Business Case Analysis, German Beer

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Deutsche Brauerei Analysis
FINA 405: Cases in Finance
Jonathan Maman
Alex Bisceglia
Carl Matar
Professor: Edward Wong
John Molson School of Business
September 21st, 2011
To:
From:
Date:
Subject:
Greta Schweitzer
Jonathan Maman, Alex Bisceglia, Carl Matar.
January 2001
The state of Deutsche Brauerei
Main Issue
Deutsche Brauerei needs to review its financial plan, dividends strategy, the
compensation structure for Oleg Pinchuk and whether or not Ukraine is a good market.
Recommendation
Company Health
Deutsche Brauerei should focus on other ways to increase profits than only increasing
sales. Otherwise, the company is doing just fine.
Credit Terms
Reach an agreement with customers for them to pay us within 30-60 days.
Debt vs Issue equity
Explore option of expand equity by issuing common shares, up to 20% to avoid issuing
new debt.
Dividends
Despite the tax savings for the firm, the Schweitzer family would end up paying more
taxes were we to change the dividend structure; therefore we recommend not to make any
changes to the current dividend policy.
Compensation for Mr. Pinchuk
We recommend to go ahead an give Mr. Pinchuk the recommended raises of 48,500 euro
and 0.6% of new sales with a new structure that takes into account the risks he is taking.
Ukraine
We see Ukraine as a good choice for expansion of the Deutsche Brauerei beers.
Analysis
Company Health
Profitability
However, if we compute the Net Income / Sales ratio (the Net Income profit margin), we
see that it decreases constantly from 62.08% in 1998 to 11.28% in 2000, followed by
8.85% in 2002. this is explainable by the fact that Sales are growing at a very fast rate
while Net Income is growing on a slower rate. The retentions of earnings have been
growing from €550 in 1997 to €1,078 in 2002, a very good sign for the growth
sustainability of the company, since the Return on Equity is growing too at the same
time.
From Exhibit 1, we see that the sales in Ukraine are increasing very fast. However, the
company is spending large amounts on operating expenses, which explains why the
Operating Profit Margin ratio hasn’t been fluctuating by that much from 1997 to 2002.
All the other profitability ratios seem to be increasing (most importantly the Return on
Assets and the Return on Equity ones): a positive sign for Deutsche Brauerei’s
profitability performance. The company is very proud of its sales growth, but it should
look at ways to improve the Net Earnings, because at the end of the day, this is what goes
into the stockholders’ pockets.
Asset Utilization
The sales and assets growth rates have been fluctuating for Deutsche Brauerei in this 5
years period, but what’s important is that the Sales/Assets ratio has been increasing from
1.10% in 1997 to 1.60% in 2002; not that much of an improvement, but usually it is hard
to improve this ratio by a lot of basis points. It is the same for the receivables growth rate
in Germany and Ukraine.
What concerns us is the Days in Receivables. The Days in Receivables for Germany
seems to be consistent year after year, but it is not the case for Ukraine. We see that the
Days in Receivables jumped from 36.3 days in 1998 to 85 days in 1999. This is due to
Oleg Pinchuk’s decision of extending the credit policy from “2 percent 10, net 40” to “2
percent 10, net 80” and then possible to 90 days.
Usually it is not a good sign for the company to extend its credit and inventory policies
since it will increase the chance of bad debt expenses, but surprisingly it has been
working for Deutsche Brauerei since Pinchuck then states that the extansion of these
policies resulted in “a sizable increase in inventory for the company in 1999 and 2000”
and “47% growth of sales in 2000”.
Leverage
We see that the Debt/Equity ratio and the Debt /Total Capital ratio decreased from 1997
to 2000; the ratio was higher in 1997 due to the aggressive penetration of the Ukrainian
market. However, we do see that from 2000 to 2002, these ratios have increased from
66% to 82.7% and 39.8% to 45.3% respectively. If the Debt/Equity ratio is increasing,
this means that the company is relying more and more on debt. This is not that much of a
problem in the short term, but could turn to a major problem in the long run if the
company doesn’t manage it efficiently. The company will most likely finance the
“investment of € 7 million in new plant and equipment” in 2001 and the “€ 6.8 million in
a state-of-art warehouse and distribution center in Ukraine” in 2002 by issuing more debt.
The Times Interest Earned ratio, EBIT/Interest, has been increasing on a constant basis
from 1997 to 2002. This is due to Deutsche Brauerei negotiating favourable terms with
the banks that they are dealing with, thus increasing their Earnings Before Interest and
Taxes.
Liquidity
The Quick ratio has been 0.84 for 3 years (1999, 2001 and 2002). Deutsche Brauerei’s is
showing consistency however they should be looking to increase these ratios to have
more flexibility in the harder times or if investment opportunities arise.
