BHP Billiton Plc - Business Accounting Ratio Analysis Evaluating the Financial Performance - Case Study Example

RUNNING HEAD: Ratio and SWOT Analyses Ratio and SWOT Analyses of BHP, Inc. of 14 August Introduction As a diversified mining company, BHP Billiton plc (or “BHP”) extracts and processes minerals, oil and gas from its worldwide production operations with primary locations primarily in Australia, the Americas and southern Africa. BHP is operating under nine customer sector groups (CGS): , petroleum, diamonds and specialty products, stainless steel material, aluminum, base metals , manganese, metallurgical coal, iron ore and energy coal, the company, its world-wide presence is thus easily noticed. With its global oil and gas business that produces assets in at least five countries, its Petroleum CSG has reached its customers. Having produced 137.2 million barrels of oil equivalent for one year as of the fiscal year ended June 30, 2009, BHP is not surprising selling its crude oil production to refiners worldwide at market prices (Reuters.com, 2010a). This paper evaluates BHP’ financial performance using ratio and SWOT analysis and recommend measures for improvement. 2. Calculation of key ratios The following ratios are needed for purposes of evaluating BHP: Gross Profit/Profitability ratio, Return on Capital Employed. Gearing Ratio, Liquidity ratio/acid test ration and Price earnings ratio. Each is computed and explained below using data from The Annual Report of BHP for 2009 (BHP, 2010) and London Stock Exchange (2010). 2.1 Gross Profit/ Profitability ratio This measures the company profitability for the past two years. Below are the resulting profitability ratios. Return on equity (ROE) is computed by dividing Net income to Total Equity, Return on Sales or Net Profit Margin is computed by dividing Net income to Total Revenues, while Gross Profit ratio is from dividing gross profit with Total Revenues. The data used to compute the ratios are found in Appendix A. 2.2 Return on Capital Employed (ROCE) This also measures the company’s profitability and efficiency of the company for the past two years. The formula is to Earnings before tax (EBIT) as numerator and to have Capital Employed, which is equivalent to Total Assets less Current liabilities as denominator. Below is the resulting ratio. The data used to compute the ratios are found in Appendix A. 2.3 Gearing ratio This also measures the company’s financial leverage for the past two years by dividing Total liabilities to Total equity. Below is the resulting ratio. The data used to compute the ratios are found in Appendix A. 2.4 Liquidity ratio/ acid test. This measures the company’s capacity to pay its maturing obligations for the current year. This current ratio is computed by dividing Current assets to Current liabilities while Acid test ration is by dividing Quick assets to Current liabilities. Quick assets equals current assets less inventory, prepaid expenses and other current assets. Below are the resulting ratios. The data used to compute the ratios are found in Appendix A 2.5 Price earning ratio This measures the attractiveness of the company’s stock in terms of its earnings. This is computed by getting price per share of its stocks and dividing the same to its earnings per share. Below is the resulting ratio. The data used to compute the ratios are found in Appendix A. 3. The overall evaluation of the company using both financial and non-financial factors including SWOT analysis. To evaluate the company, this paper uses first the financial ratios as computed earlier, the company’s performance is compared with mining industry averages. To apply SWOT analysis, there is a need to determine the company’ strengths, weaknesses and its industry opportunities and threats. 3.1.1 Profitability and Management Efficiency Two-year average return on equity (ROE) of 27% of BHP indicates obvious superiority about its past performance in relation to the industry average of 2.79%. An average of about 27% return on equity definitely attracts investors, as it would mean that for every 100 British pounds, the investors expect returns of about 27 pounds. See Table A below and see Appendix A for more details. Table A- Summary of profitability and efficiency ratios. Sources: BHP (2010) It may be noted that return on equity uses the formula where net profit is divided by the total stockholders’ equity. When compared an average rate of 0.50% if money IS invested in a bank, its present average 27% ROE makes the finding of offering more than fifty-fold and the rate is something difficult to find for investors. The 0.50% is the UK base rate of the Bank of England (Housepricecrash, 2010) that could represent the risk-free-rate investment in the UK and could be used as the minimum bank rate. Aside from profitability, it is also interesting to know whether