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Fundamental Analysis seeks to identify factors that are likely to influence directional changes in the value of a company and hence its share price. These factors may be macro or micro in context.

a)Conduct a Top Down analysis of the overall economic environment and consider how forecast changes in economic fundamentals will impact on the performances of companies in the industry your group has chosen. Consider questions including, but not limited to: What is the current interest rate? What is the current value of the $AUD? What is current GDP etc?

b)Conduct a Bottom Up analysis of companies’ current financial situation. Consider accounting ratios and measures of a firm’s performance, how these need to be compared to the industry and company history.

Top-Down Analysis

The fundamental analysis of stocks is highly important for investors in order to determine their intrinsic value for making investment decisions. This report has been undertaken for carrying fundamental analysis of an industry in Australia through selecting two ASX listed companies operating in the same industrial sector. The fundamental analysis of the industry is aimed to identify its total worth through examining the micro and macro-economic factors impacting its growth and development. The fundamental analysis is carried out through carrying top-down and bottom-up analysis that identifies the factors influencing the directional changes in the stock value of a company. In this context, the present report has carried out fundamental analysis of the mining industry in Australia through analyzing the economic factors impacting the stock valuation of two major companies operating within the industry, that are, Rio Tinto and BHP Billiton.  

The investors for making their investment decisions need to analyze the micro-economic factors impacting the industry rather than only emphasizing only on the companies performances. The top-down analysis, in this context, help the investors need to examine the micro-economic trends of the market that influences the performance of industry. The analysis begins with examining the overall macro-economic factors and then predicting the returns generated from the industry. The economical analysis is followed by the selection of particular industry and then choosing the individual companies for investment purposes.  Analysis begins with examining the overall economic factors and then predicting the returns generated from the industry. The economical analysis is followed by the selection of particular industry and then choosing the individual companies for investment purpose. The macro-economic variables analyzed during top-down investment strategy are GDP, inflation rate, interest rate and then electing the most efficient assets for allocation (Krantz, 2016). Thus, top-down approach initiates with analyzing broad economy and then selecting the best industry fitted within the macro-economic analysis and them selecting the individual companies for investing (OECD, 2004).

Australia is presently in a state of strong economic growth due to presence of an efficient legal system supported by industrial growth. The country is recognized as one of the wealthiest Asia-Pacific country that has recovered completely from the economic recession supported by the strong development in its mining and agriculture sector. The large-scale economic growth realized by the country is due to development of strong macro-economic policies, structural reforms and the mining boom (Scutt, 2016). The economic growth of the country is expected to record an increase of about 3% till the end of the year 2018. The economy of Australia is currently having a strong Gross Domestic Product (GDP) of AUD $ 1.69 trillion as of the year 2017. The GDP indicates the monetary value of all the finished products and services produced by its economy annually. It quantitatively assesses the overall economic activity of the country within a specified time-period. The strong GDP rate has resulted from the increase of its export activities and strong improvement in its labor market. The country is recognized as the largest national economy on the basis of nominal GDP with strong economic growth realized from the large presence of natural resources. The natural resources of the country are valued at US$19.9 trillion with mining sector contributing to about 8.4% of the overall GDP (Australian GDP Growth Rate, 2017).

Australian Economic Environment Analysis

The inflation rate of the country is estimated to be about 1.9% moving towards the 2-3% target band decided by the RBA (Reserve Bank of Australia). This is contributed by the increase in petrol and electricity prices in the country. However, RBA is maintaining a low interest rate in the country that has only recorded an increase of 4.68 per cent from 1990 to the year 2017. The current interest rate of the country is estimated to be about 1.5 per cent for supporting the economic growth of the country. However, RBA is planning to record an increase in the interest rate once the economy is able to attain its potential growth rate. The higher interest rates will help in reliving the pressure from the booming housing market of the country (Roggers, 2017).