Credit terms
Total increase in accounts receivables for Ukraine is $6 MM from 1998-present. Total
increase in short term Debt is $10 MM from 1998-present.
30-60 day term will reduce the large sums tied up in receivables. Oleg’s proposition to
offer 90 day term is not feasible; Deutsche Brauerei’s cashflow issues have already been
discussed in the liquidity analysis.
We don’t want to risk alienating existing distributors so existing clients with good
relationships will keep the 2/10 net 80 terms for now but these terms can no longer be
offered to new clients.
Debt vs.Issue Equity
Total increase in short term Debt is $10 MM from 1998 to present. Millions of dollars
more in accounts receivables than in cash alone since 1997.
We recognize that Deutsche Brauerei has been in the family for 12 generations, however
if the family does want to expand the business, we could issue up to 20% of equity for
5.68 Million Euros. That would cover much of the 7 Million Euros needed for the new
equipment.
This decision, of course, rests on the family and what they intend to do with the company
in the long term.
Dividends
They would require dividends of 2.8 million Euros, which is 75% of the net income.
Alternatively, if they gave those family members titles with the firm, or a formal salary,
they would end up saving tax expenses equal to 882,000 Euros.
The main function of the firm is to provide income to the Schweitzer family. While this
structure prevents the firm from growing at a freer pace, or to be less reliant on financing,
it is the shareholders’ right to claim the dividends. Given the German tax code that favors
income from investments (25% for dividends and up to 45% for the top bracket) I they
should not be changing the dividend structure. (www.taxrates.cc)
Compensation for Mr. Pinchuk
Mr. Pinchuk has done an excellent job promoting and selling Deutsche Brauerei and we
certainly would like to retain his services but we are concerned about his tactics and the
risks he is taking. He is extending very generous credit terms to clients that even the local
financial institutions wont support. We could set up more rigorous rules for granting
credit. This means we’d be taking fewer risks. The only problem with this option is that
Deutsche Brauerei is not a financial company but rather a brewery; the resources and
know-how to implement such an option are not readily available.
The second option would be to make Mr. Pinchuk more sensitive to the risks he is taking
by tying his commission not to the amount of sales but the revenue he generates. This
way we would know that he isn’t giving assets away carelessly.
Other than that, we see not problem with increasing his salary to 48,500 Euros plus 0.6%
of revenue increase in Ukraine.
Ukraine
Ukraine has a population of 48.4 million and GDP per capita of 786 USD per year
(wolframalpha). We recognize that these figures are low compared to Germany’s at
23,100 USD per person per year (wolframalpha) however we expect strong growth
figures from Ukraine as they have seen 7% increase in GDP the previous year. All this
points to broadening of our consumer base and more disposable income available to
Ukrainians to spend on our beers.
For these same reasons we also think it would be a good idea to move forward with Mr.
Pinchuk’s plan of a 7 Million Euros investment in the country. However we should be
opening new plant to better service the Ukrainian population and actually produce some
of the supply since we are nearing the edge of the capacity (1.173 million hectoliters
produced vs. 1.2 million hectoliters capacity). Simply building a warehouse to hold the
products for the distributors will only increase our costs without returns. We should see
some cost savings by using local labor and local commodities.
The tech bubble is mostly the west’s problems. In fact, isolation from the dot com crash
would mean Ukraine would be a good place to shit investments in the short to medium
term.
Plan of action
Company Health
Deutsche Brauerei should look out for efficiency in the process and reduce costs at a
moderate pace. They must also increase liquidity.
Credit Terms
Cease offering 80 day terms and reduce them to 60 days as of 2001 for new clients.
Existing clients will keep 80 day terms for now to avoid alienating them.
Debt vs Equity
Engage the board in a conversation to understand what they intend to do with the
company in the long term. Offer to look into issuing up to 20% equity to an investor.
From there contact an investment bank to get the process started.
Dividends
As the family requested, pay out the extra 698,000 Euros in dividends in 2001 split up
evenly in each of the 4 quarters.
Compensation for Mr. Pinchuk
As of the 2001, increase Oleg Pinchuk’s base salary to 48,500 euro and change his
commission structure to 0.6% of increase in revenue in Ukraine.
Ukraine
Obtain financing and set up a new plant in Ukraine to meet the new supply this new
market has opened up to us.
Appendix
Equity
Shareholder Equity in 2000: 28,390,000 Euros * 20% = 5,678,000 Euros.
Dividend analysis
Earnings before taxes 5,729 - 2,793 = 2,936.
Income tax (new)
2,793 * 35% = 1,027
Retained earnings
2,793 – 1,027 = 1909
Sources
www.wolframalpha.com
http://www.taxrates.cc/html/germany-tax-rates.html
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