the company management is efficient. To measure the latter, this paper uses return on capital employed (ROCE) (Stickney, Weil, and Schipper, 2009). BHP’s ROCE for two years yield an average the rate of 29% for the company is lower than the industry average ROA of 6%. ROA in the industry is used instead of ROCE for lack of readily available data. The only difference is that ROA does not deduct current liabilities from its denominator. While ROA may indicate profitability measure, the same may also tell how efficient management the company had in terms of profits in relation assets employed in business. ROE on the other hand measures how much management compensates resources invested by stockholders (Droms, 1990; Helfert, 1994). By comparing the two ratios, it appears that BHP is both more profitable and more efficient than industry. 3.1.2 Liquidity BHP’s ability to meet a company is currently maturing obligations is very clear with current ratio and acid test ratio above 1.0. Table B- Summary of liquidity and solvency ratios; Sources: BHP (2010a, 2010b, 2010c and 2010d). As applied now to BHP, its computed current ratio is 1.61 as against industry average of 0.71. Quick ratio of the company on the other was reflected at 1.19 as against industry average of 0.48. Both ratios for the company are higher than industry averages, indicating better liquidity. A current ratio of at least 1.0 is still considered liquid as current liabilities since the same is still matched by current assets of the company and an indication sufficient working capital. To have acid test ratio of more than 1.0 solidifies such strong liquidity position. See Table B above in relation to Appendix I. 3.1.3 Gearing Gearing or financial leverage measures BHP’s long-term capacity to keep up it stability over the long term. Normally measured by the debt to equity ratio, with the formula of having the total debt of the company divided by its total equity, solvency should assure investors that the company will not just survive the short term but it must also have a long life to recover long term investments which takes years to produce the needed returns. The debt to equity ratio of BHP is 0.98 as against industry average of 26.45. The solvency ratio makes it twenty-five times less than the industry average and this means the value the company investments from stockholder is stronger for the company as against its competitors (Stickney, Weil, and Schipper (2009). See Table B above in relation to Appendix I. 3.1.4 Market ratios Market ratios will tell how well the stocks of the company are valued by the stockholders. In terms of P/E ratio as summarized below, BHP company is better at 51.63 in 2009 but less superior at 30.98 in 2008 as against industry average of 33.69. However, the company’ average for the past two years yields higher than average. This would mean that investors would risk more in buying the company’s stocks than competitors. 3.2. SWOT Analysis This part summarizes the discussions made in the external and internal analysis using the general macro-economic environment, Porter’s five forces (Porter 1980), PEST analysis and financial analysis as would be discussed in subsequent subsections. 3.2.1.Strengths and Weaknesses Strengths are conditions or characteristics of the company, which could be tapped by the company in its design of its strategies (Massie, 1987; Plunkett and Attner, 1985). The following are the company’s strengths. Very high profitability – BHP’s profitability is strength since it will cause the company to have the needed funds to sustain many needs of the business needs including implementation of its strategies. Generally Good Liquidity - The company is generally liquid with both quick ratios current ratios for the last five years above industry averages. The company’s liquidity capacity is strength to weather short-term insolvency or it could be further used to sustain or improve profitability and/or improved capital structure. Low Gearing - Low debt to equity ratio in relation to competitors or the mining industry implies capacity to make long-term investment that could bring further profitability and stability. No weakness were indentified using financial analysis for BHP. 3.2.2 Opportunities and Threats These industry characteristics in terms of opportunities and threats are derived from Porter’s five forces and the greater macro-environment from PEST analysis that may affect the profitability of industry where the company competes. Opportunities improve the chance of better profits while industry threat does the opposite. The mining industry is expected grow as the UK economy recovers with expected growth starting 2010 although the recession is believed by some to have been fully finished yet. The increasing economic activity that would come from economic recovery can be considered as an opportunity as the same will result to higher investments in infrastructures that would require the company’s products. Another industry is the difficulty for new entrants in the industry because of requirement for big capital. 