lOMoARcPSD|1767339

Delta Beverage Case

Consultancy Report: A critical Analysis of

Financial Statements

Jasper Frankin 2055708

Chantal Kappel 2562360
Jeroen Rozendaal 2547555

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Table of Contents

Introduction of Delta Beverage ..................................................................................................... 3

Current situation .......................................................................................................................... 3

Ratios .................................................................................................................................................... 7

Different scenarios without hedge ............................................................................................... 8

Different scenarios with hedge .................................................................................................. 10

Conclusion ................................................................................................................................. 11

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Introduction of Delta Beverage

Delta Beverage is one of the top five bottlers of Pepsi in the United States. Over the course of time
this giant has been balancing on the brink of default. In a nick of time new management has been
assigned to take over and foster Delta Beverage back to a financially healthy state, and with success.
Current management was able to vigorously attack the cost structure of the company and as a result,
stopped the price fall and the decline in market share. Nevertheless, Delta Beverage is not in the
clear yet. Net income is still negative and the company has been marked by high leverage. Moreover,
the company was unable to deliver to the agreements in the debt covenant, this lead to a
restructuring of the companys finances in 1993. However, currently, the CFO of DBG is faced with a
new hurdle to overcome since, the price of aluminum has increased. This may potentially harm the
firm since, a large part of its revenues is obtained from producing and selling not just bottled soft
drinks, but primarily aluminum cans.

This report attempts to shed a light on the possible threat, by means of a holistic analysis. Firstly,
some key financial ratios will be presented to assess the current situation. Secondly, the
development path of three potential alternative outcomes will be depicted. The results will be
elaborated in the conclusion, together with the recommendations.

Current situation

From the financial information it can be seen that DBG the market for soft drinks and beverages is
close to being saturated. The demand for these products has mainly been on a decline. However,
DBG still manages to keep growing, mainly by the acquisitions it has done. The ratios below will help
in assessing the current situation of the company in order to set a strategy for the future.

Financial ratio analysis:

This section will discuss some of the key financial ratios, which give more clarity of the state of the
company and how it has developed over the last five years. The first set of financial ratios that are
going to be discussed are the ratios that focus on analyzing the liquidity and profitability of the firm.

Current Ratio 1989 1990 1991 1992 1993

Total Current Assets 39.254 33.196 36.204 41.349 50.192
Total Current Liabilities 22.733 19.233 21.998 27.291 18.147
Current Ratio 1,727 1,726 1,646 1,515 2,766

The company overall has an excess of current liabilities and on average the company has 1.876 times
the amount to pay for its current liabilities. This looks quite good since, net working capital is
positive. Moreover, this outcome indicates that the company does not have any trouble paying its
debt for the next 12 months. However, the current ratio does not take the maturity into account of
the different debt obligations. Furthermore, the current ratio of 1993 is quite high compared to the
rest. This could be an indication of inefficient use of short-term assets.

Cash Ratio 1989 1990 1991 1992 1993

Cash 5621 3053 4032 11327 17272
Total Current Liabilities 22.733 19.233 21.998 27.291 18.147
Cash Ratio 0,247 0,159 0,183 0,415 0,952

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Cash can be more easily used to pay of current liabilities than current assets. The cash ratio is
therefore a helpful tool in analyzing a firms liquidity. The table shows a slight decrease in the
beginning, but thereafter the proportion of cash to current liabilities is increasing and it already looks
much better than previous years. However, having a lot of cash may also show an inefficiency, or that
the company is stagnating in its growth. In the case of DBG, the cash could be well spent on paying
some of the debt payments in order to raise the level of trust of the creditors.

