CASE 1

DELTA BEVERAGE GROUP, INC.

GROUP 7

Dalia Abdelbaki 1979329
Chesron Esseboom 1941143
Wouter Hendriksen 2123258
































The Delta Beverage Case discusses the financial difficulties that the Delta Beverage
Group faced during 1989 till 1993, and the solutions that were brought in by the
management. The Delta Beverage Group belongs to one of the top five independent
bottlers of PepsiCo in the U.S, as it became a part of PepsiCo franchise in 1994. Delta
Beverage Group has to buy its concentrate and syrup only from PepsiCo at
established prices that would increase by the consumer price index. The other raw
materials needed for the bottling process would include ingredients with non-fixed
prices, for example; PET, fructose and aluminum. This proved to be challenging,
considering the increase in the price of aluminum by 30 percent in the first half of
1994. This was accompanied by a significant rise in the prices of PET and fructose.

John Bierbaum, chief financial officer of the Delta Beverage Group, is concerned
about these increases and is not sure if the company could bear any more increases in
raw material prices. The recapitalization plan in 1993 saved the company from
bankruptcy by closing agreements with senior debt holders. Currently in 1994, debt
holders are not willing to enter a new agreement to prevent the company from
defaulting on its debt. John Bierbaum is considering the possibility of hedging
aluminum by buying future contracts. This way aluminum prices are set and
unfavorable fluctuations could not put the company in distress.

To have a better insight of the situation at hand, and to be able to make a sound
decision on whether the CFO should hedge aluminum by buying future contracts, we
have to compute relevant financial ratios and determine the outcome of different
possible scenarios. Along the way, we will make some assumptions.

While the growth in soft drinks consumption of the South compared to the whole U.S.
is relatively high, the U.S. industry shows clearly diminishing growth rates for soft
drinks. From this we could assume that the Delta Beverage Group along with the
whole soft drink industry is in its maturity phase. Regarding the debt-to-equity ratio
and debt ratio of previous years as shown below in table 1, we could state that the
Delta Beverage Group is highly leveraged. Based on this, we could assume that the
company is not healthy and suffers from debt overhang. This would make investors
reluctant to invest in the company due to default risk, which in that case leaves
investors with nothing to collect after repaying the debt holders. The option of
borrowing funds would be too expensive in addition to the limits of the covenants.


Table 1
Year 1989 1990 1991 1992 1993
Debt 165,751 162,310 164,264 172,185 141,149
Equity 69,702 57,052 35,474 7,372 94,268
Assets 223,335 210,069 203,999 210,438 213,705
D/E ratio 2.38 2.84 4.63 23.36 1.5
Debt ratio 0.74 0.77 0.81 0.82 0.66






John Bierbaum, CFO of Delta Beverage Group, would like to consider the possibility
of hedging aluminum prices by buying future contracts, which might secure the
company in the long- term. However, defaulting on short- term obligations would be a
financial disaster. This means assessing the current financial situation of the company
implies the computation of the current and quick ratio. Those ratios measure the
ability of paying short- term obligations and need to be at least 1 for the firm to be
considered healthy. Table 2 below presents the ratios for year 1989 till 1993. In
general the higher the ratio the greater the companys liquidity.


Table 2
Year 1989 1990 1991 1992 1993
Inventory 8,893 6,726 9,808 10,607 10,104
Current Assets 39,254 33,196 36,204 41,349 50,192
Current Liabilities 22,733 19,233 21,998 27,291 18,147
Quick ratio (Acid Test
Ratio) 1,34 1,38 1,20 1,13 2,21
Current ratio 1,73 1,73 1,65 1,52 2,77


For the current ratio, we look at to which degree the current assets cover the payment
of the current liabilities. While for the quick ratio, the inventory is considered to be
illiquid in case of default and therefore is deducted from the total amount of current
assets. Delta Beverage Group maintains a current and quick ratio of above the 1 for
all stated years, which means that they are not likely to default on short- term
obligations based on historical data.

Now that the current financial situation of Delta Beverage Group is assessed, we can
consider the possibility of hedging to secure the company from increasing aluminum
prices.

Hedging or not?

