Rio Tinto is a mining and resources company with operations in various countries, including Canada, United States (US), Guinea, Brazil, and Australia. Rio Tinto is generally managed from London in the United Kingdom (UK). It is listed across several markets, including the London Securities Exchange (LSE), the Australian Securities Exchange (ASX), and the New York Stock Exchange (NYSE) (Rio Tinto, 2020). According to Rio Tinto (2020) annual report, the company’s primary commodities include iron ore, copper and diamonds, borates, aluminum, titanium dioxide, and concentrate and uranium.
BHP Billiton is an Australian-based top multinational conglomerate. The company also carries its operations within the diversified resources and mining industry. BHP Billiton was born out of a merger of two big multinationals: Broken Hill Proprietary Company (BHP) from Australia and Billiton from the United Kingdom. This led to the birth of BHP Billiton, whose main offices are located at the BHP Billiton Centre, 180 Lonsdale Street, Melbourne VIC 3000, Australia. Despite being run by one board of directors and management team, each company largely maintained its initial structure and listing. The company is listed on both the Australian Securities Exchange (ASX) and the London Securities Exchange (LSE). Jointly, BHP Billiton operates in 130 locations across 21 countries (BHP Billiton, 2020). According to BHP Billiton (2020), the company’s products include coal, iron ore, copper, silver, manganese, nickel, titanium, aluminum, uranium, oil, and gas.
Similarities between Rio Tinto and BHP Billiton
Rio Tinto and BHP Billiton, as indicated in the annual reports ((Rio Tinto, 2020; BHP Billiton, 2020), operate in the diversified resources and mining industry. Both companies are top multinationals with operations in different countries. Both companies deal in similar commodities: iron ore, copper, aluminum, titanium, and uranium. Also, both companies are listed on the Australian Securities Exchange (ASX) and the London Securities Exchange (LSE).
Differences between Rio Tinto and BHP Billiton
The companies differ in a number of ways generally on location and structure. Rio Tinto is generally managed from London in the United Kingdom (UK). It is listed across several markets, including the London Securities Exchange (LSE), the Australian Securities Exchange (ASX), and the New York Stock Exchange (NYSE) (Rio Tinto, 2020). On the other hand, BHP Billiton is managed from BHP Billiton Centre, 180 Lonsdale Street, Melbourne VIC 3000, Australia. Despite being run by one board of directors and management team, the conglomerate runs under two different entities BHP in the UK, and Billiton in Australia, each company has its different structure and listing.
Two Common Industry Factors: Both are affected by the same Factors
Rio Tinto and BHP Billiton operate in the same industry, therefore they are affected by similar industry factors. One the industry is characterized by a strong supplier bargaining power. This is due to the high labor costs and the nature of items required by both companies to conduct their operations. Most of the materials have no substitutes making the switching prices very high. The industry is also characterized by very high competition. Apart from the two, the companies’ annual reports (Rio Tinto, 2020; BHP Billiton, 2020) indicate that other established multinationals such as BP, and Anglo-American, among others that compete aggressively for the limited natural resources across the world.
Two Common Economy-Wide Factors: Both are affected by the same Factors
Since BHP Billiton and Rio Tinto operate within the same industry, they are affected by similar factors. The economic environment in which the companies operate is vital for their business. Company operations are likely to be affected by economic shocks within the economy (Rio Tinto, 2020; BHP Billiton, 2020). The main problems could occur due to changes in inflation, leading to a jump in the prices of commodities. Also, varying interest rates that affect spending within the economy will as well affect the operations.
The market prices that both companies obtain for the commodities are determined by or linked to world market prices. This poses a risk in the event of fluctuations. Also, their performance is likely to be further affected by climate change that may well reduce productivity. The nature of operations in the mining and resources industry has uncertain effects (Rio Tinto, 2020; BHP Billiton, 2020). Environmental concerns can also lead to legal challenges if not managed well.
Financial Ratio Analysis
See separate excel file; the analysis covers both Rio Tinto and BHP Billiton.
Lending Decision to Rio Tinto
Ability of Company A to repay the loan and interest
Bank financing is vital for every corporate body. Banks provide loan facilities that help companies to undertake essential investments likely to boost their business. However, before a bank chooses to lend money to any company, it has to evaluate its creditworthiness or its ability to repay the loan. The evaluation involves looking at the company’s business operations and financial performance. The company boasts an asset base of over $97 billion and revenues of over $44.6 billion as of 2020. In addition, the company is profitable, having posted an operating profit of over $16 billion in 2020, an increase from $11.5 billion posted in 2019.
Besides, the company indicates that it has sufficient ability to finance its loan obligations. In 2020, Rio Tinto’s current ratio stood at an average of 1.8 times, and the quick ratio is an impressive 1.5 times (Rio Tinto, 2020). Therefore, the basic information provides sufficient proof that the company qualifies for a 10-year loan from the Bank of Brisbane.
Company A’s net cash flows from operating, investing and financing activities
A look at the cash flow statement shows the company had total cash of over $21.8 billion at the end of the 2020 financial period. The amount represents an increase of over $2 billion over the amount it had in 2019. Rio Tinto generated over $15.9 billion from operating activities, which indicates the company has adequate resources to pay for its debt (Rio Tinto, 2020). The information that supports the qualification for decision for the 10-year loan from the Bank of Brisbane.