Quick Ratio 1989 1990 1991 1992 1993

Total Current Assets 39.254 33.196 36.204 41.349 50.192
Total Current Liabilities 22.733 19.233 21.998 27.291 18.147
Inventory 8.893 6.726 9.808 10.607 10.104
Quick Ratio 1,336 1,376 1,200 1,126 2,209

The quick ratio is similar to the current ratio only it deducts the inventory, simply because it is
believed that inventory cannot be easily converted into cash and therefore should not be included. In
general the quick ratio is positive, indicating that the company has enough quick assets to pay for its
current liabilities

Return on Assets (ROA) 1989 1990 1991 1992 1993

Net Income -18.866 -17.432 -14.835 -14.015 -7.877
Total Assets 223.334 210.069 203.999 210.438 213.705
ROA -0,084 -0,083 -0,073 -0,067 -0,037

The table shows a negative ROA, which is caused by the negative net income. Even though the ROA is
negative, there is still a visible silver lining, due to an increase in the ROA over the years. This
indicates that the loss/profit generated from the assets is decreasing/increasing, because the
company becomes more efficient in using assets to generate profit.

Return on Equity (ROE) 1989 1990 1991 1992 1993

Net Income -18.866 -17.432 -14.835 -14.015 -7.877
Total Assets 223.334 210.069 203.999 210.438 213.705
Total liabilities 188.484 181.543 186.262 206.752 166.572
Shareholders Equity 34.850 28.526 17.737 3.686 47.133
ROE -0,541 -0,611 -0,836 -3,802 -0,167

The ROE shows the proportion of profit the company makes with respect to the value of its equity.
Therefore, a higher ROE is considered to be better. For the case of DBG, it can be observed from the
table above that the restructuring is really paying of. While still negative, the ROE does show a
significant improvement between 1991 and 1993. This is a result from a decrease in the loss of profit
and an increase in the amount of equity.

Profit Margin 1989 1990 1991 1992 1993

Net Income -18.866 -17.432 -14.835 -14.015 -7.877
Net Sales 147.956 155.644 163.775 170.285 197.848
Profit Margin -0,128 -0,112 -0,091 -0,082 -0,040

From the table above it can be seen that the company has not been able to make a profit with
respect to the sales it makes. However, the level of this loss gradually diminishes, thereby portraying
the picture of a company that is well on its way of making a comeback.

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The next section will discuss the ratios that assess the level of leverage a company has.

Debt to Equity Ratio 1989 1990 1991 1992 1993

Total liabilities 188.484 181.543 186.262 206.752 166.572
Shareholders Equity 34.850 28.526 17.737 3.686 47.133
Debt to Equity Ratio 5,41 6,36 10,50 56,09 3,53

From the table it can be seen that a majority of the assets are financed by debt. This is because the
debt to equity ratio is clearly well over 1. In 1992 DBG engaged in a number of acquisitions. This
explains the enormous debt to equity ratio of this year. Thereafter, the company took several
measures to bring this ratio back to healthier proportions with lower leverage in order to manage the
risk.

Dept Ratio 1989 1990 1991 1992 1993

Total Assets 223.334 210.069 203.999 210.438 213.705
Shareholders Equity 34.850 28.526 17.737 3.686 47.133
Total Liabilities 188.484 181.543 186.262 206.752 166.572
Dept Ratio 0,844 0,864 0,913 0,982 0,779

An overall debt ratio below 1 indicates that the company has more assets than debt, which is
positive. The higher this ratio is, the riskier the business.

Equity Multiplier 1989 1990 1991 1992 1993

Total Assets 223.334 210.069 203.999 210.438 213.705
Shareholders Equity 34.850 28.526 17.737 3.686 47.133
Equity multiplier 6,41 7,36 11,50 57,09 4,53

The multiplier is a variation of the debt to equity ratio. It gives an indication of the proportion of
asset financing that is been done by debt. The table shows that the company has already taken
actions to bring back the asset financing to more sustainable alternatives than debt.

Cash Coverage Ratio 1989 1990 1991 1992 1993

Operating Earnings (EBIT) 7.095 10.051 12.009 14.038 18.812
Depreciation 7.876 7.236 5.962 6.112 7.162
Total Interest Expense 18.950 19.665 19.245 19.358 16.861
Cash Coverage Ratio 0,790 0,879 0,934 1,041 1,540

The cash coverage ratio shows that before 1992, the company was unable to pay for its interest
expense. From 1992 the ratio has improved but still the company has very little money left after
repaying its interest.

