case study - corp finance - padgett paper products
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Padgett Paper Products Company
Agida * Dantes * de Leon * Estanislao * Lope * Ronquillo
Current Situation
Padgett and Caslon have been long time banking partners
Recently, $ 3.7 Million loan was granted to Padgett when to acquire Tri-state Tablet.
The terms of the loan is abnormal Padgett's debt structure must be revised in a
mutually satisfactory manner.
Objective
To find a mutually acceptable debt structure that will minimize lender risk while increasing company value.
Methodology Review Company Background and Industry
Conditions Evaluate Padgett Paper Product’s Strategy and
Financial Performance. Provide advantages and disadvantages of the
proposed options using the financial ratios. Recommend the best solution or combination
of solutions that will benefit all concerned parties.
Company and Owners Padgett Paper Products is a 100 year old
closely-held company and only a few family members were active in the management of the company
Owners interest is mainly on dividend distribution
The main business of the company is into manufacturing stationary such as notebooks, loose leaf binders and filler paper.
It has over 5,000 wholesalers and retailers in US and Canada.
Industry Conditions During the 1970s, there has been a
consolidation in the market due to high inflation rates which made it difficult for small firms to finance their current assets. Financial difficulties and inventory problems due to the recession in the early 1980s further reduced the level of competition. Increasing paper prices created financial strains and forced small firms to sell. Price increases were not passed to customers due to strong competition from large integrated paper companies.
Company Strategies Management’s expertise is largely on
operations maintain level production to reduce unit cost minor acquisitions of companies that fit into its
product or marketing needs take advantage of seasonal sales peaks.
Management’s expertise is largely on operations and managers (Ruhl) are not finance savvy
Company Strategies Financial policy is primarily conservative.
The company also does not require high levels of debt.
Short-term borrowing used for seasonal cash needs during back-to-school sales and minor acquisitions.
Increased dependence on 90 day term notes even on large loans (including Tri-State Tablet Co. 3.6M)
The company has not taken advantage as well of its significant level of equity. D/E is not maximized and value from tax shield is lost.
Predicament Ruhl’s POV:
Forecasted lower interest due to upcoming elections
Libris proposal is too high Believes that firm should continue with the
current strategy Libris’ POV:
Pay out would take 8 years based on forecast No collateral – high risk’
Padgett Liabilities Position(1993 - 1996)
0 0
3,118
7,221
338 221 507 4550
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
1993 1994 1995 1996
Years
tho
usa
nd
of
US
D
Short term notes Long term Debt
Analysis of Current Financial Status
There is a drastic increase of 3M short term notes in 1995 and an additional of roughly 4M in 1996.
Incr ( Dcr ) Incr ( Dcr ) Incr ( Dcr )
1993-1994 1994-1995 1995-1996
Short term notes Difference 0.00 3,118.00 4,103.00
% Difference n/a n/a 131.59%
Long term Debt Difference -117.00 286.00 -52.00
% Difference -34.62% 129.41% -10.26%
Analysis of Current Financial Status
There is a huge increase in short term notes, reaching 130% increase from 1995 to 1996. There are minimal fluctuations in long term debt as compared to short term debt.
Continued…
1993 1994 1995 1996
Gross Sales 10,603 10,632 14,293 16,014
Operating Expenses 5,814 6,965 9,742 10,968
Operating Profit 4,789 3,667 4,551 5,046
Interest Expense 0 32 220 379
Other expenses ( income ) 83 -42 -39 -71
Income taxes 2,702 1,893 2,216 2,132
Profit after taxes 2,004 1,784 2,154 2,606
Number of shares ( 000 ) 1,000 1,115 1,116 1,118
Earnings per share 2.00 1.60 1.93 2.33
Dividends per share 1.00 1.00 1.00 1.00
Figures from Padgett’s Income Statements for the Fiscal Years Ended April 30,1993-1996 ( thousand of dollars except per share figures )
Incr (Dcr)
1993-1994Incr (Dcr) 1994-1995
Incr (Dcr) 1995-1996
%Diff 1993-1994
%Diff 1994-1995
%Diff 1995-1996
Gross Sales 29 3,661 1,721 0.27% 34.43% 12.04%
Operating Expenses 1,151 2,777 1,226 19.80% 39.87% 12.58%
Operating Profit -1,122 884 495 -23.43% 24.11% 10.88%
Interest Expense 32 188 159 587.50% 72.27%
Other expenses ( income ) -125 3 -32 -150.60% -7.14% 82.05%
Income taxes -809 323 -84 -29.94% 17.06% -3.79%
Profit after taxes -220 370 452 -10.98% 20.74% 20.98%
Analysis of Current Financial Status
There is a continued decrease in profit margin.
