Delta Beverage Group, Inc.

Report

GROUP 14

Asri Zefanya - 2567340

Vira Cania Arman - 2591630
Aldi Nandi Wardhana - 2595492

Advance Corporate Financial Management

2016
Abstract

The Delta Beverage Group, Inc. report analyze problems that happened to the company in
1990s. During that period, the company has sold their products widely and received a huge
sales revenue. However, due to a volatility in aluminum cans and PET containers, it creates
an imbalance condition towards their financial condition. In addition, they are highly
levered with high interest rate. With the new notes in place the company needs to
maintain their interest coverage ratio which can be done by partially hedging the
aluminium through future contract and managing selling expenses.

Background

In March 1988, a Mid-South Bottling Co. was purchased in a leveraged buyout by Pohlad
family, which has almost 30 years experience in bottling include running Pepsi bottler. In
addition, this makes PepsiCo, Inc. owns a 16% equity and preferred stock. Afterwards, it
was renamed to Delta Beverage Group, Inc. The company able to make a lots of sales and
performing joint-venture with numerous companies. However, they obliged to buy its
syrup and concentrate only from PepsiCo with their established prices which used to be
set annually and moving with consumer price index. On the other hand, the other
materials such as water, fructose, PET bottles, aluminum cans and other packaging are
acquired differently, such as by performing through a purchasing co-op.

Even though from 1991 to 1993 Delta had a good cash flow and increasing profits, Delta
unable to make its scheduled amortization payment on its bank loan without violating an
interest coverage or leverage ratio covenant. Moreover, in the first semester of 1994, the
key cost component of Delta, aluminum, increased around 30%, followed by PET resin and
fructose which increased beyond their anticipated limit. It reflected on how close Delta to a
bankruptcy. Apart from their financial conditions, whereas this company is highly levered,
their debt needs a strong consideration especially in 1992 when theres a prominent
growth in D/E ratio along with high interest rate. In order to survive, this company should
apply a partial hedge towards the aluminum prices, manage their current capital structure
policy, and make an adjustment to control their allocation cost.

Problem Statement

Delta Beverage Group Inc. was facing financial problem caused by high interest expense
which leads to negative income and inability to repay the debtors on time. In addition to
that, the price of aluminium has increased significantly throughout the year, with the price
of other raw materials such as syrup and concentrate being fixed by PepsiCo, the company
need to deal with the risk of being defaulted by its debtor as the cyclicality of the resource
can lower their income.

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Analysis

To survive in the business for a long term, it is advisable for Delta to evaluate and analyze
their position in the business. One of the well-known methods is by using SWOT (Strength,
Weaknesses, Opportunities, and Threats) analysis. Below this statement, is a SWOT
analysis of Delta Beverage Group, Inc.

Table 1 SWOT Analysis of Delta Beverage Group, Inc.

Strength
1. Very strong brand names products (Pepsi,
Mountain Dew, 7-Up, A&W brands, Squirt,
Canada Dry, etc).
2. Strong franchise-selling area for its products
(Arkansas, Tennessee, Mississippi, and Louisiana)
3. From 1989 to 1993, Delta cash flow was under
control and improved profit.
Weaknesses
1. Delta had to buy Pepsi concentrate and syrup
from PepsiCo only and only at the prices settled
by PepsiCo.
2. Net income remain negative because of high
interest expenses.
3. High on LT Debt and other liabilities.

Opportunities
1. From 1985 to 1992, soft drinks is No. 1 position
in the industry with the largest share of
stomach; more than tap water.
2. In 1995, Delta had become an important part
of franchise system of PepsiCo.
3. Use partial hedging, to overcome the rising
price of aluminium.
Threats
1. In the first semester of 1994, price of the core
raw material, aluminium, increased 30%.
2. U.S. industry growth rates for soft drinks
decreased significantly from just over 6% in
mid-1980s to around 2% in 1990s.
3. In 1988, Coca Cola buying some of the
competing brand franchises near Mid-South area.

Aside from SWOT Analysis, the company also needs to mitigate its financial risk to avert
default. As seen in table 3, Delta Beverage has a favorable profitability ratio. The company
have significant sales growth in 1993, and they manage to have their gross profit margin
around 30%-40% despite the cyclicality of aluminium price. However, due to high interest
expense they failed to have positive net income in the last five years. This condition makes
it difficult for them to find alternative financing other than debt, as equity investor might
seen this company as unprofitable. In addition, the company rely heavily on debt with Debt
to Total Assets ratio more than 0.78 in the last 5 years. However, the company have stable
quick ratio (above 1) which means that they have enough liquidity to meet their short term
liabilities.