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The income statement below shows the current situation, but also reveals forecasting figures up to
1996. Underneath the income statement is a specification of the numbers and what they are based
on. The forecast of the numbers in the income statement are based on the assumption that
aluminum prices remain the same.

Income Statement (in thousands of U.S.) Table 1

Year 1993 1994 1995 1996

Revenue $231.207 $240.473 $257.931 $276.657

Sales Mix aluminium $138.724 $144.284 $154.759 $165.994 60%

pet $60.114 $62.523 $67.062 $71.931 26%
contract $32.369 $33.666 $36.110 $38.732 14%

Total $231.207 $240.473 $257.931 $276.657

COGS

Aluminium $101.269 $105.327 $112.974 $121.176 27%

pet $37.271 $38.764 $41.579 $44.597 38%
contracts $17.479 $18.180 $19.500 $20.915 46%
Total
costs $156.018 $162.271 $174.052 $186.688

Gross profit $75.189 $78.202 $83.879 $89.969

selling expenses $36.791 $39.024 $41.393 $43.906

general expenses $20.561 $22.535 $24.698 $27.069
EBIT $17.837 $16.643 $17.788 $18.994
Depriciation & amortization $12.816 $12.175 $11.566 $10.988
EBITDA $30.653 $28.818 $29.354 $29.982

Tonnes of aluminium $7.938 $8.256 $8.756 $9.286

Futures $318 $330 $350 $371

Revenue = based on averaged growth rate of 1989-1993

Selling expenses = average growth rate of 1989-1993
General expenses = average growth rate of 1989-1993
Depreciation & amortization = average growth rate of 1989-1993
Capital expenditure = average of 1989-1993
Debt = debt mandatory prepayments (Exhibit 5)
Interest expenses = interest expenses as a percentage of total debt, averaged for the
period 1989-1993
Cash interest paid = Average of 1990-1993 of (cash interest expense/total interest
expense)
Current liabilities = average of 1989-1993
Volume growth = average volume growth 1989-1994 (of which 1994 is a given 4%)
Interest = interest expanses/debt = 16861/141149 = 12%

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the assumption that the aluminum prices will be the same in the coming years. With the different
figures the ratios are calculated.

Ratios

1993 1994 1995 1996

Senior leverage ratio 4,84 5,01 4.72 4.42 <5.00

Total leverage ratio 4,60 4,76 4,47 4.17 <6.25

Interest coverage ratio 2,67 2,58 2.75 2.94 >2

Debt service coverage ratio 1,42 1,35 1.44 1.55 >1.25

The ratios above are calculated with the assumption that the aluminum prices will remain stable for
the year 1995 and 1996. The only thing that has changed is the volume increase and the total
amount of tones aluminum that is needed. The most important ratio is the interest coverage ratio,
when this is dropping below 2 the company is in default.

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Different scenarios without hedge

The three tables below show three different scenarios. In scenario 1 the aluminum prices will
increase with 10%, in scenario 2 with 15% and in scenario 3 with 20%. Also is shown what this
changes will do with the different contractual ratios.

Scenario 1 1993 1994 1995 1996

10% 10%

Aluminium COGS $101.269 $105.327 $115.860 $127.446 49% packing

Gross profit $75.189 $78.202 $80.993 $83.699

EBIT $17.837 $16.643 $14.902 $12.724
EBITDA $30.653 $28.818 $26.468 $23.712

Scenario 2 1993 1994 1995 1996

15% 15%

Aluminium $101.269 $105.327 $117.020 $125.621 49% packing

Gross profit $75.189 $78.202 $79.833 $85.524

EBIT $17.837 $16.643 $13.742 $14.549
EBITDA $30.653 $28.818 $25.308 $25.537

Scenario 3 1993 1994 1995 1996

20% 20%

Aluminium $101.269 $105.327 $119.691 $131.421 49% packing

Gross profit $75.189 $78.202 $77.162 $79.724

EBIT $17.837 $16.643 $11.071 $8.749
EBITDA $30.653 $28.818 $22.637 $19.737

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Ratio's without Hedge

1993 1994 1995 1996
Price
increase
Senior leverage ratio 10% 4,84 5,01 5,23 5,58 <5.00
15% 4,84 5,01 5,47 5,19
20% 4,84 5,01 6,11 6,71

