Mining and petroleum giant BHP Billiton (LSE: BLT) (NYSE: BBL.US) reported a 31% rise in pre-tax profits for the first half of its current tax year (which ends in June), and last week saw the group confirm its cost-cutting credentials by putting its loss-making Nickel West mines up for sale.
On the face of it, BHP looks good value, with a forecast P/E of 11.3 and a prospective yield of 4.0%. The firm is targeting a $2bn reduction in net debt to $25bn by the end of June, at which point it might launch a share buyback programme.
However, investors also need to consider how well BHP might cope if one of its key commodities, such as oil or iron ore, fell heavily in price. To find out more, I’ve taken a closer look at the firm, using three key financial ratios of the kind that are often used by credit rating agencies to rate corporate bonds.
1. Operating profit/interest
What we’re looking for here is a ratio of at least 1.5, to show that BHP’s operating earnings cover its interest payments with room to spare:
$25,965m / $1,288m = 20.2 times cover
BHP’s ability to service its debt is unlikely to come under pressure, as current operating profits cover its interest payments 20 times over.
2. Debt/equity ratio
Commonly referred to as gearing, this is simply the ratio of debt to shareholder equity, or book value (total assets – total liabilities). I tend to use net debt, as companies often maintain large cash balances that can be used to reduce debt if necessary.
BHP’s net debt is currently $27.1bn, while its equity is $82.3bn, giving net gearing of 33%. That’s a level I’m quite comfortable with, especially given BHP’s diverse portfolio of assets.
3. Operating profit/sales
This ratio is usually known as operating margin and is useful measure of a company’s profitability.
BHP’s operating margin over the last twelve months was 40%, a very impressive figure that underlines the high profitability of both its iron ore and petroleum divisions — the two largest contributors to the firm’s profits.
How safe is BHP?
BHP’s finances appear to be very safe, with manageable debt levels and high profit margins that should enable the firm to cope with fluctuating demand or prices. The firm’s cost-cutting plans are expected to deliver strong growth in free cash flow this year, and although I’d like to see the firm’s net debt fall further, it’s not a big concern.
