8/10/2019 Deutsche Brewery Help

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Deutsche Braueri

I. Introductory Paragraph

Deutsche Brauerei has been a family owned and operated corporation for 12 generations, which has created a high level of focus and control. Each generation has kept the management and

operations processes relatively simple, centered on brewing practices and quality. Deutsche Brauereis rapid growth in recent years can be attribu ted to several factors. First and foremost, the

companys success is centered on the product itself, which has won numerous quality awards and is quite popular in Germany. Another contributing factor to the recent growth may have been

a bit inadvertent. The purchase of new equipment in 1994, which was necessary as a result of a fire that destroyed the old equipment, allowed the company to increase brewing capacity and

efficiency. Finally, Deutsche Brauereis decision to enter the Ukranian market in 1998 contributed significantly to the rapidgrowth. The collapse of the U.S.S.R. brought market reforms, and

Deutsche Brauerei jumped on the opportunity to enter the fragmented beer industry, capture the large population and capitalize on the prime location in Eur ope. Lukas Schweitzer was savvy

enough to hire local expert Oleg Pinchuk away from a competitor as the marketing manager, and Oleg was instrumental in building the business in Ukraine by securing accounts and

implementing the field warehousing to support distributors. Deutsches beer was hugely popular in the Ukraine almost immediat ely, and volume sales more than offset the depreciation of the

Ukrainian currency. Sales in Ukraine accounted for 28% of Deutsches total sales, and skyrocketed from 4,262 euros in 1998 to 25,847 euros in 2001.

II. Statement of the Case Problem

Greta, niece of Lukas and a recent MBA graduate, has newly joined Deutsches board of directors and must make a recommendation on three issues: the financial plan for 2001, the

declaration of a quarterly dividend, and adoption of the proposed incentive and compensation package for Oleg. The financial plan includes a 7 million euro investment in new plant and

equipment for the Ukrainian operations in 2001, followed by a 6.8 million euro investment in 2002 for a new Ukranian warehouse and distribution center. This is a significant investment, and the

practicality of rooting themselves in the Ukraine in this manner needs to be fully assessed before Deutsche commits to such an expensive endeavor.

The quarterly dividend proposed is 698,000 euro, an amount equal to 25% of the projected 2001 dividends. However, this dividend increase is based on projected earnings, and several factors

affect whether those earnings will materialize.

Finally, Lukas has recommended an increase in base pay and incentives for Oleg, from a salary of e40,000 plus 5% of the annua l sales increase in Ukraine, to e48,500 and 6% of sales. While

Oleg has worked hard and produced results over the past 2 years, a compensation package based on sales alone is unwise, as several factors affect a companys profitability.

III. Analysis of Problem

When DB first entered the Ukranian market, Oleg relaxed the credit policy for Ukranian distributors from 2 percent 10, net 40 to 2 percent 10, net 80 (clients could take a 2% discount if payment

was made within 10 days of the invoice, otherwise payment was due in full within 80 days). The credit policy for Ukranian distributors differed because Ukrainian entrepreneurs, while eager and

entrepreneurial, were not privy to the same capital or bank loans that German distributors had access to. The credit policy f or the Ukranian distributors was appropriate, given that they were

expanding, getting new equipment, and required more time than usual to pay. A flexible credit policy in the Ukraine is appropriate initially while building relationships and as the beer distribution

pipeline is developed. However, Oleg would like to extend the credit policy from 80 to 90 days. The current receivables show e6,168 in 2000 and is projected to increase about 50% in 2001 and

then another 30% in 2002. Having money tied up in accounts receivables is certainly not as profitable as having cash in hand. Olegs proposal to relax the credit policy even further isa high risk

and may result in distributors settling accounts even later.

Assuming for the moment that investment in new plant and warehouse in the Ukraine is a good idea, Deutsche doesnt appear to be sufficiently financially fit to pull it off. While sales have

grown rapidly for the past few years, the increasing amounts of bank debt reveal that Deutsche doesnt have the cash to finance their growth. A good portion of their profits is tied up in

inventories and accounts receivables (Exhibit 1). The quick ratio of roughly 0.85 (Exhibit 4 in the case) indicates Deutsche isnt able to meet short term obligations as well as it should. It

appears Oleg had a bit of tunnel vision when it came to increasing sales, at the expense of Deutsches overall profitability.

Indicated assumptions:

A. Credit extension is cut back in the east to 41 days and the annual rate of sales in the east grows only 2 percent per year (down from 45 percent and 30 percent).

B. The plant is not expanded in 2001 and 2002; company sales growth in east and west is only 2 percent per year. Days sales outstanding in both east and west are 41 days/

C. Dividend payments as a percentage of net income are reduced to 25 percent.

D. Your scenario that combines any and all of above in various amounts and keeps the 2000 short debt at approximately 13,000 .