The current value of $AUD is 0.79 USD with exchange rate of 0.72 USD per AUD. The value of AUD has been steadily decline from the year 2012 to 2016.

It can be said from the analysis of the macro-economic factors of the country that removal of foreign exchange controls and the stabilization of inflation rate have helped to large extent in Australia for promoting its strong economic growth after the period of global recession. The Australian economy has survived in the period of recession by eliminating of its budget deficit with the increase in the export demand for mineral resources from China. The higher balance of trade during the period of global recession has largely contributed in its economic recovery from the financial crisis. The weakening of the currency rate has helped in improving the agricultural exports and gaining educational sector growth by attracting foreign students due to economical loans facilities. These large-scale reforms adopted by the RBA have helped in boosting the economical growth of the country (The Economist, 2017).

The strong economic growth of the country is supported by the abundance of mineral and non-mineral reserves. As such, the mining sector of the country enjoys large output and exports large amount of minerals contributing to its GDP growth. The export from the mining sector of the country has contributed about 70% of the revenue in the eyar2017. The net revenue realized from exporting the mining products is estimated to increase on a large-scale by the end of the year 2021-22. The mining sector of the country as such has become to be highly price-competitive on a global scale and therefore its performance is highly impacted by the Australian dollar value and the current fluctuations in the supply and demand (Dyster, and Meredith, 2012). The mining boom in the country has attributed to improve the real household per capital income to about 13% till the year 2016. Also, it has increased the GDP of the country by approximately 6 per cent in the recent years through providing higher trade balances. This in turn increases the overall value of domestic products leading to a rise in the household income. It has also lead to a rise of 13% in the exchange rate of the country in the year 2013 which otherwise would have remained to its initial levels without the occurrence of mining boom. The mining sector is largely contributing to creating job opportunities in the country and thereby reducing the unemployment rate that in turn will support the economic prosperity. As such, the top-down analysis of the economic environment of Australia has indicated that investors can select the mining industry for investment purposes. The strong financial performance of the companies operating within the sector has indicated that the investors can realize higher capital gains through investing in the mining industry of Australia (Tulip, 2014).

The BHP Billiton and Rio Tinto are recognized to be major players in the mining sector of the country. The BHP Billiton is recognized as the largest mining company of Australia in terms of revenue realization. On the other hand, Rio Tinto is recognized as a world leader in the production of mineral ores besides having operations in Australia. It is estimated that the overall market capitalization of the mining companies has increased by about 27% in the recent years with small scale companies also realizing huge capital gains (McLean, 2013). The top mining companies of Australia have recorded a 32% rise in their profitability after surviving the downfall of global recession. The BHP Billiton has currently strongest market capitalization among its competitors, that are, Rio Tinto and Vale. The large-scale output of iron ore is driving the mining boom currently in Australia. It is estimated that about $1 decline in the iron ore price can cause a decrease of about $800 million in its trade revenue. As such, the government of the country is placing strong ensures for supporting the economic growth and development of the mining sector.

In order to carry out the bottom up analysis, ratio analysis has been conducted on both the selected companies for year 2015 and 2016. After completing the ratio analysis, a common conclusion regarding the overall performance of the industry has been under recommendation and conclusion section.

Financial data has been taken from the annual reports of both the companies that have been published at their own website under investor relation section. Ratio analysis has been done to measure the profitability, capital structure, solvency and market performance of both the companies. Details of financial data and ratio analysis have been included in below table.