With the new notes in place Delta Beverage are expected to maintain the interest coverage
ratio above 2.0 to avoid the risk of being declared default. With the volatility of aluminium
they will need to develop a strategic plan to mitigate that risk which will be explained in the
following section.

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Proposed Solutions (inc. Assumptions)

Looking at the current financial situation in Delta, several risk mitigation action needs to be
done. Before a solution can be proposed, a forecasted income statement of Delta
(1994-1999) needs to be calculated. The assumptions to be used are as follow; First, the
basis of calculation was the net revenue in 1993 (Exhibit 2 - Case Delta Beverage). Second,
the proportion of sales were divided into 60% can, 26% pet and 14% other products. Third,
COGS cans 49% from total. Fourth, other prices remain the same. Fifth, forecasted sales
growth from 1994 to 1999 used an average sales growth 1990-1993.

As seen on table 4, the company will be able to maintain the interest coverage ratio above
2, given the aluminium price will remain the same throughout the forecasted year.
However, if the price increase more than 5% (table 5), the company will have an issue
meeting the requested condition. In this case, partial hedging (table 6) will be the best
short term option, as fully hedging also have disadvantages such as limiting the profit by
losing the opportunity to gain more profit if the price of aluminium decrease lower than
the future contract price, and investor does not find it stimulating as it does not have effect
on the company's long term growth.
Table 2 Interest Coverage Ratio

In addition, the company can also reduce its selling expenses by operating more
effectively, as the company use almost half of its Gross Profit which leads to low operating
margin (table 2). Even though their operating margin ratio has increased steadily in the
past few years, a few improvement can be implemented, such as reducing commission
payment by increasing the sales target, allocating the marketing and advertising expense
to push more sales in contract and fountain that generate bigger profit, and reduce travel
for sales person, instead they can invest in sales tools where sales person can invest more
time in researching prospects first instead of travelling to customers right away.

For long term, it is advised for Delta Beverage to reassess its capital structure policy. With
the kickstart given from the new notes, the company will have time to reduce their debt to
asset and in the future instead of issuing new debt, they can issue more equity to have
more balance capital structure and reduce the interest expense in the future.

Lastly, Delta Beverages can also approach the other companies in the purchasing co-op,

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together they can negotiate the price of raw materials as they have significant buying
power due to the orders volume.

Conclusion and Recommendations

In conclusion, this report has analyzed the core problems of Delta; financial difficulties
caused by an increasing core raw material (aluminium), dependency to the PepsiCo as
their only one franchiser, improperly amount of debt that leads on high interest expense
and negative net income. Nevertheless, Delta still have a chance to improve their strengths
and opportunities and take control the beverage industry if Mr. Bierbaum implements
several strategies as follows: apply partial hedging for short term option, operate the
company more effective and efficient to reduce the expenses, reduce commission
payment by increasing the sales target, and allocating the marketing and advertising
expense to push more sales in contract and fountain that generate bigger profit.
Furthermore, for long term plan, Delta should consider to reassess their capital structure
policy as well as negotiate the raw material price together with the purchasing co-op.

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Exhibit

Table 3 Financial Statement Analysis 1989-1993

Table 3 shows the profitability of Delta Beverage between 1989 to 1993. Likewise the major trend is
increase in operating profit margin, gross profit margin and revenue growth. On the other hand, their
liquidity remain stagnant until 1993, while Debt to Equity ratio increased and dropped significantly in
1992 and 1993.

Table 4 Forecasted Net Income (no increase in Aluminium Price)

Table 4 explains the forecasted net income of Delta, with the assumptions with no increase in aluminium
price, no additional assets & franchise, depreciation & franchise amortization remain constant.
Moreover, the calculation use forecasted growth from 1994 to 1999 using an average sales growth
1990-1993. The data also shows that the company ability to honor its debt (interest coverage ratio) was
improved. Generally, it is a warning signals if the ratio below 2.0.

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 Table 5 Forecasted Income Statement with Increase in Aluminium Price
(5%, 15%, and 22.5%)

Table 5 shows the company risk of being announced bankrupt if the aluminium price raise above 5% per
year as the interest coverage ratio dropped to below 2.0 in 1995 if the price raise more than 15%
annually as well as in 1996 and 1997 the price increase more than 22.5%.

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 Table 6 Forecasted Income Statement Hedged

6.1 Price Increase 22.5%

6.2 Price Increase 5%

Table 6 shows the proportion of raw materials needs to be bought through future contract in order to
keep the interest coverage ratio above 2.0.

References
Pepsi Pictures, accessed September 21, 2016,
http://www.tradekorea.com/product/detail/P529786/Coca-Cola-,-Sprite-,-Fanta,-Pepsi,-355ML-Can-.html

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