Profitability 1993 1994 1995 1996
Diff 1993-1994
Diff 1994-1995
Diff 1995-1996
Sales Growth n.a. 3.37% 35.56% 11.95% 32.18% -23.60%
Gross Profit Margin 40.27% 39.06% 38.74% 38.77% -1.21% -0.32% 0.03%
Operating expenses/sales 22.08% 25.59% 26.40% 26.55% 3.51% 0.81% 0.15%
Pre-tax margin 17.87% 13.51% 11.84% 11.47% -4.36% -1.67% -0.37%
After-tax margin 7.61% 6.55% 5.84% 6.31% -1.06% -0.72% 0.47%
ROE n.a. 11.36% 13.01% 14.63% 1.65% 1.61%
ROA 10.67% 9.23% 8.66% 8.41% -1.44% -0.56% -0.26%
EBIT/total assets 25.05% 19.18% 18.46% 16.51% -5.86% -0.72% -1.95%
Dividend Payout 49.90% 62.50% 51.81% 42.90% 12.60% -10.69% -8.91%
Self sustaining Growth rate n.a. 4.26% 6.27% 8.35%
Analysis of Current Financial Status
OPEX steadily increases
Profitability 1993 1994 1995 1996
Diff 1993-1994
Diff 1994-1995
Diff 1995-1996
Sales Growth n.a. 3.37% 35.56% 11.95% 32.18% -23.60%
Gross Profit Margin 40.27% 39.06% 38.74% 38.77% -1.21% -0.32% 0.03%
Operating expenses/sales 22.08% 25.59% 26.40% 26.55% 3.51% 0.81% 0.15%
Pre-tax margin 17.87% 13.51% 11.84% 11.47% -4.36% -1.67% -0.37%
After-tax margin 7.61% 6.55% 5.84% 6.31% -1.06% -0.72% 0.47%
ROE n.a. 11.36% 13.01% 14.63% 1.65% 1.61%
ROA 10.67% 9.23% 8.66% 8.41% -1.44% -0.56% -0.26%
EBIT/total assets 25.05% 19.18% 18.46% 16.51% -5.86% -0.72% -1.95%
Dividend Payout 49.90% 62.50% 51.81% 42.90% 12.60% -10.69% -8.91%
Self sustaining Growth rate n.a. 4.26% 6.27% 8.35%
Analysis of Current Financial Status
Margins are becoming tight due to competition
Profitability 1993 1994 1995 1996
Diff 1993-1994
Diff 1994-1995
Diff 1995-1996
Sales Growth n.a. 3.37% 35.56% 11.95% 32.18% -23.60%
Gross Profit Margin 40.27% 39.06% 38.74% 38.77% -1.21% -0.32% 0.03%
Operating expenses/sales 22.08% 25.59% 26.40% 26.55% 3.51% 0.81% 0.15%
Pre-tax margin 17.87% 13.51% 11.84% 11.47% -4.36% -1.67% -0.37%
After-tax margin 7.61% 6.55% 5.84% 6.31% -1.06% -0.72% 0.47%
ROE n.a. 11.36% 13.01% 14.63% 1.65% 1.61%
ROA 10.67% 9.23% 8.66% 8.41% -1.44% -0.56% -0.26%
EBIT/total assets 25.05% 19.18% 18.46% 16.51% -5.86% -0.72% -1.95%
Dividend Payout 49.90% 62.50% 51.81% 42.90% 12.60% -10.69% -8.91%
Self sustaining Growth rate n.a. 4.26% 6.27% 8.35%
Analysis of Current Financial Status
There is a constant dividend payout over the years despite fluctuations in other indicators of profitability
Profitability 1993 1994 1995 1996
Diff 1993-1994
Diff 1994-1995
Diff 1995-1996
Sales Growth n.a. 3.37% 35.56% 11.95% 32.18% 23.60%
Gross Profit Margin 40.27% 39.06% 38.74% 38.77% 1.21% -0.32% 0.03%
Operating expenses/sales 22.08% 25.59% 26.40% 26.55% 3.51% 0.81% 0.15%
Pre-tax margin 17.87% 13.51% 11.84% 11.47% -4.36% -1.67% -0.37%
After-tax margin 7.61% 6.55% 5.84% 6.31% -1.06% -0.72% 0.47%
ROE n.a. 11.36% 13.01% 14.63% 1.65% 1.61%
ROA 10.67% 9.23% 8.66% 8.41% -1.44% -0.56% -0.26%
EBIT/total assets 25.05% 19.18% 18.46% 16.51% -5.86% -0.72% -1.95%
Dividend Payout 49.90% 62.50% 51.81% 42.90% 12.60% 10.69% -8.91%
Self sustaining Growth rate n.a. 4.26% 6.27% 8.35%
Analysis of Current Financial Status
Plowback rate of less than 10% can be considered very low.
