Finance over the Business Cycle - Case Study Example

BHP Billiton Name: Institution: Table of Contents BHP BILLITON 3 Executive Summary 3 Firm Analysis 3 Financing 4 Advantages and Disadvantages of Utilizing Equity Financing 7 Advantages of Equity Financing 7 Risk and performance 8 External Risks 8 Financial Results and Currency exchange rate fluctuations 8 Political events in the countries in which they operate in 8 Performance 9 Earnings per Share 10 Dividend per Share 10 Dividend Pay-out Ratio 11 Investments 12 Sustainability and long term Viability 12 Valuation 13 Capital Asset Pricing Model 13 Valuation Model 14 References 15 BHP BILLITON Executive Summary BHP Billiton uses a blend of Debt and Equity. The company’s latest financial ratio, the 2013 financial report showed that the company’s Debt to Equity ratio was 0.46 times. The value 0.46 times shows that the company uses more equity as a source of capital compared to debt [BHP13]. The main risks that the company faces are Fluctuations in prices of commodity and the impacts of the ongoing economic volatility in the world, currency exchange rate fluctuations and the political events in the countries in which they operate in [BHP13]. A lot of analysts are of the fact that in the past 5 years, the stock performance and the share price of the BHP Billiton has not been so good. Firm Analysis The shareholders contribute a significant part of the capital that runs the business. In BHP Billiton there is a clear separation between the ownership and the management of the company [BHP13]. The owners of the company are the shareholders whereas the company is run by the board of directors and the Chief Executive Officer. This structure, ownership and management is one of the best ways in which the company runs since one party checks the other party. BHP Billiton faces competition from three other companies in the industry and they include Vale S.A, Rio Tinto Limited and Alcoa Inc. [BHP13]. From the analysis of the BHP report, it is important to note that there is Unity in management of BHP Billiton and also among the shareholders hence no conflicts among them. There are also no issues regarding agent costs relating to the costs. The HSBC Custody Nominees (Australia) Limited are the major shareholders with 17.36 of the issue capital. This is followed by JP Morgan with a percentage share capital of 12.86% and National nominees, which has a share percentage of 9.25%. The document below shows the list of the top shareholders, from the highest to the lowest. Financing The companies financing structure, play an important role in the growth and development of any company. So how does financial structure influence growth and development? This so because there are certain advantages and disadvantages that are associated with a specific capital ratio. BHP Billiton uses a blend of Debt and Equity. The company’s latest financial ratio, the 2013 financial report showed that the company’s Debt to Equity ratio was 0.46 times. The value 0.46 times shows that the company uses more equity as a source of capital compared to debt [BHP13]. The graph below (graph a) shows the financing structure of BHP Billiton for the past few years [Mac14]. (Graph a) From the graph above, it can be noted that the company has significantly reduced its debt financing over the few years and this justifies the decrease in the value of Debt to Equity Ratio. The second graph (graph b), analyses the structure of BHP Billiton in comparison to other companies in the industry [Mac14]. From the table above it can be observed that BHP Billiton is among the three companies with the lowest Debt financing ratio. (Graph c) The graph above shows that BHP Billiton is rated below average in the debt to equity ratio among its competitors. Advantages and Disadvantages of Utilizing Equity Financing There are situation where equity financing can be more appropriate compared to other modes of financing such as loans [Cov06]. Advantages of Equity Financing The business angels and capitalists bring with them valuable contacts, skill and experience to the company. They can further assist with the key decision making activities and strategy. The company does not have to keep up with the costs of servicing the debt finance hence allowing the company to utilize the capital for business activities. In most situations, the outside investors always target to see the company deliver value and therefore help company explore and also execute the ideas. Since BHP Billiton has more Equity than Debt, It is therefore right to imply that the company benefits from the advantages stated above. Risk and performance The International scope of the BHP Billiton’s operation, is a major contributing factor risk that faces its operation and results. The main risks that the company faces are Fluctuations in prices of commodity and the impacts of the ongoing economic volatility in the world, currency exchange rate fluctuations and the political events in the countries in which they operate in [BHP13]. External Risks The fluctuations in in the prices of commodity and the volatility of the economy in the world affect the result and performance of BHP Billiton negatively. This mainly impacts on the posted results, asset values and cash flows [BHP13]. The prices that the company obtains from their oils, minerals, gas are mainly determined by the prices in the global market. Financial Results and Currency exchange rate fluctuations BHP Billiton’s assets, cash flows and earnings are significantly influenced by a variety of currencies because of the different geographical locations under which the company operates in [BHP13]. The fluctuation of the currencies in the countries in which BHP Billiton operates in does have significant impact on the posted financial results. Political events in the countries in which they operate in There are certain acts that are beyond the control of the BHP Billiton, such a factor is the political situation in a country. The company happens to operate in emerging markets, which tend to pose greater risks that have an impact on the company’s profits [BHP13]. Performance A lot of analysts are of the fact that in the past 5 years, the stock performance and the share price of the BHP Billiton has not been so good. However, presently the share performance is up by 35 percent. Analysts argue that BHP Billiton is likely to be a