Delta case

Group 17

Introduction
Delta Beverage Group (DBG) is one of top five independent bottle producer of
Pepsi in the United States. The restructuring plan, that was introduced in
1993 prevented DBG from defaulting. However, the volatility of aluminum
price is considered as a threat to the company. As a franchise of PepsiCo,
DBG has no power to influence the retail price. Therefore, DBG could not
transfer the risk from raw material price volatility to its customers.
To prevent the price volatility risk, futures are used. Futures are a better
method for hedging than operational hedging. Theoretically, reducing
volatility would not effect on future cash flow of the company. However, once
the price is locked, DBG will not enjoy the lower price if the aluminum price
goes to down.
In order to make the decision, we need to analyze current financial situation
of DBG first in order to see if the company could handle the risk by itself.

Current financial situation

By analyzing the financial statements of DBG, we can indicate that their
average sales growth rate is 7.79% which mainly results from its acquisition
operations in previous years. Compared to the last ten years growth, the rate
of soft-drink market shows a clear decreases trend in the recent years. As a
high leveraged company, and according to the market performance, DBG is in
the mature phase of its product life cycle. Ratio analysis could provide deeper
insight in the firms operation.

Current ratio analysis

DBG has average current ratio of 1.88 which could be considered as a good
sign. Normally, the current ratio should be above 1 to show that the firm has
the ability to pay off its short-term obligations. DBG doesnt have high
amount of inventory, as the result, the quick ratio of the company also
doesnt change a lot from current ratio with average of 1.45. However, both
quick and current ratio of DBG reached a high point in 1993, which might be
a sign of current asset inefficiency use. Both ratios show the company has
enough ability to pay off its short-term debt and show that there is no threat
to the company.
D/E ratio shows the leverage level of the company. An average D/E ratio of
13.88 indicates that most of companys assets are financed by debt holder.
D/E ratio peaked to 46.71 in 1992, which could be caused by DBGs number
of acquisitions actions. This was the point where DBG almost defaulted due to
their interest obligations.
Following step performed by DBG is the recapitalization plan. D/E ratio
returned to 2.99 at 1993 because of recapitalization. However, this ratio still
clearly shows the risk of DBG from investors point of view. High amount of
debt enlarges the chance of default as well as interest payment. The business

Delta case

Group 17

risk also increases based on high amount of interest payment. This makes
DBG in a weak position for attracting investors. Without increase equity,
financial risk makes company more vulnerable to borrowing additional funds.
The company is experiencing income losses based on high interest payment
but the situation is slightly improving. Recapitalization slightly reduced
interest payment, but it still shrinks the profits of the company. The
improvement of net income has a positive effect on ROE and ROA, although
those ratios are still negative. However, because of increase in equity and
positive trend of net income, DBG will also receive an improvement of ROE.

Hedging options
Operational hedge for DBG is not possible due to the fact that the market
strategy should stay based on the production mix and cannot be changed.
Financial hedge is the option Bierbaum is taking into consideration. Other raw
materials such as concentrate and fructose are not possible to hedge
because there are no futures for such items. Based on expectations, for the
rest of 1994 the aluminum price will stay at the same level as in 1993.
Although the prices will remain the same, historical records of aluminum price
show the high risk of volatility. (Exhibit 10 of the case). Moreover, the
volatility of aluminum cash price was 30.4 percent.
Financial hedge of DBG will focus on aluminum price hedging. The exposure
to aluminum price and DBGs financial structure should be analyzed before
making real decisions. Any debt default could push Delta to declare
bankruptcy. Having that in mind, company should stay away from technical
default and should keep its coverage ratio higher than 2.

Present and future financial statement analysis

According to market data and the financial report, some conclusions can be
made without deep calculations.
First of all, the aluminum future price between 15 and 27 months is around
7% higher than cash price, if we assume that the price will remain constant.
This statement holds only if we dont consider any operational issues, and
take aluminum price volatility of 30% into consideration. It is smart to buy the
futures if the companies interest coverage ratio is close to its required level of
2.0. When we look at the costs of producing a can, 49% percent are packing
costs which has an impact on the total costs of Sales. (The total cost of
aluminum makes up more than 10% of the Total Cost of Sales, roughly 40% of
the cost of aluminum cans is the price of aluminum and the sales of cans
which accounts for 60% of the net Revenue)
Secondly, knowledge about the aluminum market is necessary for the
company. The LME is a sophisticated trading platform and over-the-counter
(OTC) products are largely available. It is important to have a thorough
understanding of the normal price level of aluminum. Buying futures only if
there is a moderate chance of long lasting price drops, otherwise it can ruin

Delta case

Group 17

the business on the macroeconomic level. A good example is the European

airline industry where most airlines had bought futures to hedge their risk on
oil prices. Ryanair was one of the few who hadnt bought the futures which
became one of its biggest competitive advantages, therefore DBG needs to
make a thorough assessment of the hedging behavior of its competitors.

Forecasted Income Statement

In order to take deeper look of the financial situation, the forecasted income
statement is made for analysis. The forecasted revenue is based on average
increase rate of historical financial data. In addition, we have assumed an
annual price increase of 30%, 22.5% and 15%. 22.5% is based on calculated
annual growth rate of July 1993 to June 1994. The increase of 30% is the
data from the case (Exhibit 10) and 10% is a dummy number to create
different scenarios. We have calculated the impact of different price increases
of aluminum on the interest coverage ratio and compared them with the
situation if futures were bought.
Based on our calculation, a price increase has a relative big effect on the
coverage ratio. If the price increase with 22.5% then the coverage ratio will
fall below the covenant ratio of 2.0 in 1996. If the price increase with 15%,
DBG still could handle the risk by its own.

Conclusion
Based on our calculation, hedging is only important if the price of aluminum
will increase 22.5% in 1995. 27 months hedge is a better option if DBG decide
to buy futures. If the price increase even higher, like 30%, DBG should hedge
even earlier. Aluminum price has volatilities of 30.4%, to ensure the company
will not fallen into default, the hedge with future could be our advice for DBG
to hedge its financial risk.

Delta case

Forecasted Income Statement

Ratio analysis

Group 17

Delta case

Scenario 1

Scenario 2

Scenario 3

Group 17