Financial Assignment On Rio Tinto Ltd Business Performance 2015 And 2016

Question

Required: This assessment task is a written report and analysis of the financial performance of a selected company in order to provide financial advice to a wealthy investor. It will be based on financial reports of a listed company on the ASX . This assignment requires your group to undertake a comprehensive examination of a firm’s financial performance and must be submitted by Week 11 .

Question: Your group is an investment adviser, working to build a foundation of wealth for your clients. One of your wealthiest clients already has a diversified portfolio, which includes managed funds, property; cash/fixed interest and a few direct share investments in Australia and around the world.

The assignment is a written comprehensive report and analysis of the firms’ financial performance (including referencing).

Your group is required to do the following tasks:

1. Prepare a brief description of the company, outlining the core activities, the market(s) in which it operates within and any factors in the companies’ history which you consider help present a “picture” of your company.

2. Specify ownership-governance structure of the company:

• Name the main substantial shareholders:
  • With higher than 20.00% of shareholdings. Based on this argument you should classify a firm as a family or non-family company, and With higher than 5.00% of shareholdings.
• Name the main people involved in the firm governance:
  • The Chairman
    Board members
    CEO.
    Whether any of these people have the same surname as any of substantial shareholders (>20% share capital). If yes- you could use this as an argument for the presence of an owner or family member(s) in the firm’s governance. o Whether any of shareholders with more than 5% share capital are involved in firm governance.

3. Calculate the following Fundamental Ratios for your selected company for the past 2 years. Annual reports are accessible via company websites:

• Short term solvency (Liquidity ratios)
• Long term solvency (Financial Leverage ratios)
• Asset utilization (efficiency or turnover ratios)
• Profitability ratios
• Market value ratios

4. Using the information from the ASX website: www.asx.com.au you must complete the following tasks:

• Prepare a graph / chart for movements in the monthly share price over the last two years for the company that you are investigating. Plot them against movements in the All Ordinaries Index.
• Write a report which compares movements in the companies’ share price index to the All Ords Index. For instance, how closely correlated is the line with the All Ords Index. Above or below? More or less volatile?

5. Research via the internet or financial/business publications:
From research via the internet (using credible sources) or financial/business publications, note any significant announcements which may have influenced the share price of your company. These factors could include merger activities, divestitures, changes in management’s earnings forecasts, changes in analysts’ forecasts, unusual write-offs or abnormal items, macroeconomic factors, industry wide factors, significant management changes, changes in the focus of the company, impact of competitors or law suits etc. (Restrict the number of announcements to 5).

6. Go online to http://www.reuters.com/finance/stocks/ and type in the code for your company into the Search Stocks field and click on the magnifying glass button.

• What is their calculated beta (?) for your company?
• If the risk free rate is 4% and the market risk premium is 6%, use the Capital Asset Pricing Model (CAPM) to calculate the required rate of return for the companies’ shares.
• Is the company you have chosen a “conservative” investment? Explain your answer.

7. Weighted Average Cost of Capital (WACC)

• Using information from the latest company report for the company (i.e. interest rate on their major source of long-term loans) and the estimated cost of equity capital calculated (in part 6ii above), calculate the WACC for your company.
• Explain the implications that a higher WACC has on management’s evaluation on prospective investment projects.

8. Consider the debt ratio for your company over the past two years:

• Does it appear to be working towards the maintenance of a preferred optimal capital structure? (i.e., does it appear to be “stable”?). Explain your answer.
• What have they done to adjust/amend their gearing ratio? Increase or repay borrowings? Issue or buy back shares? Has the Director’s Report given any information as to why they have made any adjustments?

9. Dividend policy : Discuss what dividend policy of the management of the company appears to be implemented. Explain any reason related to that particular dividend policy.

10. Based on your analysis above, write a letter of recommendation to your client, providing an explanation as why you would like to include this company in his/her investment portfolio. Please refer to the ratio results calculated earlier and any other trends or factors that you believe to be important.

11. Formal structure and referencing.

Answer

Executive summary
Financial performance of a company can be ascertained with the help of ratios. Ratio analysis helps to shed light on the financial performance. In this report, Rio Tinto that deals in metal mining and one of the major rival of BHP Billiton is selected for the purpose of the study. The report initiates with an introduction followed by the corporate governance structure. Further, the performance ratios are computed to analyze the performance of the company. The report spreads to various parts such as computation of beta, WACC and debt ratio. Moreover, the dividend policy is reviewed to nature of dividend payment by the company. Summing up all the factor and the performance, the recommendation and conclusion are drafted.

