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Capital Structure after the Crisis

November 15, 2010

The global recession has forced many companies to reevaluate their capital structure. Both the cost of debt and the likelihood of bankruptcy at high debt levels increased, offsetting the benefit or reduced tax expenses at high debt levels. It is therefore no surprise that the largest diversified miners have decreased their gearing. They have benefited from increasing commodity and share prices to reduce debt stake of firm market value to around 33% ((D/E); or 25% in D/(D+E)), in line with the industry’s historical average. A year ago Ernst & Young observed in a report on debt in the mining industry that the gearing had increased to 46%.

Liability comparison
The liability breakdown based on market value of equity for the 4 major diversified miners shows the strong position of BHP Billiton (Figure 1). The 86% equity in the financing mix, combined with over $12bln in cash, gives the company an enormous financial flexibility. Anglo American struggles to keep up with the other majors at a total of 66% equity (gearing of approx. 50%).

The Book Value liability comparison does not show significant differences. The relatively large portion of common stock in Vale’s balance sheet mainly indicates that the company issued large amounts of stock more recently than the other companies.

Figure 1 - Liability structure comparison


Asset comparison

Figure 2 - Asset comparison

While gearing of the companies varies quite a bit, the asset base is remarkably similar (Figure 2). The assets of the large miners typically show approx. 67% Plant, Property & Equipment (PP&E). The most obvious variation among the companies is the percentage of “other fixed assets”, which hold the goodwill created by paying a premium in acquisitions of other companies. Rio Tinto’s balance sheet still holds $14bln goodwill (33% of total assets), mainly because of the acquisition of Alcan in 2007. The relatively high percentage for Anglo American is not caused by goodwill but by a high proportion of long term investments in other companies.

Another important difference is the percentage of cash carried by the various firms. While the diversified miners typically need approx. 2-3% of asset value as operating cash, BHP Billiton holds 14% ($12bln), signaling a pile of excess cash held as a war chest for potential acquisitions. Rio Tinto’s cash at 4% of asset value is a healthy level, but indicates the company does not have much flexibility for acquisitions and/or capital projects in the short run.


Company specifics

The figures below show the evolution of asset base and capital structure of each of the four miners over the past 4 years.

BHP Billiton

BHP Billiton has maintained a stable asset base over the past years, using the large profits to slowly build a war chest for acquisitions. After the failure of the bid for Rio Tinto in 2008 and the potential failure of the bid for PotashCorp of Saskatchewan this year the company will have to reconsider announcing a superdividend or repurchasing shares to give cash back to shareholders.

The gearing of the company has decreased steadily over the last 4 years, helping it to cruise through the crisis as one of the strongest players in the industry. The gearing of approx. 16% (14% debt /86% equity) gives the company significant leeway for future expansion.

Figure 3 - BHP Billiton Capital Structure


Vale’s asset base has not been as stable as BHP Billiton’s. The $17bln acquisition of Inco in 2006 and subsequent smaller asset acquisitions had significant impact on the asset base. However, goodwill is limited to $3bln and the company is rebuilding a strong cash position due to the high iron ore price of the last year.

The gearing of 33% (25% debt / 75% equity) is normally seen as a stable position in the industry. Prior to the crisis the gearing of the company was much higher, but the strong performance in the iron ore business has helped the company to grow by increasing equity without raising additional debt.

Figure 4 - Vale Capital Structure


Rio Tinto

Rio Tinto clearly had the worst position of the major firms going into the crisis. The acquisition of Alcan at the end of 2007 for over $38bln was mainly financed by increasing debt. The asset base still holds 33% goodwill associated with this acquisition. The high leverage almost caused Rio Tinto to be acquired by BHP Billiton on 2008, but the company was saved by the deteriorating debt market and strong performance in the iron ore market.

CEO Tom Albanese has made reducing the leverage one of the key priorities over the past 2 years and seems to have succeeded as current leverage is back to 33% (25% debt / 75% equity). However, the cash position of the company is still not very good, limiting the potential for capital expenditure for the coming year to approx. $5bln.

Figure 5 - Rio Tinto Capital Structure

Anglo American

They key activity of Anglo American in the past years has been to divest non-core activities and return to mining. The asset side of the balance sheet shows this development, as PP&E slowly climbs to the ‘normal’ 2/3 of assets. The 21% ‘Other fixed assets’ includes approx. $7bln in long term investments, unusually high for the industry.

The liabilities of the company are managed flexibly with the environment. Current gearing of 50% still is high, but partly reflects the somewhat more diverse nature of Anglo American’s activities compared to the other miners. Still the company will have to be careful to keep up with the other diversified players: as the only large diversified miner without a strong presence in iron ore it might become an interesting target for a joint acquisition effort of BHP Billiton and Vale.

Figure 6 - Anglo American Capital Structure

Source: Google Finance

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