Scenario Short-Term Debt Net Income Return on Equity

2001 2002 2001 2002 2001 2002

A.

10,626 10,530 3,606 3,811 12.3% 12.6%

B.

4,276 (1,387) 3,874 4,315 13.2% 14.2%

C.

15,939 17,160 3,805 4,489 12.2% 13.0%

Base Case

17,862 21,372 3,724 4,311 12.7% 14.2%

When we modify the 2001 forecast assumptions for Scenario A (decreasing projected Ukraine sales from 45% to 2%) the short term debt picture improves, but at the expense of a decreasing

ROE and net income. Scenario B (not expanding and modifying credit policy) is better for Deutsche, as short term debt is eliminated by 2002, while net income and ROE remain relatively

stable. Scenario C doesnt really do much to chip away at the short term debt (probably because of the heavy investment in Uk raine expansion), with little to show in net income and a decline in

ROE.

Scenario A exemplifies that it isnt profitable for Deutsche to invest in receivables at all, as Oleg would like us to believe. Exhibit 4 for Scenario A attached shows the impact on the debt-to-

equity ratios when we modify the assumptions, improving significantly from 77% and 83% to 52% and 47% in 2001 and 2002 respectively. The company is also able to get a better handle on

receivables for Ukraine.

Scenario B demonstrates that it may not be the best time for Deutsche to invest in a plant and warehouse in the Ukraine. Until they get a better handle on receivables and have more cash on

hand to finance a good portion of the expansion (instead of relying on bank debt), not expanding in 2001 would allow Deutsche to eliminate the short term debt and still see improvements in net

income and ROE for 2001.

Scenario C alone doesnt do too much for Deutsche, other than probably tick off all the older relatives. There is very little impact on short term debt, minimal increase in net income and ROE

actually declines. Dividends paid to shareholders are a traditional indicator of a firms financial health, and for public companies, a consistent dividend payment is a good sign for investors. But

Deutsche is a privately held company, and while they have traditionally aimed for a dividend payment of 75% of earnings for each year to satisfy the older, retired relatives, if dividends were

reduced slightly, those funds can be used to pay off debt and reinvest in Deutsches long term sustainability.

IV. Recommendations

Regarding the credit policy for Ukranian distributors, Oleg argues that this process is profitable for the company (Deutsche borrows at 6.5% to finance Ukraine receivables, and nets a return of

roughly 130%). However, Exhibit 1 in the base case shows accounts receivables in the Ukraine increased 30% from 1999 to 2000, and is projected to increase for the next 2 years (50% then

30% based on the previous year). Having a large amount of money tied up in receivables is risky. I would recommend that the credit policy be modified to give a higher discount to those that

pay the accounts in full on time, for example, 3 percent 10 net 80, or in an attempt to get a better handle on the receivables, 3 percent 10 net 45.

As for the adoption of the 2001 financial plan, I would recommend a more conservative approach in terms of the expansion plans. The numbers Oleg provided assumes Ukraine sales will

continue to increase at a high rate, but the Ukrainian beer market is still in the early stages. Deutsche should be more conservative and consider waiting to purchase new equipment and a

warehouse in the Ukraine until they can fund a good portion of it themselves, instead of relying on loans. Right now, the break-even point is close to sales of 1,000,000 hectoliters (ex.5) so

controlling costs should be a concern. As the market matures, competition will chip away at Deutsche, and the company will have to deal with decreased market share and volume sales.

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Having to pay on large loans for the proposed expansion on top of that will certainly impact profitability.

Deutsche has traditionally aimed for a dividend payment of 75% of earnings for each year, which has satisfied the family and been sufficient for the older, retired relatives.

Lukas suggested the 2001 first quarter dividends equal of the historical 75% of earnings for the full 2001 year earnings projections. Dividends should be based on actual profits, so when

basing the dividend on projected profits as Lukas suggested, I would recommend erring on the conservative side and maybe paying 65% of projected earnings for the first quarter. Paying a

more conservative dividend early in the year will allow Deutsche to see if the projections match actual earnings. If the first and second quarter earnings are in line with the projections, Deutsche

can always pay a higher dividend in the subsequent quarters to reach that 75% mark for the year. In the meantime, Lukas can justify it to the family by saying they have always taken care of

the older generations, but the time has come to look out for future generations.

I agree that Olegs performance for the past 30 months warrants an increase in salary and compensation. Lukas proposed a whop ping 21.25% increase in base salary from 40,000 to 48,500

and an increase in incentives from 5% of sales to 6% of sales. I agree with the proposed increase in base salary, but I would recommend leaving the compensation at 5%, as the projected

increase in volume sales will still net Oleg a nice incentive package. In lieu of that, I would recommend a flat or sliding flat bonus of some sort based on Olegs ability to reduce the accounts

receivables and inventories while increasing volume sales.