I need two separate reports for the same topic. Have even attached the rough draft of the analysis that we have conducted. In assignment pdf you have the questions to be answered under individual report
Executive Summary BHP is an Anglo- Australian multinational mining, metals and petroleum public company headquartered in Melbourne, Australia. The company has a market capitalization of 170.9 billion AUD. The company trades as a dual -listed company in some of the major stock markets. The PE ratio is 12.7x for the group which is lower than that of the Australian market (15.5x). Although the company is decreasing the debt over time it still has a high level of debt and a highly volatile share price over the past 3 months. This report: critically analysis the risks faced by the company by using the financial risk management tools. Alongside, there is a critical analysis of the funding used by the company and recommendations stated. International risk management tools: COMMODITY RISK · Political risk Diversification and monitoring To reduce political risk BHP has minimised its exposure by diversifying their portfolio commodity, markets, geography and currency, to provide resilience to political risk. The regular monitoring on geopolitical course is to understand the potential trends on the business to identify and to mitigate actions at the earliest. The engagement with the government to be in par with any change in the potential impact from trade, resource policies and other economic policy (US-China trade war) will help alleviate the likelihood of any potential political risk. Joint ventures with local companies BHP has joint ventures with Mineral Americas and Petroleum to increase shareholder’s reducing political risk associated with that country as the local government will be less inclined towards taking the assets from their own citizens. https://www.bhp.com/our-approach/operating-with-integrity/non-operated-joint-ventures/. In Trinidad and Tabago, a joint venture with the Ruby projects shows an FDI of $500 million. Cross border Merger & Acquisitions Foreign Direct Investment and Greenfield help hedge political risk: Petroleum Place Foreign Direct Investment or Greenfield Hedging the type of political risk Comments Ownership % United States Foreign Direct Investment and Greenfield investment Operational risk and micro risk (Trade war) largest foreign investor in surging shale oil and gas industry 35-44% Trinidad and Tabago- Foreign Direct Investment Operational risk Showing FDI of $500 million. In offshore oil and gas field. 45% United Kingdom Foreign Direct Investment Transfer risk Foreign Direct Investments at premium. In offshore oil and gas field Algeria Foreign Direct Investment Transfer risk Joint interest unit of offshore oil and gas unit. 45% Place Foreign Direct Investment or Greenfield Comments Ownership South America Foreign Direct Investment Copper mines in Chile, Peru, Brazil, Colombia 57.5%,33.75%, 50%, 33.3% North America Foreign Direct Investment Potash in Canada 100% Mineral Americas Local Borrowing: BHP finances its funding through loans, notes and debentures, cross currency swaps etc. To hedge the political risk financing through local borrowing is suitable. BHP borrows in US dollars. Recommendations: Political risk cannot be hedged only by looking at the ownership or way of investments, income inequality deterioration can be major reasons for political risk. The company should invest in political stable (unlike US-China) countries with a clean track record of wining of the political party to avoid any risks. · Price risk BHP is exposed to turbulent price movements in minerals, oil, and gases. A threat for BHP’s future profitability would be long-term price volatility/ sustained low prices. The company secures majority of its price in advance, as a tool for the price risk. Mr Beaven said. https://www.afr.com/companies/mining/bhp-billiton-to-hedge-for-first-time-in-10-years-20160708-gq17c5 The main reason being price shift, · Global economic and geopolitical factors · Industry specific demand · Increased supply (new productive resources) etc., Recommendations: · Production Contract: Enabling a steady/high certainty of future income · Pooling: Averaging price by increased export by reducing price variation. · Maintaining credit ratings · Funding: Ability to fund for current and future capital projects · Cost Risk The risks involved with BHP are prone to inflationary pressure. To hedge cost risk, the company has global access to the debt market targeting credit rating metrics and gearing levels. There has been an incremental change in operations resulting in higher cost risk. Recommendations · Contract mining v/s sale or leaseback · Implementing front- and back-office automation · Divesting noncore assets https://assets.ey.com/content/dam/ey-sites/ey-com/en_gl/topics/mining-metals/mining-metals-pdfs/ey-top-10-business-risks-facing-mining-and-metals-in-2019-20_v2.pdf https://www.cpaaustralia.com.au/-/media/corporate/allfiles/document/professional-resources/business/managing-commodity-risk.pdf?la=en&rev=3fe5254501cf4764837576df1c23b5ab INTEREST RATE RISK BHP is exposed to interest rate risk in terms of investments and borrowings which could possibly change the interest rates that could affect the future cash flows/ fair value of the fixed interest rate financial instruments. It is treated as a part of portfolio risk management strategy. Their policy is to pay US dollar floating interest rate on exposure to interest rates. Most of the debt is issued at fixed interest rates. Although their earnings are sensitive to change in the trend of interest rates on floating factor of their borrowings, their main exposure is to a 3-month US LIBOR benchmark. There was a slight decline of 2 bp from 2.34% to 2.32% in June 2018-2019. Therefore, interest rates and the net debt may not continue to be constant over the coming financial year (current year 2020) Recommendations · Prefer forward prices over spot rate to reduces volatility from economic variables(short-term) · Both prices do not vary much due to strong correlation RHEA Currency/ Foreign Exchange Risk: · Natural Hedge BHP, being one of the world’s largest mining companies, has its operations spread over in a lot of countries, resulting in exposure to major foreign exchange rate risk, also known as the currency risk. Like any other large firm, BHP also faces the two primary types of risks, that is the transaction risk, which comes across during the process of buying and selling of commodities overseas; and the translation risk which is associated to converting assets and liabilities of the firm, that are denominated in foreign currency, to domestic currency. · The ramifications of the transaction exposure directly affect the cash flow of BHP. Moreover, the operating costs as well as the cost of equipment that are locally sourced, is determined by the fluctuations in local currency, mainly the Chilean Peso & Australian dollar. BHP’s presentation or functional currency is the US dollar; hence the BHP group has, 1. Most of its sales transacted in USD; and 1. Surplus cash borrowed and held mainly in USD Thus, avoiding transaction exposure towards foreign exchange using natural hedge. · In case some joint arrangements or subsidiaries do not have US dollar as the functional currency, such transactions or monetary items are then translated to foreign currency in the following manner: Foreign currency denominated item Exchange rate used Transactions Date of the transaction Monetary assets & liabilities Period-end rate Thus, managing the translation exposure. · DERIVATIVES USED: · Cash deposits held in any foreign currency other than the US dollar, derivatives are used. · FORWARD CONTRACTS & CROSS CURRENCY INTEREST RATE are used as the derivative instruments for- 1. Cash deposits held in foreign currency. 1. Conversion of monetary items into the functional currency. 1. Forwards used for transactional exposure. · Currencies primarily causing the most risk for BHP are: Australian Dollar, the Pound Sterling, the Chilean Peso & the Euro. Types and Sources of funding used .Internal funding has contributed for 150% and 86% of total net funding flows, in both, for Foreign listed and Australian resource firms as of 2003. The proportion of internal financing is greater than in non-resource markets. For instance, other listed Australian non-financial companies usually have 68% of internal financing. BHP has financed expansion throughout the 1920s and 1930s with internal funds and a bank overdraft. BHP had a strong history of financing expansion through retained earnings and periodic equity issues. The company funds itself from equity and debt. Debt Source of Funding Along with these, the debt source of funding is undertaken from Bank Loans, Notes and Debentures, Finance Leases, Bank Overdrafts, and Short-Term Borrowings. Credit Rating BHP also provides registered shareholders with a Dividend Reinvestment Scheme that enables registered stakeholders to buy on the market BHP stock leveraging cash dividends. Capital Allocation Strategy · BHP Billiton who has announced a reduction in capital and exploration expenditure from US$21.7 billion in 2013 to US$16.2 billion in 2014 and the focus will move to generate more volume from existing equipment and the lowering of unit costs. (1). · Minimum 50 percent Payout Ratio dividend policy is best adapted to cyclical cash flows and facilitates counter-cyclical investment. (BHP Capital Allocation Briefing, 2018). Currently, BHP has a 76.5% payout ratio. BHP’s dividends in 3 years until 2023 are forecast to be covered by earnings (68.5% pay-out ratio). Debt-Equity Historical Analysis Source: BHP Capital Allocation Framework Recommendations: · Myers (1977) also believes that businesses with large potential for development appear to have higher leverage levels. BHP has raised its debt commitments in the light of historical evidence, which could hamper its growth potential, however, if there is a tax benefit for corporate borrowing, the optimum approach requires a trade-off between the tax benefits of lending and the expenses of the inadequate possible investment strategy. · BHP Group had debts of US$ 13.8b due within 12 months, and debts of US$ 36.1b owing beyond 12 months, according to the last reporting balance sheet. On the other side, it had cash in receivables worth US$ 14.3b and US$ 3.73b, payable within one year. As such, debt obligation has far more than its cash and short-term receivables, merged, bringing total US$ 31.8b. This shortfall is not so poor because BHP Group is worth a whopping US$ 105.8b and could collect adequate money if the need existed to sustain its balance sheet. BHP Group has recorded a free cash flow of 72 percent of its EBIT over the last three years, which would be roughly reasonable, provided free cash flow excluding interest and tax. Such free cash flow places the firm in a strong place to compensate for debt obligations. Reference: 1 Mining Council of Australia (13) and BHP Billiton (14) 2. S. Myers, Determinants of corporate borrowing, Journal of Financial Economics, 5 (1977), pp. 147-175 3. https://www.rba.gov.au/publications/bulletin/2013/mar/6.html#r2 4. https://www.mining-technology.com/features/alternative-financing-for-the-mining-industry/ 5. https://www.asx.com.au/asxpdf/20180918/pdf/43ydvy79dymhpv.pdf 6. BHP Annual Report 2017, 2018, 2019 7. BHP - Capital Allocation Briefing, 2018 Other issues Counterparty credit risk: BHP group faces counterparty credit risk arising from non-fulfilment of obligations of credit (like short term investments in the form of deposits with the bank) or derivatives contracts. Markets of listing Taxation and BHP’S contribution to global economy The country in which BHP operates provides not only essential services to the citizens but also invest in future communities. Investments contribute to