BHPs Share Valuation and Analysis

Question: Describe about the BHPs Share Valuation and Analysis. Answer: Company/Industry Description BHP Billiton Limited is among the leading oil, gas, and metal producers. The company has diversified income streams regarding geographies and business lines. It operates through Iron Ore, Petroleum and Potash, Coal, and copper segments. The Iron Ore sector is tasked with the exploration, development, and production of Iron ore. Petroleum and Potash segment, on the other hand, is responsible for both the production of gas and oil and the pre-development of Potash. The coal sector, which is among the companys most significant segments, mines both thermal and metallurgical coal. The final segment mines copper, lead, zinc, silver, uranium, molybdenum, and gold. BHP Billiton has production processes primarily located in Australia and America but products sold worldwide, through marketing businesses strategically located near the consumers. Singapore houses the companys primary marketing business because 72% of the companys sales are in Asia (Bhpbilliton.com, 2015). Other marketing businesses are in Houston, United States, reflecting the fact that more than half of the companys gas and oil is sold to North America. The company also has many regional marketers positioned in proximity to customers. BHPs core strength is in the fact that its energy and mineral supplies are crucial at every stage of economic growth (Bhpbilliton.com, 2015). Emerging economies need construction materials such as steel for their expanding populations, heavy industries and new cities. As the economy continues to grow, and individuals become wealthier, demand for steel slows. Demand for consumer materials such as copper begins to pick up. As income rises further, demand for agricultural products such as Potash increases. BHPs strategy is take the ownership and operate large, expendable, long-life, and low-cost upstream resources broadened by geography, market, and commodity. The strategy has helped the company to deliver superior margins throughout various commodity and economic cycles (Bhpbilliton.com, 2016). Its low cost, and diversified, tier one asset base increases the resilience of the cash flow. It helps to minimize the exposure to a single currency or one commodity and assists in providing a more robust and predictable financial performance, which enables it to grow its business throughout product cycles and deliver greater long-term value to the shareholders. The company is continually developing and growing its diversified assets to continue meeting the changing customers needs. Its products play a critical role in not only fueling todays growth but the growth to occur a century from now. The companys aim is to maximize the economic and social benefits of its operations, minimize its environmental footprint, and add to economic development through productivity, innovation, and technology (Bhpbilliton.com, 2016). BHP has in place a portfolio of growth options to help it plan for both the short and long-term and continue creating value for its shareholders. For the quarter ending September, the company is expected to record an 87% growth in share earnings to around 86 cents per share. Market-wide Influences Affecting the Company and its Shares BHP runs in a vibrant environment that has seldom exact and complete information. The company primarily manages the risk outlined in this section under their portfolio management approach, which hugely depends on the outcomes of diversification rather than the management of individual risks. Some of the marketing-wide influences that affect the companys shares include commodity prices, exchange rate fluctuations, interest rates, health, safety, and environmental issues, world political events such as war, natural disasters, and calamities, and alternative energy sources. Others include intense competition, investor sentiment, and January effect. Commodity prices are one of the major influences affecting the company and its shares. For example, in the Financial Year 2012, commodity prices were substantially impacted by the ongoing gradual economic slowdown in China, debt concerns in Europe, and uncertainty about US recovery (Bhpbilliton.com, 2012). With the shrinking Chinese demand growth for steel making materials combined expanding supply growth from seaborne sources, the raw material prices for that year greatly dropped from the previous years level. Geopolitical tensions provided price support for Petroleum segment, while the declining gas prices in the US dealt a big blow to the Coal sector as manufacturers switched to the now cheaper gas. As the Chinese economy continues to recover, the commodity prices are expected to increase in the future. BHPs operations could be profoundly impacted by government regulations