Bhp Billiton Corporate Finance

Published Date: 02 Nov 2017

BHP Billiton is one of the world’s largest diversified natural resources group, engaged in mineral exploration and production. It has its operation in sectors such as Petroleum, Aluminium, Base Metals, Diamonds, Specialty Products, Stainless Steel Materials, Iron Ore, Manganese, Metallurgical Coal, Energy Coal etc. BHP Billiton extracts and processes minerals, oil and gas across the globe. Their sales are geographically diversified however more concentrated in emerging economies.

BHP Billiton is a Dual Listed Company (DLC) comprising BHP Billiton Limited (Australian Listed) and BHP Billiton Plc (UK Listed). The two entities continue to exist as separate companies, but operate as a combined group known as BHP Billiton. BHP Billiton was created through the DLC merger of BHP Limited (now BHP Billiton Limited) and Billiton Plc (now BHP Billiton Plc), which was taken place in mid 2001. The merger proved to be a wedding of two highly complementary companies, which has now realised the heavy hitter with a market capitalisation of around $180bn.

The headquarters of BHP Billiton Limited, and the global headquarters of the combined BHP Billiton Group, are located in Melbourne, Australia. BHP Billiton Plc is located in London, United Kingdom. Both companies have identical boards of directors and are run by a unified management team. Shareholders in each company have equivalent economic and voting rights in the BHP Billiton Group as a whole.

The DLC structure maintains pre-existing primary listings on the Australian Stock Exchange (through BHP Billiton Limited) and London Stock Exchange (through BHP Billiton Plc), along with a secondary listing on the Johannesburg Stock Exchange (through BHP Billiton Plc) and American Depositary Receipts listings on the New York Stock Exchange.

BHP Billiton’s Corporate Finance Policies and Practices: Over Last Five Years

BHP Billiton is a highly diversified company with strong fundamentals. Even recent economic meltdown has also no significant effect on its profits and the company is growing stronger and stronger. BHP Billiton is a mining giant with interests in many countries across the globe. Apart from a huge presence in Australia, BHP Billiton owns, fully or partially, mines, oil & gas and processing facilities in more than 20 countries. BHP Billiton's diversification plan has been extremely beneficial for the company's bottom line. The strength and resilience of BHP Billiton finance policies can be gauged from the fact that despite immense pressures due to recent global recession, it has reported a continuous growth in profits. When international banks were facing problems with liquidity and wanted help from governments for a bail-out plan, BHP Billiton had adequate cash flows for maintaining its share buy-back program thanks to its strong corporate finance policies.

The future also looks very bright for BHP Billiton investors based on its healthy balance sheet. Another factor which goes in favour of BHP Billiton is, it’s very low debt-equity ratio. As new urban infrastructure is being developed in India and China, utilities and power infrastructure is being put in ahead of the main urban structures and in the case of power supplies this is generally underground which requires vast amounts of copper being best for purpose.

The strong financial performance enabled the BHP Billiton to reduce net debt and continue to invest strongly in capital and large exploration programs. The BHP Billiton’s financial strength leaves it well positioned to invest in growth areas and participate in opportunistic mergers and acquisitions. The Western Australia iron ore production joint venture with Rio Tinto is described as an example of focused pursuit of capacity growth in Tier One assets. The BHP Biliton’s balance sheet strength has allowed the company to continue to increase its dividend over year. BHP Billiton’s strength in depth has enabled it to ride the recession rather better than most of its peers. With many of its peers stretched financially during recent recession, this give BHP Billiton an advantage when looking at new projects or potential acquisitions as it is able to be less restrained than most in financial terms. BHP Billiton’s solid balance sheet is the strongest in the industry, is and will be one of its best weapons if it needs to ward off rivals making counter offers for expansion. BHP Billiton’s financial state depends on commodity, oil and prices. However the diversity in its business within natural resources provides a better horizon.

BHP Billiton’s corporate finance policies are long term growth oriented. Their huge investments in petroleum sector are now providing very strong fruitful result and huge profit margins. BHP Billiton has world class assets which provide required cash flow for their new projects and future expansion plans. BHP Billiton’s have given consistent dividend over few decades due to their strong financial policies.

BHP Billiton has very solid financial strength which reflects in their solid credit ratings. They have capital management program in place and their capital management program is focused on to return extra capital to their shareholders; reinvest capital in most financial viable projects which provides regular return irrespective of economic climate and very strong balance sheet.

BHP Billiton has archived massive increase in earnings and subsequently invested heavily in expansion plan in last five years. BHP Billiton has plans to spend tens of billions of dollars over the next few years, expressing confidence the commodities boom will last for several more years. BHP Billiton has expressed its confidence that, while prices might be volatile, the outlook for demand and prices for their key commodities is for a continuation of the right balance between supply and demand that has under-pinned the soaring prices. They want to increase the production capacity of their iron ore business.