1. Introduction: One of the largest and well-known metal mining industries in the world is Rio Tinto which is an Austrian-British international. It was established in the year 1962 and has the main objective to provide its stakeholders the best returns by having a good portfolio. It is made up of five different groups of products namely – aluminium, diamond, iron ore, minerals, and copper. The firm has made a great effect to expand across forty different countries and thus also have a huge workforce of over 60000 employees. At first, Rio Tinto entered the market as a single entity firm but with the time it changed its thoughts and changed to dual listed company thus serving both the entities at the same time (Rio Tinto, 2016). The company is conducting its business in six different continents, but it still focuses its operations mainly in Canada and Australia. Its business is mostly carried out by partly or wholly owned subsidiaries. And also the company is having huge fame because it is listed on both the London Stock Exchange and Australian Stock Exchange.

2. Ownership-governance structure
Substantial stakeholders: The company Rio Tinto have built a complete framework where it has employees people for different tasks like remuneration, audit, substantiality issues and nomination. Because of the huge ownership structure and the institutional procedures of the company, it regulates most of the stock market thus causing bull or bearish markets for its big-investors to deal with the perceived values. The company holds more than the 20% holdings of the shares of the HSBC custody nominees Limited (Rio Tinto, 2016). Thus after analyzing all the information, it can be concluded that Rio cannot be considered a family company. Other holders with the holding percentage more than 5% are Nominees Pty Ltd (5.70%), National Nominees Ltd (5.17%), JP Morgan Nominees Australia Ltd (16.94%) and Blackrock Holding (6.28%).

Governance: The top management structure of the company for completion and assessment of the works consists of the chairman, CFO, chief executive and many other non-executive directors namely Robert Brown, David Constable, Megan Clark, Ann Godbehere, Anne Lauvergeon, Paul Tellier, Sam Laidlaw, Michael L’Estrange, Simon Thompson, and John Varley. Further, an executive board comprised of Bold Baatar, Vera Kirikova, Chris Salisbury, Stephen McIntosh, Alfredo Barrios, Joanne Farrell, Simone Niven, and Arnaud Soirat. A relationship between the two employees Bold and JP Morgan was found which existed for about eleven years. This indicates that there was involvement of the managerial aspects of the firm (Rio Tinto, 2016).

The company is also entitled to operate with utmost integrity and be responsible for the actions we take. The standards help guide our behavior with other principles which include integrity, the privacy of data, due diligence, conflict of interest, etc. These are too assisted by the training of the workforce. While in the review conducted in the year 2016, safety and excellence were added to the company’s missions and objectives with the help and consultation of the employees. The company maintained distance with the ugly practices of bribery and corruption (Rio Tinto, 2016). It had a very good relationship with their stakeholders and had transparent dealing with them. The honesty and the agreement of the firm’s programme are direly related to the approach of the business integrated standard which is completely risk-based. The company also looks after the well-managed system of training materials and the delivery as they are one of the most important parts for engaging the employees and beholding them from risks. The human rights which are given the most importance by the company are – security, employee rights, land access and resettlement, the environment including the use of water, labor rights and many such more rights relating to the health services to the employees (Rio Tinto, 2016). Also, the company had engaged with its investors, civil society and community members in the year 2016 to discuss the dealings related to the land access, cultural heritage, labor rights and environment.

3. Computation of Performance ratios
Profitability Ratios

Profitability ratios are used to assess the manner in which the business generate earnings in contrast to the expenses and other costs that are incurred in the normal operations of the business. It needs to be noted that a higher profitability ratio in contrast to competitor is beneficial. Moreover, the same ratio is compared with the ratio of previous year period. Hence, a higher ratio indicates a positive environment for the company (Fields, 2011). The profitability ratio computed for Rio Tinto is gross profit margin, Net profit margin, return on assets and return on equity.

The gross profit margin is used to highlight the well being of the business and it helps in ascertaining how efficient is the organization when it comes to the utilization of labor and materials in the process of production (Subramanyam & Wild, 2014). The gross profit margin has enhanced for the company indicating an efficient use of the process of production. The ratio was 19.87% in the year 2015 but climbed to 20.67% in 2016. The net profit margin is known as the profitability ration and is used to project how efficiently, the company has used or managed the expenses. The board of the company or the management calculate the ratio to understand how efficiently the organization is performing in converting the profits (Gibson, 2010). The return on assets and return on equity changed to positive meaning that the company has used the assets in a positive manner. The higher the profitability ratio, the better for the company.

Liquidity Ratios: Liquidity, as well as efficiency can be termed as a ratio that ascertains the resources pertaining to short-term and the way the management assists the company. Liquidity is used to project the extent of the resources the company has to cover its short term obligations and it ascertains whether the company is in a strong liquidity state. On the other hand, the efficiency ratio projects the efficiency with which the company manage the assets of the company (Horngren, 2013). It is similar to the liquidity ratio because it measures the manner in which the company can produce profit from the resources. However, if the management fails to tame the resources then the profit will be reduced.

