The Delta Beverage Group Inc.
The Delta Beverage group is an independent bottler who has become one of the top five bottlers of Pepsi product during the late 80’s and early 90’s. They have a very strong line up off customers during this time including Pepsi, Mountain Dew, Slice, Mug, 7-up, Dr. Pepper etc. During the late 80’s the Delta Beverage group managed to accomplish growth by buying some competitive companies and joint ventures with other bottling companies. This created growth in their operating cash flow and operating profits. Despite these positive growth the Delta Beverage Group had to suffer with negative net income due to high interest expenses what led to missing a its amortization payment to the bank what brought them in technical default on their loans. In combination with a high leverage rate bring the Delta Beverage Group in a bad financial situation. The Delta Beverage group core business needs raw materials that are subjected to strong market fluctuations; the products are PET, fructose and aluminum. Because of the strong fluctuation in the market prices of these raw materials, the buying process is proven as very challenging considering the strong increase in the price of aluminum of 30% during the first six months of 1994. This was accompanied by the strong price increases of PET and Fructose. The CFO of the Delta Beverage group, John Bierbaum, is very concerned about these strong fluctuations in the prices of raw materials. The company has just been saved from bankruptcy in 1993 by a recapitulation plan with the debt holders and the company cannot bear more price increases in raw materials. The debt holders are not willing to do this recapitulation again. John Bierbaum is considering to the possibility of hedging the aluminium by buying future contracts to prevent strong fluctuations in the price of their main core material. This will keep the price of aluminium stable and prevent that the Delta Beverage Group to be in distress due to the aluminium prices. To be able to make a decision to hedge the aluminium contract we will analyse the debt position and market position of the Delta Beverage Group. The whole market of soft drink consumption in the US is showing diminishing growth rate. Because of this we assume that the soft drink industry is in their maturity phase. If we look at the debt ratio (table 1) of the Delta Beverage Group we can conclude that the company is highly leveraged and assume that the debt ratio is not healthy with a suffering debt ceiling. The unhealthy debt ratio will scare investors away due to the high default risk, because of this the option to bring in more loaned capital would be an expensive option. To uncover whether Delta Beverage should hedge future contracts or not, certain computations need to be made in terms of financial ratios, which will include debt/equity ratio, and the debt ratio. Table 1.
Year Debt Equity Total Assets D/E Ratio Debt Ratio
1989 165,751 69,702 223,335 2.38 0.74
1990 162,310 57,052 210,069 2.85 0.77
1991 164,264 35,474 203,999 4.63 0.81
1992 172,185 7,372 210438 23.36 0.82
1993 141,149 94,268 213,705 1.50 0.66
Note 1: Debt = Long term debt and other liabilities Equity = Preferred stock + Common stock + Stockholders equity –Accumulated deficit D/E ratio = Debt/Equity Debt ratio = Total liabilities/ Total assets. John Bierbaum wants to overlook the option to hedge the aluminium prices by buying future contracts on aluminium. If they go with this option this might secure the Delta Beverage Groups position on a long term, however this will mean that the short-term financial position will suffer. The table below (table 2) show the liquidity of the company, and from here we can conclude that the short term positions, the current and the quick ratio) is high at the end of 1993. The current and quick ratios are both above 1 what indicates that the Delta Beverage Group is not likely to default on short-term obligations. Hedging future contracts might secure the company’s long-term financial position, however the shortterm financial position of the company needs to be assessed. If the short-term position is not strong enough, it might lead to the company defaulting. Table 2.
Year Inventory C.Assets C. Liabilities Acid Test Ratio Current Ratio
1989 8,893 39,254 22,733 1.34
1990 6,726 33,196 19,233 1.38
1991 9,808 36,204 21,998 1.20
1992 10,607 41,349 27,291 1.13
1993 10,104 50,192 18,147 2.21
1.73
1.73
1.65
1.52
2.77
Note 2: Acid test ratio = (Current assets – inventory)/ Current liabilities Current ratio = Current Assets/ Current liabilities. As we can see by examining the table above, the current ratio and the acid test ratio are above 1 from 1989 up to 1993; therefore Delta Beverage is unlikely to default on their short-term obligations. Since the company is secure on the short-term front, we can now look into whether the Delta Beverage should hedge future contracts of aluminium or not.
Hedging Should the Delta Beverage Group hedge the aluminium prices or not? John Bierbaum is looking for a financial hedge, as operational hedge is not an option due to the production mix, which is not a market segmentation strategy. The only core material that is available for financial hedge is aluminium as there are no future contracts for the other materials. Therefore we will look at whether the 15-month or the 27-month future contract is the most appropriate for the company. Since the company expects the prices for aluminium to be on a rise and volatile, the company will not be able to keep up with the interest payments if the interest coverage ratio falls below 2. Since the prices between a 15-month and a 27-month future contract are quite similar, the most feasible option for Delta Beverage is to purchase the 27-month future contract option.
Price Aluminum 22.50% 17.50% 22.50% Future 15M Future 27M
1993 2.12 2.12 2.12 2.12 2.12
1994 2.30 2.30 2.30 2.30 2.30
1995 1.84 2.05 2.26 2.52 2.42
1996 1.91 2.14 2.38 2.18 3.10
Note 3: The table above shows the interest coverage ratios for cash payment, 15 month and 27 month future contracts on aluminium.