As the commodity prices remain strong for several years, the profit of BHP Billiton also soaring high. The market-related pricing for iron ore over the past year, which has been driven by BHP Billiton, has seen prices soar and the increased margins flow almost immediately into their profits. BHP Billiton is trying to drive through a changed approach to the pricing of coking coal, where prices have been set on a quarterly basis. Their coking coal prices are also going up towards record levels, with the impact of the relatively concentrated supply more influenced by the series of floods in Queensland, the key source of production. That has given BHP Billiton even greater negotiating leverage over the mills, at least in the short to medium term.

Economies of scale are another factor used by BHP Billiton to make them profitable. Economies of scale lower cost and increase services to customers. These advantages help shield competition in the industry and increase services with less additional investment. Economies of scale are barriers to entry against other firms competing against the current entrants. Large companies like BHP Billiton have huge economies of scale.

For BHP Billiton expanding their low-cost assets during periods of peak prices makes a lot of sense, given how quickly the investments will pay for themselves. There are several factors which affects the financial policies of the BHP Billiton are detailed below.

Fluctuations in commodity prices

Fluctuations in currency exchange rates

Influence of China and India and impact on consumption

Actions by governments or political events across globe (Middle East is current example)

Ability to successfully integrate acquired businesses

Ability to recover investments in mining and oil and gas projects

Low operating cost

Unexpected natural and operational catastrophes

Climate change and greenhouse effects

Adequate human resource

Strong political influence

Strong influence in governance processes

BHP Billiton’s Strategic Investment

BHP Billiton has planned to do huge strategic investment over next 5-years in buying natural resource assets, oil and gas exploration and acquiring natural resources companies. Due to their planned strategic investment over last 5-10 years in natural resource assets, even during the recent recession; BHP Billiton has done exceptionally well. As the global economic outlook has improved, emerging economies are driving the growth of their natural resource business. The long term prospect of the BHP Billiton’s business is very strong. Currently three companies are dominating the world natural resource market. These are BHP Billiton, Vale and Rio Tinto.

BHP Billiton’s investment strategy is clear and long-term focused based on its well established corporate finance policies. They have unchanged strategy in natural resource business since 2001. They focus on large, long-life, low-cost, upstream, high-quality assets, diversified by commodity, geography and markets. This strategy means more predictable business performance over time which, in turn, underpins the creation of value for their shareholders, customers and employees. The company announced in November, 2010, that it would buy back its shares worth $4.2bn from market. This means that they will complete the share buy-back option which was started in 2006 worth $13bn.

During this financial year, the excess cash may be used for fresh $15bn-$20bn buy-back programme when results will be announced, as per a mining analyst from HSBC. In this huge cash pile up situation, BHP Billiton has few options mentioned below.

Return money to shareholders through ‘super’ dividends or share buy-backs;

More investment and expand production capacities as much as possible;

Try out for some more acquisitions.

Keep cash with them and adopt wait and watch policy for further developments.

They can invest more money in diamond, uranium and oil & gas business. However any Greenfield project in oil and gas takes 3-5 year to reach in production stage.

Risk Free Borrowing for Acquisition/Expansion

As a DLC, BHP Billiton can afford significant amount for its future acquisition or expansion plans. BHP Billiton can afford an estimated $75bn to $80bn as a risk free debt for its future expansion plan. As world’s a biggest miner, BHP Billiton, can spend up to $80bn for developing its asset. Currently they are looking for diversification of their portfolio to minimize the risk.

Based on their excellent credit rating which is A+ grade as per Standard & Poor’s and A1 grade as per Moody’s, they have very high bargain power for getting cheaper debt in current market scenario. In year 2010, BHP Billiton has arranged a syndicated loan worth $45bn to back the Potash hostile bid, with six banks involved in the financing.

The following key figures explain the BHP Billiton’s current financial situation.

Total Cash: BHP Billiton has huge cash in its kitty. Their total cash has risen by $7bn in last 5 years. In year 2010, they had $18bn total cash in their balance sheet as shown in Figure 1.

Figure 1

BHP Billiton’s cash reserve was $12.5bn in year 2010, up from 1.35bn in 2006. This provides BHP Billiton a huge opportunity to go for expansion through acquisition and organic growth. BHP Billiton is a cash rich company and highly geared as well. "The strength of its balance sheet and ability to generate cash set BHP Billiton far apart from the competition" says PSG Alphen Asset Management’s Van Schaik. Because of its huge internal cash generation, BHP Billiton is able to fund many of its big projects internally. BHP Billiton’s long life and low cost assets provides deep cushion in comparison to its competitors.

Total Debt: BHP Billiton has negligible debt on their balance sheet. BHP Billiton’s total debt has risen only by $7.5bn in last 5 years. In year 2010, they had $16.5bn total debt on their balance sheet as shown in Figure 2. BHP Billiton’s debt are so low that institutional investors cannot find relatively risk-free debt instruments at the right rate of return, so BHP will have no problems finding buyers for its debt: it's one of the biggest companies in the world with a solid credit ratings.

Figure 2

Total Equity: BHP Billiton equity value is rising continuously over last five years. BHP Billiton’s total equity has risen by $25bn in last 5 years. In year 2010, they had $49.5bn total equity on their balance sheet as shown in Figure 3.