The current ratio is termed as the liquidity ratio that projects the fund's rotation through the business to ensure that stock and debtors are converted to cash to pay off the creditors and are done by dividing the current assets with the current liabilities. The current ratio for Rio indicates that the company has more of current assets in tune with the current liabilities and hence can discharge the obligations (Damodaran, 2010). On the other hand, the quick ratio signifies the potential of the company to pay the liabilities and is a better indicator than the current ratio because the stocks are excluded. The quick ratio of the company is more than the standard ratio of 1:1 indicating the strength of the liquidity the company contains. The fixed asset ratio of the company is stagnant that signifies the company has utilized the assets in almost the same manner in both the years

Solvency ratios

The solvency ratio can be defined as the ratio that exhibits the long-term liability of the company. The debt ratio of the company indicates that the company’s debt has declined from 0.43 to 0.42 meaning the company reduced the debt composition. A debt ratio less than 0.50 indicate that the company has used the debt in a proportionate manner. As per the equity ratio, it can be commented that the component of equity for the company has varied in the last 2 years (Christensen, 2011). However, having an equity ratio of 0.45:1 is effective for the company.

4. Graph

(Rio Tinto Ltd, 2016)

5. Announcements:

Buy back of Mine - The announcement made by Rio Tinto regarding the mine-influenced the share price. Hence, the action created an upward movement in the prices of the stock.

Prices of Iron Ore: Stabilization in the prices of iron ore was visualized in the year 2016 after a long gap of two years. The decline remained intact till 2015 and aftermath the prices began to rise in a formidable manner (Rio Tinto, 2016).

Stabilization in the prices of iron ore was visualized in the year 2016 after a long gap of two years. The decline remained intact till 2015 and aftermath the prices began to rise in a formidable manner (Rio Tinto, 2016).

Lowering of average production costs - The lessening of the cost of production led to another movement in the prices of the stock. It enabled the company to carry on the profitable activities and took the business to a great height. The noteworthy factor was that of Pibara iron (Rio Tinto, 2016).

The outlook for copper prices - The iron ore price recovery was a major boost to the mechanism of recovery. The news concerning the revamp of $1 trillion of the U.S infrastructure led to increment in the copper prices (Rio Tinto, 2016).

Coal rationalization - The coal mine of Zululand was sold in South Africa and the rationalization announcement caused a sharp fall in the coal shipment of the company.

6. Beta and value computation

1. As per the computation, the beta of Rio came to 1.64 revealing that the stock of Rio Tinto is volatile in nature and moves faster than the market. When the beta of the stock is more than 1, it means that the stock movement is more as compared to the market (Shah, 2013).
2. CAPM
   E(R) = RFR + ?_stock (R_market – RFR)
   = 0.04 + 1.64 ( 6-4 )
   = 0.04 + 3.28
   =3.32
3. Rio cannot be tagged as a safe or a conservative investment as the beta stands more than 1 that is 1.64. Stock with beta more than 1 is risky in nature as it moves faster as compared to other stocks (Spiceland et. al, 2011).

7. WACC

1. Weight of equity = E/ (E+D)
   = 101006.30/ (101006.300 + 20346)
   =0.8323
   Weight of debt = D/(E+D)
   =20346.5/ (101006.300 +20346.5)
   =0.1677
   Cost of equity = 1.33000000% + 1.26 + 6% = 8.89%
   Cost of debt = 787/ 20346.5 = 3.868%
   WAC = E(E + D) * Cost of equity + D/ (E+D)* Cot of debt* (1- tax rate)
   = 0.8323 * 8.89% + 0.1677* 3.868% * (1- 56.04%)
   =8.41%
2. Implications of the High WACC: With the increase in the WACC of a firm, the firm’s tendency to suffer a risk or loss based on its operations increases. Also, an increased WACC will tend to increase the investors demand more returns. Also in the investment projects, a higher WACC may bring problems for the management as it may restrict them from making correct decisions (Brealey et. al, 2011). The WCAA data of the debt obligations, the return expected by the firm and the cost of the debt or equity financing can be used to ascertain the total expenses of the firm relating to the financing resources. This can also be the reason for improper management. The company thus is trying to decrease the cost of the capital by decreasing these of WACC and using any other cheaper source of finance. The WACC uses the figures of relative expenses to find out the single cost of the capital figure using the different sources (Da et. al, 2012). Therefore it is clearly stated that a higher WACC results in higher risk and cost for the company. We can say that there is higher risk in the company when the cost of the company exceeds its forecast.