Total leverage ratio 10% 4,60 4,76 4,96 5,28 <6.25

15% 4,60 4,76 5,18 4,90
20% 4,60 4,76 5,79 6,34

Interest coverage ratio 10% 2,67 2,58 2,48 2,33 >2

15% 2,67 2,58 2,37 2,51
20% 2,67 2,58 2,12 1,94

Debt service coverage ratio 10% 1,42 1,35 1,26 1,14 >1.25
15% 1,42 1,35 1,19 1,26
20% 1,42 1,35 1,01 0,87

The ratios above show that there is only a need for a hedge if the price will rise with 20% in 1995 and
also with 20% in 1996. We also looked at the interest coverage ratio under the assumption of a price
increase of 30 and 40%, as shown in the table below. When the prices rise with these percentages
there is a need to hedge because the company will otherwise fall in default, due to the fact that the
interest coverage ratio falls below 2 for these situations.

Interest coverage ratio 1993 1994 1995 1996

30% 2,67 2,58 2,49 1,90
40% 2,67 2,58 1,99 0,67

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Different scenarios with hedge

The following tables show the financial results for the period 1993-1996 when Delta opts to hedge
the aluminum price using a 15 month and 27 month future. Furthermore, the effects of this decision
on the contractual ratios are shown. As can be expected, the 27 months future allows for a bigger
initial investment, but pays off in the long run in comparison with the 15 month hedge.

Scenario 1, 15 month hedge 1993 1994 1995 1996

6,3% 16,8%

Aluminium $101.269 $109.008 $112.373 $121.624 49% Packing

Gross profit $75.189 $80.935 $93.733 $101.124

EBIT $17.837 $19.376 $27.642 $30.150
EBITDA $30.653 $31.551 $39.208 $41.138

1993 1994 1995 1996

Senior leverage ratio 4,84 4,58 3,53 3,22 <5

Total leverage ratio 4,60 4,35 3,34 3,04 <6.25

Interest coverage ratio 2,67 2,83 3,67 4,04 >2

Debt service coverage

ratio 1,42 1,51 2,07 2,30 >1.25

Scenario 2, 27 month hedge 1993 1994 1995 1996

8,70% 0%

Aluminium $101.269 $109.008 $113.655 $113.655 49% Packing

Gross profit $75.189 $80.935 $92.451 $109.093

EBIT $17.837 $19.376 $26.360 $38.119
EBITDA $30.653 $31.551 $37.926 $49.107

1993 1994 1995 1996

Senior leverage ratio 4,84 4,58 4,34 4,23 <5

Total leverage ratio 4,60 4,35 4,11 3,99 <6.25

Interest coverage ratio 2,67 2,83 2,99 3,08 >2

Debt service coverage

ratio 1,42 1,51 1,61 1,65 >1.25

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Conclusion

The conclusion of this report is that hedge in only necessary if the price of aluminum will rise with
20% in 1995 and 1996. The company than should take a 27 month hedge. When the prices rise with a
even bigger percentage the company has to hedge earlier. Because the company has been in default
before the manager can take a hedge to be certain that the companys interest coverage ratio is
above 2. Because the aluminum prices are raised by 22% in the period July 1993 June 1994 it is
possible that the prices will rise with 20% each year in a period of 2 years. The aluminum price
volatilities is 30.4%. So to be certain the company will not fall in default again, we recommend a
hedge for Delta beverage. When this hedge is taken Delta Berverage will not fall in default. The
hedge is given a certainty to the managers of Delta Berverage that the possible rise of aluminum
prices will not lead to a default.

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