such as import and export prices, control in imports, among others. Increased regulatory requirements, social and environmental approvals have the potential to delay the construction, significantly impact the economies of the new gas and oil projects, and constraint the expansion of existing operations. Any future tax changes in Australia have the potential to impact on BHPs financial performance. BHP has operations in almost every continent. One of its resources-oil- is found in regions that are prone to conflicts. The company operates in emerging markets, which poses additional risk to the profitability of its operations. Some of the risks associated with oil demand and supply include the possible war between Israel and Arab Nations, the insurgency in Nigeria, and possible terror attacks in emerging or OECD nations. There is also the possibility of civil unrest due to the nationalization of assets, high inflation, nullification or renegotiation of current contract deals, changes in laws, and other unforeseeable risks. There is another risk of corruption and interference from the government in many developing nations. Any of the abovementioned risks may influence BHPs demand and supply situation and eventually have an effect on its financial performance. During the global financial crises, many economies face an additional burden of funding debt obligations and may need additional resources and revenues. They may adjust the royalties and impose additional taxes on a level where exploration becomes unviable. While BHP Billiton may cut supply, raise prices, and recover the revenues, such a development has greater chances of negatively impacting the companys financial standing and reduce the projected earnings and potential investments in those nations. Most of BHPs oil facilities are in areas with high risk of hazard. The company has its exploration, manufacturing, processing, production, and logistical operations in many offshore and onshore geographical locations. Its operational processes are prone to accidents such as fire and explosion, shipping and port incidents, loss of oil control, among others. The companys operations and geographical locations are prone to natural catastrophes such as hurricanes, floods, earthquakes, and tsunamis. Such events may create disruptions in production. The facilities lost could be more than premiums saved, and this could adversely affect the companys prospects and financial results. Demand and supply imbalances may affect both the short-term and long-term prices. When the supply is disrupted, such as after the 2005 Rita and Katrina hurricanes, short-term supply may fall short of short-term demand of resources, thereby exerting upward pressure on prices. The high prices may discourage consumption thereby affecting the companys short-term revenues. The rising demand for oil in the recent years has seen an increased production of crude. Due to latest developments, reserves have depleted at an alarming rate. Considerable BHPs revenues are tied to oil production. Therefore, the companys financial condition is directly dependent on the success of its acquisition efforts, and its capacity to substitute the current reserves. There are also severe uncertainties surrounding the estimation of gas and oil fields. Technical, geological, and economic postulations are only applicable at the time of evaluation. Estimations may considerably change as soon as new information gets available. Developments in the global market such as the international financial crisis may significantly impact the reserves economic estimation to the extent that they may require restatements, which have the potential to negatively affect the companys financial results, conditions, and prospects. The company faces severe competition in the mining and metal industry. Competitors are cropping up every passing day, and the industry is now tending towards concentration. Large multinationals dominate within each segment. Moreover, the cyclical nature of the industry suggests that the high growth rate is not sustainable in the long-term. The industry is exposed to changes in energy prices, as one of its initial costs. As aforementioned, its margins are highly vulnerable to variations in the costs of raw materials. Intense competition can potentially lead to the loss of market share and exert pressure on the companys margins. BHP is subject to extensive regulations regarding the safety and health of the people and the environment. With the evolving safety standards and community rules, the company is subject to unforeseen environmental expenses and compliant taxes (Wouters, 2015). A good example is the now defunct carbon tax in Australia, which was not in operation some few years ago. Just like any other listed company, BHPs share price is subject to investors sentiment. Investors