8. Debt ratio

Debt ratio should stand less than 0.50 because that indicates the composition of debt is lower in the company and the company has utilized more of equity and other funds. When it comes to Rio Tinto it is observed that the debt ratio has declined in the past 4 years meaning that the company has repaid the debts and utilizes more of equity (Bodie et. al, 2014). Hence, debt ratio is proportionate for Rio Tinto.

9. Dividend policy of Rio Tinto: The dividend payout of the company will be ascertained only after knowing the actual financial outcome of the company, the board’s decision whether it wants to retain profits for growth and expansion and also whether the company intends to make an effective balance sheet. The purpose of the formulation of dividend policy in a company is the balance between the final and interim dividend which helps to weight the final dividend (Trefis, 2016). The process is carried out by the board in such a manner that there is a balance maintained between the investment made by the company and cash return to the shareholders because, in the end, the company is responsible for maximizing the wealth of shareholders (Ferris et. al 2010). A company has to undergo certain examinations because of the cyclical nature of the industry, because of uncertain cash generation and fluctuating earnings, the dividend policy helps in assisting the company in regards to the ordinary dividend or the extra dividend that can be given to shareholders (Albrecht et. al, 2011).

10. Recommendation and Conclusion: As per the per the report and the discussion, it can be commented that the performance of Rio Tinto in 2016 was optimal because of a variety of positive impact in its favor. The company has a proper debt structure together with the equity and hence, the company been able to match the expectations. The governance and risk management of the company is structured in an effective manner leading to a positive result. The external factors influenced the share prices of the company, however; in 2016 the company saw an upsurge. Hence, it needs to be understood that the iron ore prices and conditions are an important factor in the performance of the company. Therefore, the management must handle this department with precision and ensure that the iron prices do not lead to immense volatility in the share prices. In addition, the ratio analysis of the company completed projects that the company has been able to utilize the resources and boats of immense liquidity. The liquidity of the company is strong and hence, the company will be able to meet the obligations even if it faces a crunch in the present situation.

References
Albrecht, W., Stice, E. & Stice, J 2011, Financial accounting, Mason, OH: Thomson/South-Western.

Bodie, Z., Kane, A. & Marcus, A. J 2014, Investments, McGraw Hill

Brealey, R., Myers, S. and Allen, F 2011, Principles of corporate finance, New York: capital: Interpreting the empirical evidence’, Journal of Financial Economics vol. 103, pp. 204–220

Christensen, J 2011, ‘Good analytical research’, European Accounting Review, vol. 20, no. 1, pp. 41-51 https://www.researchgate.net/publication/227613941_Good_Analytical_Research

Da, Z., Guo, R.J. & Jagannathan, R 2012, ‘CAPM for estimating the cost of equity

Damodaran, A 2010, Applied Corporate Finance: A User’s Manual, New York: John Wiley & Sons

Ferris, S.P., Noronha, G. & Unlu, E 2010, ‘The more, merrier: an international analysis of the frequency of dividend payment’, Journal of Business Finance and Accounting, vol. 37, no. 1, pp. 148–70.

Fields, E 2011, The essentials of finance and accounting for nonfinancial managers, New York: American Management Association.

Gibson, C 2010, Financial Reporting and Analysis: Using Financial Accounting Information, Cengage Learning.

Horngren, C 2013, Financial accounting, Frenchs Forest, N.S.W: Pearson Australia Group. McGraw-Hill/Irwin

Rio Tinto 2016, Rio Tinto Annual Report and accounts 2016, viewed 1 February 2018 http://www.riotinto.com/documents/RT_2016_Annual_report.pdf

Rio Tinto Ltd 2016, Market Index, viewed 1 February 2018 https://www.marketindex.com.au/asx/rio

Shah, P 2013, Financial Accounting, London: Oxford University Press Spiceland, J., Thomas, W. and Herrmann, D 2011, Financial accounting, New York: McGraw-Hill/Irwin,University Press

Spiceland, J., Thomas, W. and Herrmann, D 2011, Financial accounting, New York: McGraw-Hill/Irwin,University Press

Subramanyam, K & Wild, J 2014, Financial Statement Analysis, McGraw Hill

Trefis 2016, The Year 2016 In Review: Rio Tinto To Benefit From Improvement In Business Conditions Going Forward, viewed 1 February 2018 http://www.nasdaq.com/article/the-year-2016-in-review-rio-tinto-to-benefit-from-improvement-in-business-conditions-going-forward-cm728072

Williams, J 2012, Financial accounting, New York: McGraw-Hill/Irwin.

Appendix

Balance sheet

Income Statement