performer this year and the next few years. This growth in stock performance is attributed to the emerging market growth and the sound strategy embraced by BHP Billiton [Atk14]. Stock analysis BHP Billiton along with its subsidiaries, operate in various parts of the world. Despite operating in various parts of the world and considering the volatility of this kind of business, the company has been branded as a dividend achiever since it has been able to achieve consistent increase in dividend pay-out, 13 years in a row. The company last dividend increase was in the year 2012 where the Board approved a 3.6% increase in the mid-year distribution where the dividend share price at 1.14 dollars per share. The total return to every shareholder can be valued at 19.60% to the shareholders [DIV13]. Earnings per Share The company has also made significant efforts in building the Earnings per Share in the past 10 years. This is because in 2003 the Earning per Share form a value of 0.62 dollars per share to a value of 5.54 dollars in 2013. However analysts expect the stock to shoot up even further in 2014 to a value of 5.70 per share [DIV13]. Dividend per Share It is important to note that the company has also been able to boost its distribution over the past decade. This is vivid from the figures since the company paid 2.20 dollars per share from a value of 29 cents per share from 2003. From the graph above, it can be observed that there were times when the stock performed poorly, but it has managed to recover and it shows strong signs and consistency in growing. Dividend Pay-out Ratio BHP Billiton’s dividend pay-out ratio has remained below the 50% mark for the past 10 years, except for the year 2009 where there was a spike. However, the lower the pay-out the better it is for the company since it gives room for dividend growth hence reducing the impacts of short term earnings fluctuations [DIV13]. Presently, the BHP Billiton Company is valued at about twelve times earnings, yields 3.30% and has a very sustainable distribution [DIV13]. Investments The BHP Billiton has various significant projects that it plans to invest in so as to expand its operation. The most recent and major investment project to be undertaken by BHP Billiton is that it plans to invest 1 billion dollars in deep water exploration in Tobago and Trinidad. The company has set aside 500 million dollars for the first exploration phase and a further 500 million dollars over the next phase commonly refered to as the optional phase [Car141]. This form of investment is long term. This specific project, is different from the previous projects since it involves deep water exploration. Sustainability and long term Viability The company’s charter value of sustainability shows its priority towards putting health and safety first and also being environmentally responsible. Sustainable development is core to BHP Billiton and the company integrates safety, health, social, environmental and economic factors into their key decision making processes [BHP13]. The company always aims at improving the standards of living of the communities in which they operate in. Broader economic contributions, approach to resource conservation tend to benefit the regions in which the company operates in. Valuation The above diagram will aid in the valuation of the company’s dividend and growth patterns. From the latest financial report, the Earnings before Interest and Tax for the company declined by 22%, which amounted to a value of 6.1 billion US dollars [BHP13]. The decrease in the prices of commodities also affected the company’s EBIT and reduced it by 8.9 billion U.S dollars. However, the company managed to reduce the operating cost and hence drive their productivity upwards [BHP13]. Because of this initiative, the company managed to save up to 2.7 billion dollars. On the other hand the total dividends of the financial year 2013 increased by 4 % to a value of 116 cents per share [BHP13]. Capital Asset Pricing Model The report mainly utilizes the Capital Asset Pricing Model so as to determine the value of Equity. The Capital Asset Pricing Model is used to calculate the value of expected return on Assets using the formula Using the above stated formula, it would be important to determine the value of Equity, these are equity risk premium, Stock Beat and risk free rate of return. Beta of BHP Billiton 1.12% Risk free FROM government bond 3.13% Expected market return 9.01% These values have been obtained from http://www. Bloomberg.com We replace these values on the formula stated above. = 3.13% + 1.12 (9.01% - 3.13%) = 9.72 The expected rate of return = 9.72% Valuation Model The Gordon Growth Model, is the best type of model that can be used to determine the share intrinsic values of most companies. This same procedure can be used in the case of BHP Billiton. The formula for the Gordon Growth Model is V0 = D0(1+g) / (r-g) Under this method, the same assumptions are used and these are the value of the dividends are 10 cents and they are expected to grow at 3.32% for the next 3 years and grow at 1.18 afterwards. Last dividend in 2013 1.19 BHP PROJECTED Dividend in2014 1.22951 Estimated price per share 19.2243 Current market price per share 37.9 The company’s Dividend in 2013 = 1.19 dollars Therefore the 2014 dividend estimate = 1.19 * (1 + 3.32%) = 1.229 Thus this value can be used to calculate the estimated price per share. Estimated price per share 1.229 / (0.0972 – 0.0332) = 19.224 =19.224 dollars. When the share market price are compared, considering the its value as at 24th May is 37.9 dollars and therefore recommendation of selling the BHP stock considering the price, is overvalued in comparison the calculated intrinsic value 19.224 dollars. Irrespective of its current price and valuation results, the BHP Billiton debt concentration has a huge risk in continuing its operation. The next periods will be a great determining factor as to whether the company will receive great benefits from its operation. Because of this reason, BHP Billiton is not considered as a good investment and therefore the BHP shares should be bought for speculative purposes and not investment purposes. References BHP13: , (BHP Billiton, 2013), Mac14: , (Macroaxis Inc., 2014), Cov06: , (Covas & Haan, 2006), Atk14: , (Atkinson, 2014), DIV13: , (DIVIDEND GROWTH INVESTOR, 2013), Car141: , (Carla, 2014), Read More