Financial Data of BHP Billiton (Amount in Million Dollar)

Particulars

2015

2016

Net Profit

 $                            4,390.00

 $                  (6,207.00)

Total Assets

 $                        124,580.00

 $                118,953.00

Net Revenue

 $                          44,636.00

 $                  30,912.00

Current Assets

 $                          16,369.00

 $                  17,714.00

Current Liabilities

 $                          12,853.00

 $                  12,340.00

Inventory

 $                            4,292.00

 $                     3,411.00

Prepaid Expenses

 $                                         -   

 $                                  -   

Quick Assets

 $                          12,077.00

 $                  14,303.00

Total Debts

 $                          46,959.00

 $                  52,323.00

Shareholder's Equity

 $                          64,768.00

 $                  54,290.00

Profit attributable for shareholders

 $                            4,390.00

 $                  (6,207.00)

Earnings Per Share

 $                                     0.71

 $                           (2.40)

Number of Equity Shares in million

2667.00

2661.00

Payout Ratio in %

45.50%

0.00%

(Annual Report 2016 and 2015, BHP Billiton and Rio Tinto)

Financial Data of Rio Tinto (Amount in Million Dollar)

Particulars

2015

2016

Net Profit

 $   (1,719.00)

 $       4,776.00

Total Assets

 $   91,564.00

 $     89,263.00

Net Revenue

 $   34,829.00

 $     33,781.00

Current Assets

 $   15,554.00

 $     15,086.00

Current Liabilities

 $   10,046.00

 $       9,362.00

Inventory

 $      3,168.00

 $       2,937.00

Prepaid Expenses

 $         242.00

 $           266.00

Quick Assets

 $   12,144.00

 $     11,883.00

Total Debts

 $   44,169.00

 $     40,611.00

Shareholder's Equity

 $   37,349.00

 $     39,290.00

Profit attributable for shareholders

 $   (1,719.00)

 $       4,776.00

Earnings Per Share (in dollar)

 $            (0.47)

 $                2.55

Number of Equity Shares in million

1825.00

1808.00

Payout Ratio in %

132.60%

0.00%

(Annual Report 2016 and 2015, BHP Billiton and Rio Tinto)

Ratio Calculations

Particulars

2015

2016

Profitability Analysis

Return on assets

Net Profit / Average Total Assets

BHP Billiton

3.52%

-5.22%

Rio Tinto

-1.88%

5.35%

Net Profit Margin

Net Profit / Net Revenue

BHP Billiton

9.84%

-20.08%

Rio Tinto

-4.94%

14.14%

Liquidity Analysis

Current Ratio

Current Assets /Current Liabilities

BHP Billiton

1.27

1.44

Rio Tinto

1.55

1.61

Quick Ratio

Quick Assets / Current Liabilities

BHP Billiton

0.94

1.16

Rio Tinto

1.21

1.27

Capital Structure Analysis

Debt to Equity Ratio

Total Debt / Shareholder’s Equity

BHP Billiton

0.73

0.96

Rio Tinto

1.18

1.03

Equity Ratio

Total Equity / Total Assets

BHP Billiton

51.99%

45.64%

Rio Tinto

40.79%

44.02%

Market Performance

Earnings per Share

Profit attributable for shareholders / Number of common Stock (Shares)

BHP Billiton

 $                                     0.71

 $                           (2.40)

Rio Tinto

 $                                  (0.47)

 $                             2.55

Dividend per Share

Total Dividend Distributed / Number of Common Stock (Shares)

BHP Billiton

 $                                     2.48

 $                             1.56

Rio Tinto

 $                                     2.20

 $                             1.51

(Annual Report 2016 and 2015, BHP Billiton and Rio Tinto)

Profitability analysis refers to measurement of profit earnings capacity of the entity. It can be measured by measuring the profit with resources implied by the management in the business. For this purpose ratio like net profit ratio, gross profit ratio, return on equity and return on assets are used to measure the entity profitability (Bull, 2007).

Return on Assets: This ratio is calculated to calculate the amount of profit earned on the total assets employed by the entity. The formula to calculate the return on assets is given as net profit divided total assets (Bull, 2007).

BHP Billiton and Rio Tinto belong to same industry i.e. mining industry. There have been many changes to this industry in year 2015 and 2016. The changes to this industry have led the companies to suffer loss. In year 2015, the return on assets of BHP Billiton was 3.52% and it was decreased to -5.22% in year 2016. So it can be said that there has been major decline in profits of this company. In case of Rio Tinto the ROA in year 2015 was -1.88% and got increased in year 2016 to 5.35%. So it can be said there is no similarity between the profit earnings capacity of the chosen companies (Annual Report 2016 and 2015, BHP Billiton and Rio Tinto).

