BHP - Financial distress testing

PUBLISHED: 04 Aug 2017 @ 11:01 | Comments (0) |

The last two Newsletters showed that BHP (LSE:BLT) has a low cyclically adjusted price earnings ratio and reasonable prospects for generating good profits and cash flow on the sale of its commodities, even if world prices fall from this point.

However, companies on low CAPEs often show financial instability and vulnerability to distress. A way of examining this issue is to calculate the Piotroski score for the company.

I’ll undertake both a Piotroski analysis centred on the year to June 2016 and for the more recent reporting period of the six months to December 2016.

Piotroski analysis

Positive net income before extraordinary/exceptional items?

BHP reported a loss of $6.4bn in the year to 30^th June 2016. But that was after deducting $7.7bn of exceptional items. Ignoring exceptionals, it had an underlying attributable profit of $1.2bn, and so a Piotroski point is awarded for that period.

For the most recent six months BHP made a profit so one point for the December 2016 analysis.

Positive cash flow from operations?

Cash generated from operations was $12.7bn in the year to June 2016, and $7.7bn in the six months to December 2016. BHP thus gains a score of ‘1’ for this factor for both the annual analysis and the latest interims results.

Positive change in return on assets employed in the business from the previous year?

Losses were made in the year to June 2016 whereas profits were made in 2015, so no Piotroski point for the annual analysis to June 2016.

In the latest six months profits were made contrasting with a loss the year before, therefore one Piotrioski point on the December 2016 analysis.

Cash flow greater than profit? (so profits are not driven primarily by positive accruals, which may be ‘managed’).

BHP gains its second point here on both the annual analysis and the December 2016 analysis.

Change in leverage over one year. Has the firm’s long-term debt reduced relative to its total assets?

This ratio was 26.3% in June 2016, worse than the 20.3% for June 2015, so BHP does not gain a Piotroski point here for the annual analysis.

But for the July-December period the ratio of long-term debt to total assets declined to 25.78% from 26.01% the year before, so BHP gains a Piotroski point on the December analysis.

Has the firm’s current ratio (current assets divided by current liabilities) improved over the past year?

For the June 2016 analysis it was 1.44 in 2016 and 1.27 in 2015, so a point is gained.

Similarly, for the December 2016 analysis the current ratio rose and so a point is gained for that analysis.

Has the firm avoided raising fresh equity capital (e.g. rights issue or placing) in the last year?

Yes for both the June and December analyses, so it gains a point for each.

Has the gross profit margin improved this year compared with last?

There is no gross profit figure to look at with this type of business, however operating profits fell to losses for the year to June 2016 so I’ll be conservative and not award a point.

The six months to December 2016 saw a recovery to profitability and so a point is awarded for the latest period analysis.

Has the ratio of turnover to beginning-of-the-year total assets improved this year compared with last? (This indicates greater efficiency in the use of its assets from either having fewer assets for a given level of sales or raised sales).

The turnover to assets ratio was in the year to June 2016 was 0.25, but in 2015 it was 0.29, so no point for the yearly analysis.

However for the December analysis turnover rose greatly while total assets fell so a point is awarded.

Totting it up

An overall score of 5 out of 9 for the June 2016 analysis is OK, but the long term interest bearing liabilities of over $31.8bn along with $4.7bn short term debt is worrying. (Net debt was a slightly more modest £26.1bn).

Also, its credit rating was pushed down in the year to June 2016 to A, A3, from A+ in 2015.

But……

……..It is surprising what a slight upturn in commodity prices can do………………To read the rest of this article, and more like it, subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1

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