Profitability 1993 1994 1995 1996
Diff 1993-1994
Diff 1994-1995
Diff 1995-1996
Sales Growth n.a. 3.37% 35.56% 11.95% 32.18% 23.60%
Gross Profit Margin 40.27% 39.06% 38.74% 38.77% 1.21% -0.32% 0.03%
Operating expenses/sales 22.08% 25.59% 26.40% 26.55% 3.51% 0.81% 0.15%
Pre-tax margin 17.87% 13.51% 11.84% 11.47% -4.36% -1.67% -0.37%
After-tax margin 7.61% 6.55% 5.84% 6.31% -1.06% -0.72% 0.47%
ROE n.a. 11.36% 13.01% 14.63% 1.65% 1.61%
ROA 10.67% 9.23% 8.66% 8.41% -1.44% -0.56% -0.26%
EBIT/total assets 25.05% 19.18% 18.46% 16.51% -5.86% -0.72% -1.95%
Dividend Payout 49.90% 62.50% 51.81% 42.90% 12.60% 10.69% -8.91%
Self sustaining Growth rate n.a. 4.26% 6.27% 8.35%
Analysis of Current Financial Status
Despite rise and fall in sales, OPEX, NI, and other figures in the its Income Statement, Padgett’s Div per Share remains constant.
Trend of Figures from Padgett's Income Statement(1993 - 1996)
10,603 10,632
14,29316,014
2,004 1,784 2,154 2,606
5,8146,965
9,74210,968
83 -42 -39 -711.00 1.00 1.00 1.00
-2,000
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
1993 1994 1995 1996
Years
tho
usa
nd
of
US
D
Gross Sales Profit after taxes
Operating Expenses Other expenses ( income )
Dividends per share
Analysis of Current Financial Status360/Turnover on Sales (1993-1996)
-
50
100
150
200
250
Receivables Inventory AccountsPayable
WorkingCapital
Fixed Asset Net worth
Metrics
Nu
mb
er o
f D
ays
1993 1994 1995 1996
Analysis of Current Financial Status
receivables are collected every 2.25 months
inventory is consumed up every 4.17 months
payables/dues are settled within 0.57 months
working capital is turned over every 3.61 months
fixed asset value is turned over every 2.11 months
net worth is turned over every 5.39 months
360/Turnover on Sales 1993 1994 1995 1996
Receivables 64.7 73.3 62.0 67.6
Inventory 99.5 102.4 106.9 125.1
Accounts Payable 15.4 21.4 21.1 17.1
Working Capital 157.6 150.3 113.9 108.4
Fixed Asset 65.6 70.5 62.0 63.3
Net worth 210.1 212.1 166.6 161.8
Analysis of Current Financial Status
There is a drastic increaser in Debt-Equity Ratio over tha last 2 years.
Padgett Leverage Position(1993 - 1996)
0.22 0.21
0.46
0.67
0.02 0.01 0.03 0.020.00
0.20
0.40
0.60
0.80
1993 1994 1995 1996
Years
Debt/equity Ratio Long term debt / Equity Ratio
Analysis of Current Financial Status
acquisition of Tri-state additional 3.6m loan
has more short term notes than long term debt
high interest expense due to more short term notes
total long term debt 6.1x of short term notes in 1995 and 15.9x in 1996
current liabilities is already higher than current assets less inventory
higher current liabilities
Leverage 1993 1994 1995 1996
Debt/equity Ratio 22.3% 20.6% 45.6% 67.0%
Long term debt / Equity Ratio 2.2% 1.4% 3.0% 2.5%
Interest coverage (EBIT/interest ) n.a.
115.9
20.9
13.5
Short term notes/ Long term debt Ratio
-
-
6.1
15.9
Liquidity
Quick Ratio ((cash + securities +AR )/current liabilities)
2.7
2.4
1.1
0.8
Current ratio ( current assets / current liabilities )
5.8
5.8
2.8
2.1
Analysis of Current Financial Status Key Findings:
There is a huge amount of short-term notes vis-à-vis long–term debt: a very risky position
Owners continue to get constant dividends regardless of the firms financial status
Plowback rate is very lowCurrent liabilities could not anymore be
financed by current assetsDebt/Equity Ratio reveals that current
situation may lead to bankruptcy in the long run
General Recommendation
Shift to long-term financing to finance long-term assets First level of leverage
• Collateralized assets (c/o Rachelle)• Mortgage general purpose building (c/o Rachelle)• Continue using LIFO instead of FIFO (c/o Erle)
Second level of leverage• Debt through insurance company (c/o Mic)• Factor Receivables at 2% instead of 2/10 net 30 (c/o
Rachelle)
LIFO Instead of FIFO
LIFO stands for last-in, first-out, meaning that the most recently purchased items are recorded as sold first.
Most recent good bought is more expensive than the older ones.
LIFO reduces income taxes in times of inflation
LIFO Instead of FIFO
Gross Margin = Net Sales – Cost of Goods Sold
Operating Profit = Gross Margin – OPEX
Profit before taxes = Operating Profit – Interest and Other Expenses
Income Tax = Profit before taxes * %tax
• Assumption: %tax remains constant• Refer to Financial Model for Example
Microsoft Excel Worksheet
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