sentiment refers to the general mood of investors in the stock market (Gao, 2011). Since stock valuations reflect expectations, the BHPs stock may not be correlated with the companys financial condition. The price may rise if investors expect the companys financial status to improve in the future. BHPs Share Valuation and Analysis Share valuation is the calculation of the hypothetical value of the company and its stocks (Stowe, McLeavey Pinto, 2012). Assessment helps to predict the stocks potential/future market prices and profit from price movement. Shares that are undervalued are bought, while those that are overvalued are sold, in the anticipation that overvalued shares will decrease in value over time, while undervalued shares will appreciate in value in the future (Beneish Nichols, 2013). In BHPs case, we will use NTA backing method, CAPM, earning capitalization model, dividend discount model, and Future Cash Flows to determine whether the shares are overvalued or undervalued. NTA Backing Method Net Tangible Asset Backing, otherwise known as Net Tangible Asset per share is a method used to determine the amount each shareholder would receive if at a particular point in time, the company is forced into liquidation and all the assets are sold (Greco, Cricelli Grimaldi, 2013). Net tangible assets refer to the companys total assets less par value of preferred stock, any liabilities, and intangible assets such as patents, goodwill, and trademarks. The amount is then divided by the number of outstanding shares to get net tangible assets per share. NTA = total assets par value of preferred stock- total liabilities - intangible assets NTA/share = net tangible assets number of shares on issue As at June 2016, the consolidated balance sheet for BHP Billiton had total assets of US $ 118,953 million; total liabilities stood at US$ 58,882 million. The total intangible assets were US $ 4,119. At the same time, the company had US $0 million of preferred stock. Consolidated Balance Sheet as at 30 June 2016 30 June 2016 US$M 30 June 2015 US$M Current Assets Cash and cash equivalents 10,319 6,753 Trade and other receivables 3,155 4,321 Other financial assets 121 83 Inventories 3,411 4,292 Current tax assets 567 658 Other 141 262 Total current assets 17,714 16,369 Trade and other receivables 867 1,499 Other financial assets 2,680 1,159 Inventories 764 466 Property, plant and equipment 83,975 94,072 Intangible assets 4,119 4,292 Investments accounted for using the equity method 2,575 3,712 Deferred tax assets 6,147 2,861 Other 112 150 Total non-current assets 101,239 108,211 Total assets 118,953 124,580 LIABILITIES Current liabilities Trade and other payables 5,389 7,389 Interest bearing liabilities 4,653 3,201 Other financial liabilities 5 251 Current tax payable 451 207 Provisions 1,765 1,676 Deferred income 77 129 Total current liabilities 12,340 12,853 Non-current liabilities Trade and other payables 13 29 Interest bearing liabilities 31,768 27,969 Other financial liabilities 1,778 1,031 Deferred tax liabilities 4,324 4,542 Provisions 8,381 7,306 Deferred income 278 305 Total non-current liabilities 46,542 41,182 Total liabilities 58,882 54,035 (BHP Billiton Results for the Year Ended 30 June 2016, 2016) NTA= 118, 953- 0- 58,882-4, 119 Net Tangible Assets= US$ 55,952 million NTA/Share= 55, 952, 000, 000 No of shares on issue = 55,952,000,000 2, 661, 000, 000 NTA/Share= $21.026 Conclusion The current market price of BHP Billiton shares is $21.55. So, the shares are currently overvalued. Recommendation As per the NTA backing method, investors currently holding the shares are better off selling them now since the prices are bound to drop in the future. The major weakness of this method is that it does not take into consideration the intangible assets. Capital Asset Pricing Model (CAPM) The model is built on the idea that the stocks future cash flows should be discounted by taking into consideration the riskiness of the said cash flows, with the risk measured by a beta factor (Kelleher, 2010). The market is assumed to have a beta of one. So, a portfolio or a company with a beta of greater than one is considered riskier than the market. A company with a beta of less than one is less risky than the market. The sum of risk-free security and risk premium gives the expected return of the stock. The risk premium is determined by the beta for the stock. If the required return is less than the expected return, then the investment should not be made. TheCAPM formulais: ra= rrf+ Ba(rm-rrf) Where: ra= the rate of return of the risky asset rrf= therate of returnfor a risk-free asset rm= the broadmarket's expected rate of return Ba=betaof theasset The rrf is usually 2.4 percent, which is the Australian 10-year government bond rate. The beta (risk measure of stock) can be obtained from an