Limiting factors that can affect the usefulness of financial statements and ratios
Companies take adequate measures to prepare financial statements that present the company’s accurate and fair position as at the reporting date. Despite the effort put into presenting the information to stakeholders, various factors limit the effectiveness of financial statements. The problems are carried along even in calculating financial ratios since data required is acquired directly from the reports. First, companies prepare financial statements based on historical data. The values of the different items in the financial statements only reflect the proper position when they are acquired due to changing market forces (Melicher and Norton, 2016). If the items are not revalued, they will not present authentic information.
Also, there are different accounting policies, and standards companies depend on in preparing the financial statements. The people who are engaged in doing the work may apply different standards based on their personal judgments. Financial statements present limited information regarding non-financial matters that are critical in the companies’ operations. Lastly, predicting the future company performance using current information is tricky given that many assumptions make accurate predictions (Melicher and Norton, 2016). These assumptions may not be valid and will not reflect the actual position of the company.
Profitability and Risk ratios
Financial ratios can be used to assess various elements regarding a company, including profitability and risk. The ratios help investors to determine whether the company is ripe for investment or not (Melicher and Norton, 2016). In this report, the central area of focus is evaluating the profitability and risk of Rio Tinto and BHP Billiton for the years 2018, 2019, and 2020.
Over the three years, Rio Tinto posted the worst performance in 2019, and 2018 had the best performance. In 2019 there was a slowdown in performance due to a significant price reduction in the alumina and aluminum segment, and the copper segment was impacted by lower grades (Rio Tinto, 2019). Despite the challenges, Rio Tinto posted a net profit margin, gross profit margin, and return on assets of 0.17, 0.28, and 0.08, respectively. According to Rio Tinto (2020), the company could recover, posting profits slightly over $23.9 billion. The net profit margin, gross profit margin, and return on assets went up to 0.23, 0.38, and 0.11, respectively.
On the other hand, BHP Billiton posted impressive results in 2019. The company’s net profit margin, gross profit margin, and return on assets of 0.22, 0.37, and 0.15, respectively. The performance in 2020 slowed down to a net profit margin, gross profit margin, and return on assets of 0.20, 0.34, and 0.09, respectively. In assessing the companies’ risk of investment, the debt to total assets, cash debt coverage, and times interest earned were evaluated. Rio Tinto debt to total assets for 2018, 2019, and 2020 were 0.45, 0.49, and 0.47, respectively. The cash debt coverage for 2018, 2019, and 2020 were 0.28, 0.36, and 0.36 respectively.
The times interest earned for 2018, 2019, and 2020 were 32.37, 21.24, and 63.96, respectively. For BHP Billiton, the debt to total asset for 2018, 2019, and 2020 were 0.46, 0.49, and 0.50, respectively. The cash debt coverage for 2018, 2019, and 2020 were 0.44, 0.47, and 0.31 respectively. The times interest earned for 2018, 2019, and 2020 were 8.01, 10.59, and 11.43, respectively (BHP Billiton, 2019 and 2020).
Recommend whether St. Lucia Investments should invest in Company A or Company B or alternatively reject both offers.
The profitability and risk results discussed above show that both companies have varying results each year. However, the critical distinguishing ratio is the times interest earned. The times interest earned indicates the ability of an organization to pay its debt using the current earnings (Melicher and Norton, 2016). Considering the high times interest earned ratio posted by Rio Tinto, I would recommend that St. Lucia Investments should invest in the company.
Explain the meaning of the price earnings (PER) ratio and EPS
The price-earnings (PER) ratio is used to assess a company’s current share price against the earnings-per-share (EPS). Investors rely on this measure to define the comparative value of a company’s shares in an apples-to-apples assessment. If the PER is high, it could be interpreted that the company’s stock is over-valued, or else that investors expect the company to post high growth rates in the future. The earnings-per-share (EPS) is a vital indicator of a company’s profitability. It shows the amount of money a company generates for each share. It is also generally used to estimate a company’s value. Therefore, a company with a higher EPS is thought to have a higher value. Investors will pay more for its shares considering its ability to generate more profits relative to its share price (Melicher and Norton, 2016). Table 1 below indicates the trend in PER and EPS for Rio Tinto and BHP Billiton for 2018, 2019, and 2020:
Table 1: PER and EPS for Rio Tinto and BHP Billiton for 2018, 2019 and 2020.
|Rio Tinto||BHP Billiton|
The figures in Table I above shows that Rio Tinto has a higher EPS than BHP Billiton and, therefore, is more valuable and profitable. On the other hand, BHP Billiton has a higher PER. It could mean that the company is overvalued.
BHP Billiton, (2019). 2019 Annual Report. Web.
BHP Billiton, (2020). 2020 Annual Report. Web.
Melicher, R.W. and Norton, E.A. (2016). Introduction to Finance: Markets, Investments, and Financial Management. 16th ed. Wiley Publishers.
Rio Tinto, (2019). 2019 Annual Report. Web.
Rio Tinto, (2020). 2020 Annual Report. Web.