Net Profit Margin: Net profit evaluates the profit from the revenue point of view. The formula to calculate the net profit margin is income after tax divided by the net revenue. This ratio is very important from investor’s point of view as this ratio give idea about the increase in profit corresponding to increase in sales. In case sales has been increased but profit was decreased, than it can be said that there is huge increase in expenses.

The net profit of BHP Billiton was 9.84% in year 2015 and it was negative 20.08% in year 2016. The decline in profits is due to decline in revenue amount in year 2016. In case of Rio Tinto, the net profit ratio was negative 4.94% in year 2015 and 14.14% in year 2016 (Annual Report 2016 and 2015, BHP Billiton and Rio Tinto).

Overall profitability performance of BHP Billiton was considered good in year 2015 and highly poor in year 2016. In case of Rio Tinto it was totally opposite.

This ratio tells the short term solvency position of the company. It means level of current assets companies keep to pay the current liabilities for the particular period. To evaluate the liquidity performance of both the chosen companies ratio like current ratio and quick ratio has been calculated.

Current Ratio: Current ratio means current assets divided current liabilities. As per the formula it tells times the current assets entity posses to pay the current liabilities. The disadvantage of this ratio is that it also takes inventory and prepaid expenses into valuation despite of that they are not considered as good source of cash and cash equivalent. Current ratio of BHP Billiton was 1.27 times in year 2015 and it was increased to 1.44 in year 2016. While it was 1.55 times in year 2015 and 1.61 year 2016 in case of Rio Tinto. It can be said that liquidity performance of both companies is good but Rio Tinto posses more working capital as compare to BHP Billiton (Dyster and Meredith, 2012).

Quick Ratio: It is calculated as quick assets divided by current liabilities. It is similar to current ratio but it removes the disadvantage that the current ratio has, as it does not take inventory and prepaid expenses into the calculation of quick assets. Quick ratio of BHP Billiton was 0.94 and 1.16 in year 2015 and 2016 respectively. On the other hand Rio Tinto has quick ratio of 1.21 in year 2015 and 1.27 in year 2016. It can be concluded that Rio Tinto has better stability to the liquidity performance as compare to BHP Billiton (Annual Report 2016 and 2015, BHP Billiton and Rio Tinto).

Capital means funds employed by the company to finance various assets of the entity. Capital is broadly divided into equity and debt capital. Mixing the proportion of both these capital is known as capital structure management. Debt to equity ratio and equity ratio are calculated to evaluate the capital structure of both the companies (Drake and Fabozzi, 2012).

Debt to Equity ratio: This ratio is calculated by divided amount of long term debt by the equity amount. Long term debt means non-current liabilities that are due after one year time period. Equity means shareholders capital. Debt to equity ratio of BHP Billiton was 0.73times in year 2015 and it was raised to 0.96 times in year 2016. On the other hand, debt to equity ratio of Rio Tinto was 1.18 times in year 2015 and 1.03 in year 2016. Overall capital structures of both the companies are dependent on the debt source of finance which is considered as the charge on the net profit of the entity (Dyster and Meredith, 2012).

Equity Ratio: This ratio is calculated as equity capital divided by total assets of the entity. This ratio tells percentage of equity capital used to finance the total assets. On the basis of ratio calculation it can be said that 51.99% of total assets was financed by equity capital in year 2015 and it got reduced to 45.64 % in year 2016 in case of BHP Billiton. On the other hand, about 40% of total assets were financed through equity capital in both the years.

Overall capital structure of both the companies was mostly dependent on the debt capital. So it can be said that there is need to take prompt action to make changes in the capital structure of the company (Drake and Fabozzi, 2012).

