Delta Beverage Group, Inc.

1. INTRODUCTION

Delta Beverage Group, Inc. (DBG), is a large bottling company based in the South Central United States. In July 1994, the CFO John Bierbaum was struggling with the current financial situation of the company. Last year the company was saved from bankruptcy by a recapitalization plan. Now, rising aluminium prices are posing a new threat to the firm. As aluminium cans accounted for 60% of net revenues, it was the right time for John Bierbaum to consider taking action against profitability fall due to substantial aluminium price increase. An operational hedge, a financial hedge or simply hoping for the best, respectively were taken into account. While history shows that the price of aluminium is highly volatile, simply hoping for the best might not be appropriate. Therefore, the question remains whether DBG should engage in a hedge, or not.

While assessing this question, it is important to keep the debt covenant from the recapitalization plan in mind. DBG must keep an interest coverage ratio of above 2. Otherwise the company will be pushed into technical default.

First, the current financial situation is explained on the basis of several ratios. Second, several assumptions are made to forecast the future. Finally, different scenarios are provided and an advice will be given to Mr. Bierbaum.

2. CURRENT FINANCIAL SITUATION

Looking at the case volume and sales, it can be concluded that DBG is a large company with modest growth. This small growth can partly be explained by the acquisitions DBG took in 1992 and 1993. As the growth rates for the whole soft drinks industry over the past years has been modest, the small growth of DBG is no exception.

Table 1: Debt ratio and leverage ratio

(in thousands of U.S. dollars)

1989

1990

1991

1992

1993

Debt

165,751

162,310

164,264

172,185

141,149

Equity

69,702

57,052

35,474

7,372

94,268

Total Assets

223,334

210,069

203,999

210,438

213,705

Total Liabilities

188,484

181,543

186,262

206,752

166,572

Debt ratio

0.74

0.77

0.81

0.82

0.66

Leverage ratio

2.38

2.84

4.63

23.36

1.50

The debt ratio and the leverage ratio are calculated to measure the solvency of DBG. The leverage ratio can be calculated by dividing debt by equity. A leverage ratio above 2 indicates that there are risks for the investor, however this varies across industries. Looking at table 1, it can be concluded that DBG is highly leveraged. In 1992 there was a peak whereafter the Recapitalization Plan was conducted in 1993. The leverage ratio in 1993 was much lower, and healthier, in comparison to 1992. This reduction was caused by a conversion of a portion of the debt into equity.

The debt ratio defines how much of the assets are financed with debt. DBG has an extremely high debt ratio, especially in 1991 and 1992. Due to the Recapitalization Plan this fortunately could be reduced, but it still remains high. A ratio of 0.5 is preferred, but for capital intensive industries a ratio of 0.7 is not uncommon. A high debt ratio causes a high financial risk, which makes it almost impossible to issue more debt. Furthermore, it makes DBG less attractive to investors.

Table 2: Current ratio and quick ratio

(in thousands of U.S. dollars)

1989

1990

1991

1992

1993

Current Assets

39,254

33,196

36,204

41,349

50,192

Inventory

8,893

6,726

9,808

10,607

10,104

Current Liabilities

22,733

19,233

21,998

27,291

18,147

Current ratio

1.73

1.73

1.65

1.52

2.77

Quick ratio

1.34

1.38

1.20

1.13

2.21

The current ratio and the quick ratio are calculated to measure the liquidity of DBG. The current ratio explains to what extend DBG is able to pay its short term liabilities with its short-term assets. The quick ratio also explains the ability to pay short term obligations, but excludes inventory from the calculation as it is not easy to convert. Both ratios should be above 1.