online broker (based on historical data). The beta for BHP Billiton is 1.38. We get the broad markets expected rate of return by adding the Australias historical risk premium to the risk-free rate. Australias historical risk premium is 6.5 percent. So, the expected rate of return is 8.9 percent (6.5+2.4). So, the ra for BHP Billiton comes to: ra= 2.4% +(1.38(8.9%-2.4)) = 11.37% Conclusion The rate of return of the share is 11.37%, as opposed to the markets expected rate of return of 8.9. So, BHPs share would give higher returns than the overall market. Recommendation One should consider investing in it but with assumptions that the trade will be without taxation and transaction costs, and traders are price takers. However, when investing, there is the need to consider the fact that the asset is riskier than the market (beta of more than 1, therefore, the returns are not guaranteed) Discounted Cash Flow Method Under this method, we use the CAPM to calculate the fair price of an investment (Gorman, 2013). The fair value of an investment is obtained from the risky asset rate of return by getting the PV of investments future cash flows. By extension, one can compare the shares fair value by its market price to determine whether the share is overvalued or undervalued. Consider the share overvalued if the price estimate is higher. If lower, consider it undervalued. Earning Capitalization Model Capitalization of earnings is most appropriate when the firm is expanding or when the earnings of the company are stable (Damodaran, 2012). The companys earnings will only be stable when it neither employs external financing nor retains any earnings. In such a case, b will be 0, and the growth rate (given by br) will also be 0. Furthermore, when there is no retention, Earnings (Eo) will be equal to the dividend (Do). The value per share in such scenario will be given by: Po = Eo (1-b) Ke- br Assuming that BHP Billiton has investment opportunities generating internal rate r equal to equity capitalization rate, we have: Po= Eo Ke Theoretical value of BHP shares will be: Po= - 1.2 11.37% = -1.2 0.1137 Po= - 10.554 Conclusion and Recommendation The reported earnings per share for BHP Billiton for the financial year 2016 are -$1.2 (maybe due to the fact that earnings were not stable). Since that the theoretical value of shares is too less than the market value, you refrain from investing in the stock. Overall Conclusion and Recommendation Based on the four the above four models, BHP Billitons share appears overvalued. Though the rate of the return of the companys shares is 11.37% (which is higher than the broad market expected rate of return), it would be risky to invest in the stock since it has a beta value of greater than 1 (1.39). An investor currently holding BHP Billitons stock should consider selling it because the prices are likely to drop in the future. But with 2017 fiscal estimates of $1.36 per share, and with the companys earnings expected to rise almost 60% in comparison to an average growth of about five percent for SP 500 (SPX) corporations, its shares may surpass price targets and the earning expectations. References Beneish, M. and Nichols, D. (2013). Identifying Overvalued Equity. SSRN Electronic Journal. Bhpbilliton.com. (2015). BHP Billiton | Overview of assets Marketing. [online] Available at: https://www.bhpbilliton.com/investors/annual-reporting-2016/overview-of-assets-and-marketing [Accessed 23 Sep. 2016]. Bhpbilliton.com. (2016). BHP Billiton | BHP Billiton | Strategy. [Online] Available at: https://www.bhpbilliton.com/aboutus/strategy [Accessed 24 Sep. 2016]. Bhpbilliton.com. (2012). BHP Billiton | BHP Billiton | Strategy. [Online] Available at: https://www.bhpbilliton.com/aboutus/strategy [Accessed 24 Sep. 2016]. BHP Billiton Results For the Year Ended 30 June 2016. (2016b). 1st ed. [pdf] Brisbane: BHP Billiton, p.31. Available at: https://www.bhpbilliton.com/~/media/bhp/documents/investors/news/2016/160816_bhpbillitonresultsyearended30june2016.pdf?la=en [Accessed 25 Sep. 2016]. Damodaran, A. (2012). The little book $ of valuation. Hoboken, N.J.: John Wiley Sons. Kelleher, J. (2010). Equity valuation for analysts investors. New York: McGraw-Hill. Gao, Z. (2011). Expected Earnings Growth, Stock Valuation and Investor Sentiment. SSRN Electronic Journal. Greco, M., Cricelli, L. and Grimaldi, M. (2013). A strategic management framework of tangible and intangible assets. European Management Journal, 31(1), pp.55-66. Gorman, L. (2013). An Internally Consistent Approach to Common Stock Valuation. SSRN Electronic Journal. Stowe, J., McLeavey, D. and Pinto, J. (2012). Share Repurchases and Stock Valuation Models. SSRN Electronic Journal. Wouters, C. (2015). Towards a regulatory framework for microgridsThe Singapore experience. Sustainable Cities and Society, 15, pp.22-32.