How BHP Billiton’s capital structure illustrates an internal investment opportunity

Stock market

Leverage is a tough aspect to evaluate for a commodity producer. While conventional debt ratios are helpful in determining the capital structure of a company like BHP Billiton, we need to be able to put that kind of information into perspective, so as to be able to come up with a reasonable conclusion from the research. This article is going to help demonstrate a framework for doing such an analysis, and help readers to understand how to different financial metrics can be used to assess the various impacts of a company’s debt load.

The first step to evaluating the capital structure of a company like BHP Billiton is to look at how it is that the company’s nominal debt load fills up the balance sheet. With a debt-equity ratio of nearly 1, a current ratio of nearly 1, and a quick ratio of .65, we can see that the company is reasonably solvent at this point in time. To put these numbers into perspective, the company could pay off nearly off of the year’s debt obligations without selling another ounce of product, and more than half of those liabilities off immediately if a solvency event occurred.

Combining this information with the way in which the company earns nearly twice the amount of the nominal obligations remaining over the course of a year, the company could reasonably become debt free over the course of 1-2 years if it was to begin liquidation. This illustrates the safety of the company, and how it is that the company’s large volume of assets greatly outweighs its debt obligation. Given that the company is also carrying an interest coverage ratio of 31x, and maintains a cash flow-to-debt ratio of .39, we can see that the company’s capital structure tends to favour a conservative balance for the time being. That being said, given the company’s apparent tendency to be on the hunt for acquisitions over the year, we can start to evaluate how it is that the capital structuring of BHP Billiton might actually provide us with an indication of an investment opportunity.

Understanding how it is that BHP Billiton is currently covering an almost excessive amount of its current debt load off with its existing operating incomes, and has an extensive asset base against which it could borrow, we need to begin asking ourselves about whether or not this is a state of equilibrium for the company’s capital structure, or if it is indicative of the company’s next corporate action. In this situation, BHP’s recent history of going on an acquisitions hunt suggests that the company still has room to continue buying up companies and assets for their resource properties. This conclusion is then further supported by the way in which the company was actually preparing to make a major acquisition in Canada over the year, but had the proposal vetoed by the Federal government.

This left BHP with an additional $300million in debt capital that was prepared, but never issued to complete the transaction. That being said, if BHP’s management team supported the issuance of $300million worth of additional acquisitions (which would increase the company’s asset book value by a respectable amount), it stands to reason that they would again be willing to pursue such a degree of debt to financing their further expansion. Given that the company then proceeded to maintain a fairly clean balance sheet , rather than taking steps to use the offered debts to buy-back shares and improve the company’s leverage against its existing asset base, we can see how it is very possible that the company is keeping itself in a position to continue making acquisitions over the coming years.

Granted, such an evaluation only covers the analysis of the company’s ability to continue making purchases into the future in broad strokes, it provides us with a framework to use when looking at how it is that companies made capital structuring decisions. From here, we could then delve into the managements discussion notes and earnings call information to look for confirmation of an acquisition-friendly strategy going forward.

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Written by February 24, 2014. Category: Company Research. Tagged: .

About Sara L

I have been involved with finances one way or the other since 1986. I've seen markets crash and create new highs. Buy when scared money sells and hold fast when others bail.

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