Figure 3

Gearing: BHP Billiton gearing ratio is very low and lowest in mining sector compared to its competitors. They are able to keep low gearing over last five years as shown in Figure 4. BHP Billiton enjoys a strong credit rating and they can easily borrow $80bn to $90bn for their expansion plan without endangering its balance sheet. BHP Billiton’s gearing ratio would not rise significantly dangerous if the company expansion plan is fully funded by debt.

Figure 4

Beta Value: BHP Billiton has current beta value of 1.41. This reflects their market worthiness, their strong balance sheet and future outlook. Beta value a stock is nothing but it shows the relation of a stock or group of stocks to its index. Statistical calculations and formulas using to identify the exact beta value of a stock. Knowing the beta value of a stock will give us better idea on the volatility side of a stock against its index. An investor can identify the beta value of a sector, that is a group of stocks, to even know the volatility of the sector or stocks in that sector against the index. BHP Billiton’s has beta value of 1.41 means that when the index coming down to 10%, the stock price of BHP Billiton will come down to 14.1%.

Weighted Average Cost of Capital (WACC): BHP Billiton has WACC as 11%. Investors use WACC as a tool to decide whether to invest. The WACC represents the minimum rate of return at which a company produces value for its investors. As BHP Billiton has yielded Return on Investment of 23% in year 2010 and more than 126% in last 5 year has a WACC of 11%. This means for every dollar the company invests into capital, the company is creating 12 cents of value. WACC serves as a useful reality check for investors. In this WACC risk free rate for debt has taken as 4.2%. The total cost of debt is assumed as 6.7%.

As total asset of the BHP Billiton Group is estimated worth $180bn, hence they can afford to spend $80bn in expansion as a group. The commodity prices are soaring all time high and emerging markets countries are willing to pay higher commodity prices. The profit of the BHP Billiton is rising year over year. BHP Billiton’s other commodities, especially oil, are also mostly rising in price which provide company a better bargaining in arranging cheap debt. The company has negligible debt and even a spare $11bn to throw at a share buyback.

However a 2008-style recession which is unlikely, will have very bad affect on BHP Billiton’s balance sheet which will be stretched by the $80bn debt. However during recent recession BHP Billiton was able to generate very healthy returns on its asset. As a fundamental of expansion, BHP Billiton have now preference for building asset, rather than buying assets is a welcome change of style. The BHP Billiton is doing what it has always done since merger in 2001, increasing spending at 20% a year. On almost every financial measure (dividends, buybacks etc), BHP has outperformed its peers for years.

BHP Billiton has its concentration on large, low-cost mines, runs a simpler model than the big oil companies. Currently they are looking major opportunity in oil and gas sector for its expansion. BHP Billiton has to go for the large expansion plan because of the huge extra cash generated from the operation. BHP Billiton, along with the entire resources sector, is riding on the crest of the biggest commodities boom in recent history – and as a result is throwing off cash.

With global population growth, plus the rapid urbanisation of emerging markets, the demand for commodities seems insatiable. The land-grab for natural resources has been ferocious already – but plenty believe it is just warming up. With this huge money BHP Billiton can launch a big takeover bid to its rival like Rio Tinto (again), Anglo-American, Xstrata or some other entity. If they can spend this much money, the combined business may be a resources superpower with a market valuation that bigger than Microsoft, Apple etc.

According to the company, BHP Billiton has since 2001 increased capital expenditure by an average of 20% a year, while boosting cash dividends by an average of 25% a year. Since 2005, BHP Billiton has completed buy-backs totalling $12.7bn and paid out $17.9bn in dividends. BHP is expected to go further by announcing big increases in its dividend payment and another fresh share buy-back programme.

In this environment, with the price of base metals and other resources soaring, potential acquisitions are also arguably at their most expensive. At the very least they are hard to value long-term. But both the BHP Billiton and investors know they are living in an uneasy status quo. Commodity prices are likely to stay high for some time – filling miner’s coffers even further. Driven by booming global population growth and rampant emerging markets, the mining cycle is not expected to fall away for many years.

First, there's a big upsurge in mergers and acquisitions (M&A). If a company can borrow money at less than 1% and go out and buy a business yielding 6% or 7% a year, then it isn't very hard to make a deal stack up financially.

The one thing you can say for certain is that if a price is at a three-century low, there is nothing normal about it. It's clearly exceptional. The think tank Policy Exchange predicted last weekend that interest rates could be back up to 8% in two years, as the impact of the huge expansion of the money supply fed through into prices. That may or may not be accurate. But one thing seems certain: a return to a more normal rate of around 5% is guaranteed at some point in the next two or three years.

BHP Billiton is now pursuing a different strategy. Concerned about BHP Billiton’s exposure to cyclical industrial commodities, they are attempting to insulate BHP Billiton by diversifying. Very few can compete with BHP Billiton on financial terms. BHP is cash rich and an attractive proposition for institutional investors.

Appendix: References

BHP Billiton Annual Reports (2006 to 2010)

Lecture Notes: Bob Stadling

Watson and Head (2010) Corporate Finance: Principles and Practice 5th edition, Prentice Hall

http://www.wikiwealth.com/research:bbl

http://www.guardian.co.uk/business/2011/feb/15/bhp-billiton-record-profits-expected