for the company regarding the supply of poor quality goods and damaged reputation. The company's diversified product base is capable of utilising opportunities in ever developing world. The GDPs of developing countries indicate that there will be good marketing for diamonds and speciality products. The rising energy needs of the world assure an ever increasing opportunity for the oil and energy sector of the Company. Aluminium, base metals, carbon and steel find importance in find marketing in rising needs of automobile and aeronautical industries. These opportunities of rising needs of energy and ever growing industrialisation of the world, assures substantial opportunities for the company. The main threat for the company is from the field of diamonds and commodity products as the PBT also decreased in that sector in the last financial year. The threat is also considered as moderate and it can be eliminated in future activities and operations of the company as it was a commodity, the company newly ventured and the operation which was new in the history of the company. The decrease in PBT is due to the more operational costs that occur for the newly ventured products. This phenomenon is common for any company which venture into the area of new products. So, the threat of decreased PBT is not considered as substantial threat as it was from the product which was introduced by the company in the recent past. The past and future of the company were appraised and predicted at a positive note. The financial position of the company was regarded and recorded as sound. The income, cash flows, asset management, cost effectiveness, PBT and net income were good and sound for expecting high returns on the investment done in the company. Generally we sell the shares which suspect that may fall in near future. We buy shares which we expect to rise in future. But BHP shares are maintaining a certain level in the stock exchange which is ever growing and very less falling. Another important thing is earnings per share are reasonable, which makes investor to hold the shares for the continuous income. Recommendation: Hold the shares. Let us compare the performance of BHP with Blue scope steel. The net profit percentage of BSL 15% is less than above20% for BHP. The assets (current and fixed) of BHP are more than BSL and the ratios which indicate the usage of assets, cash, equity, increase of turnover were in good condition for BHP than BSL. The earnings per share is a little more for BHP than BSL. But BHP share is having consistency, while that of BSL lacks that. So the share of BSL is recommended to sell when it is increased, but that BHP is recommended to hold, for it gives standard and continuous, low risk income over a certain period. References: The references were given in the order of Name/s of author/, date of publication, title of publication, publisher/organisation, edition, type of medium, date of item retrieved, name or site address on internet. 1. cbdd team, 2006, horizontal and vertical analysis course, cbdd, electronic, 13-07-07, cbdd.wsu.edu/kewlcontent/cdoutput/TR505r/page37.htm 2. Schaum, 2006, Financial analysis, Mc graw hill, electronic, 13-07-06, http://books.google.co.in/booksid=_lnmxnhoAUEC&pg=PA68&lpg=PA21&ots=3O4aP7LMV7&dq=vertical+analysis&sig=e0LpmpFi5Iu02rCf5Y4UjtzBuKY 3. biz-ed team, 2006, Ratio analysis, Biz-ed, electronic, 13-07-06, http://www.bized.ac.uk/compfact/ratios/ror1.htm 4. biz-ed team, 2006, Ratio analysis profit, Biz-ed, electronic, 13-07-06, http://www.bized.ac.uk/compfact/ratios/profit1.htm 5. Trans union team, 2006, debt analysis, trans union, electronic, 13-07-06, http://annualcreditreport.transunion.com/popup/debtAnalysis.jsp 6. Scott trade team, 2006, capital appreciation, Scottrade, electronic, 13-07-06, http://www.investorwords.com/695/capital_appreciation.html 7. Cbdd team, 2006, vertical analysis, cbdd, electronic, 13-07-06, cbdd.wsu.edu/kewlcontent/cdoutput/TR505r/page38.htm 8. Text book 'Investment' written by William F.Sharpe/Gordon J.Alexander/Jeffery V.Bailey. 9. Annual report of BHP from the BHP web site. Read More