4. Recommendations to the board of directors as to how they can improve each of the key ratios mentioned above in point The board of directors can generally improve the key ratios by increasing revenues, increasing cost efficiency and applying proper financing and investment strategies. It should make use of its and should take advantage of the industry opportunities (Pearce II, J.and Robinson, Jr. R. 2004) to attain it wealth maximization objective (Arnold, Glen, Bodie, Kane and Marcus , 2007; Higgins 2007). The high profitability and efficiency, if maintained or further improved could maintain or further improve the good liquidity of the company. This will keep the company stable by maintaining its low gearing or leverage position. Given also it higher average price earnings ratios than the industry, BHP could be inferred to have a good future which it could sustain. To further increase its stock price is also the effect in increasing its profitability that will increase its net cash flows every year. Any increase in stock price must however be generally supported with increasing revenues and as sustained by the economy. Increasing therefore profitability, which would have the favorable effect on liquidity and gearing should have the effect of increasing stock prices that would in effect increase the wealth of the stockholders. Increasing revenues is a function of quantity of products or services sold and prices. Since quantity and prices are influenced by demand of the product and are affected by economic conditions, the company will have to make use its company strengths of strong profitability, good liquidity and low gearing to attain is further objectives of attaining the object of further wealth maximization of stockholders. It should take advantage the favorable conditions of world economy after recovering from 2007 financial crisis. Stockholders who are assured of maximized wealth (Brigham and Houston, 2002) with the company are of course expected to keep their investments with the company, which would in turn assure the stability and continued growth of BHP. Increasing revenues therefore requires keeping the prices of its products competitive in relation to competitors and keeping low its cost of doing business. To attain the first requires maintaining availability of its products in the market by ensuring continued supply to its customers while ensuring the required quality of these products. To maintain or further improve its cost position it has to position the company to invest in research that could reduce the cost of its operation in relation to competitors. It should also avoid making unnecessary and unproductive investment in assets that could increase its cost of capital since this could reduce profitability and retrain profit maximization objective. Appendix I -Summary of Financial Ratios; Sources: BHP (2010), MSN (2010), Reuters (2010b) References: Arnold, Glen (2004). The Financial Times Guide To Investing: The Definitive Companion to Investment and the Financial Markets. London: FT Prentice Hall Bernstein, J. (1993). Financial Statement Analysis. Sydney: IRWIN BHP, Inc (2010). Annual Report for 2009. Retrieved 13 August 2010 from http://www.bhpbilliton.com/bbContentRepository/docs/annualReport2009.pdf Bodie, Kane and Marcus (2007):Essentials of Investments, Sixth Edition, The McGraw−Hill Companies, 2007 Brigham and Houston (2002). Fundamentals of Financial Management, Thomson South-Western, London, UK Droms (1990). Finance and Accounting for Non Financial Managers. England: Addison-Wesley Publishing Company Helfert, E. (1994). Techniques for Financial Analysis. Sydney: IRWIN Higgins (2007). Analysis for Financial Management, Eighth Edition. The McGraw−Hill Companies Massie, J. (1987). Essentials of Management. UK. Prentice-Hall International MSN (2010). Stock price of June 2008 and 2009 - BHP. Retrieved 13 August 2010 from, http://moneycentral.msn.com/investor/charts/chartdl.aspx?Symbol=BHP&&ShowChtBt=Refresh+Chart&DateRangeForm=1&CP=0&PT=7&C9=1&ComparisonsForm=1&CE=0&DisplayForm=1&D4=1&D5=0&D3=0&ViewType=0&PeriodType=7 Pearce II, J.and Robinson, Jr. R. (2004), Strategic Management. Ninth Edition, London: McGraw-Hill Plunkett and Attner (1985) . Introduction to Management. Boston, Massachusetts: PWS-Kent Publishing Company Reuters (2010a). Company Profile. Retrieved 13 August 2010 from http://www.reuters.com/finance/stocks/companyProfile?symbol=BLT.L. Reuters.com (2009b). Industry ratios. Retrieved 13 August 2010 from x Stickney, Weil, and Schipper (2009). Financial Accounting: An Introduction to Concepts, Methods and Uses. Cengage Learning. Read More