Under this analysis, analyses of companies are done considering their performance with the market drivers.

Earnings per Share: This ratio will tell the income earned per share by the company. This ratio is highly important from the customer point of view. On the basis of ratio analysis table and net profit earned by the both the companies it can be said that in year 2015, market performance of BHP Billiton was considered as better than Rio Tinto but it was totally opposite in year 2016 (Annual Report 2016 and 2015, BHP Billiton and Rio Tinto).

Dividend per Share: Both companies have distributed the dividend in year 2015 and 2016 despite of losses occurred in both the firm.

Conclusion

On the basis of overall analysis it can be said that performance of BHP Billiton was satisfactory in year 2015 but company has suffered great loss in year 2016. On the other hand Rio Tinto has suffered huge losses in year 2015 but it got stable in year 2016. On the industry point of view it can be said that many companies has gone into losses in year 2016 due to impact of foreign transactions and government policies.

On the basis of overall analysis it is highly recommended to the shareholder’s to hold the equity shares for more than 2 years to give time to industry to achieve its full performance. It is expected that in future that chosen companies will start earning good profits (Dyster and Meredith, 2012).

References

Annual Report 2015. BHP Billiton. [Online]. Available at: https://www.bhp.com/investor-centre/financial-results-and-operational-reviews [Accessed on: 21 September, 2017].

Annual Report 2015. Rio Tinto. [Online]. Available at: https://www.riotinto.com/investors/results-and-reports-2146.aspx [Accessed on: 21 September, 2017].

Annual Report 2016. BHP Billiton. [Online]. Available at: https://www.bhp.com/investor-centre/financial-results-and-operational-reviews [Accessed on: 21 September, 2017].

Annual Report 2016. Rio Tinto. [Online]. Available at: https://www.riotinto.com/investors/results-and-reports-2146.aspx [Accessed on: 21 September, 2017].

Australia - Economic forecast summary. 2017. [Online]. Available at: https://www.oecd.org/eco/outlook/australia-economic-forecast-summary.htm [Accessed on: 21 September 2017].

Australian GDP Growth Rate. 2017. [Online]. Available at: https://tradingeconomics.com/australia/gdp-growth [Accessed on: 20 September 2017].

Bull, R. 2007. Financial Ratios: How to use financial ratios to maximize value and success for your businesses. Elsevier.

Drake, P. P. and Fabozzi, F. J. 2012. Analysis of Financial Statements. John Wiley & Sons.

Dyster, B. and Meredith, D. 2012. Australia in the Global Economy: Continuity and Change. Cambridge University Press.

Dyster, B. and Meredith, D. 2012. Australia in the Global Economy: Continuity and Change. Cambridge University Press.

Krantz, M. 2016. Fundamental Analysis for Dummies. John Wiley & Sons.

McLean, I. 2013. Why Australia Prospered: The Shifting Sources of Economic Growth. Princeton University Press.

OECD. 2004. Understanding Economic Growth A Macro-level, Industry-level, and Firm-level Perspective: A Macro-level, Industry-level, and Firm-level Perspective. OECD Publishing.

Roggers, D. 2017. RBA flags higher interest rates. [Online]. Available at: https://www.theaustralian.com.au/business/markets/rba-flags-higher-interest-rates/news-story/db608922f255d2f6a35bebbf10b02340 [Accessed on: 21 September 2017].

Scutt, D. 2016. Australia's economy is stronger than anyone thought. Business Insider Australia. 

The Economist. 2017. How Australia broke the record for economic growth. [Online]. Available at: https://www.economist.com/blogs/economist-explains/2017/09/economist-explains-3 [Accessed on: 21 September 2017].

Tulip, P. 2014. The Effect of the Mining Boom on the Australian Economy.  [Online]. Available at: https://www.rba.gov.au/publications/bulletin/2014/dec/pdf/bu-1214-3.pdf [Accessed on: 21 September 2017].

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