As stated in the case an operational hedge is not recommendable because of the
different market segments in which Delta is active. For fructose and PET financial
hedging is not possible because there are no future contracts on the market. The
expectation about the price of aluminum, that Mr. Bierbaum stated, is very risky since
the volatility of the price is high and the company is on the edge of default. If the
price of aluminum keeps rising Delta wont be able to cover its interest payments, this
will end in a default. In order to keep the interest coverage ratio above 2.0 in the
upcoming years its advisable to consider the option of a financial hedge for
aluminum. If the prices remain on the same level a financial hedge is 7-9% more
expensive than buy aluminum with cash. The price can easily rise with more than this
percentage. Because the price of a 15m and 27m hedge are almost the same its
advisable to hedge for 27 months. In the table below is shown what the effect of a
financial hedge is on the interest coverage ratio of Delta. In the scenarios we
described we first used the percentage increase of last year, which was 22.5%. Next to
that we calculated the effect of a 17.5% and 12.5% increase in aluminum prices.
These calculations are shown in the appendix of this paper. The interest coverage
ratio only drops below 2 above an increase of 20%. Because of the minimum price
difference between 15m and 27m futures we recommend Mr. Bierbaum to buy 27m
future option on aluminum.

Table 3: Coverage ratio's
Price aluminium 1993 1994 1995 1996
22,50% 2,12 2,30 1,84 1,91
17,50% 2,12 2,30 2,05 2,14
12,50% 2,12 2,30 2,26 2,38
Future 15M 2,12 2,30 2,52 2,18
Future 27M 2,12 2,30 2,42 3,10



Conclusion & recommendations

The CFO of Delta Beverage Group is considering the possibility of hedging
aluminum prices by buying future contracts. This way the company can hedge the risk
of fluctuating prices. Assessing the current financial situation shows that the debt-to-
equity ratio and debt ratios are high, which means that the company is highly
leveraged causing an increased chance of default and debt overhang. Additionally,
Delta Beverage Group is a maturing company operating in a diminishing growth
industry. The net income and equity on return have increased, which could indicate
that the company is recovering from its losses, although both are still negative. The
current and quick ratios are above 1, which means that the company can meet its
short- term obligations and is not likely to default. A further increase in raw material
prices could lower net income, which could have negative effects on the firm. While
hedging for PET and fructose is not possible, hedging for aluminum would eliminate
some of the risk of price increases.

Hedging would be the most recommendable option for Mr. Bierbaum to defend its
company for rising aluminum prices. The high volatility of aluminum is a high risk if
Mr. Bierbaum decides to dont buy the futures.!














Appendix

1993 1994 1995 1996
Total revenues 231207 244926 259458 274853
Sales mix


Cans 138724 146955 155675 164912
Bottles 60114 63681 67459 71462
Contract sales 32369 34290 36324 38479



Total revenues 231207 244926 259458 274853



Cans 101269 107277 113643 120386
Bottles 37271 39482 41825 44306
Contract sales 17479 18516 19615 20779
total cogs 156018 165276 175082 185471



Gross profit 75189 79650 84376 89382



General expenses 20561 21907 23341 24868
Selling expenses 36791 39169 41701 44396
EBIT 17837 18574 19335 20118



Tons of Aluminium 7938 8256 8812 9406
8256/1.04

Average volume growth rate 6.3%






Futures needed 318 330 352 376


Scenario 1: same Aluminium price increase as last
year
(1461/1193)-
1=22.5%

1993 1994 1995 1996

COGS-aluminium packaging 101269 109448 119105 126172

Gross profit 75189 81261 78914 83596

EBIT 17837 20185 13872 14332

Depreciation&amortization 10894 10083 9333 8638

EBITDA 28731 30269 23205 22970





Debt 141149 137149 131149 125149

Interest expense 13550 13166 12590 12014 9,60%




Interest coverage ratio 2,12 2,30 1,84 1,91




Scenario 2: Aluminium price 17,5%

1993 1994 1995 1996

COGS-aluminium packaging 101269 109448 116476 123387

Gross profit 75189 81261 81542 86380

EBIT 17837 20185 16501 17116

Depreciation&amortization 10894 10083 9333 8638

EBITDA 28731 30269 25834 25754





Debt 141149 137149 131149 125149

Interest expense 13550 13166 12590 12014





Interest coverage ratio 2,12 2,30 2,05 2,14


Scenario 3: Aluminium price 12,5%

1993 1994 1995 1996

COGS-aluminium packaging 101269 109448 113848 120603

Gross profit 75189 81261 84170 89164

EBIT 17837 20185 19129 19900

Depreciation&amortization 10894 10083 9333 8638

EBITDA 28731 30269 28462 28539





Debt 141149 137149 131149 125149

Interest expense 13550 13166 12590 12014





Interest coverage ratio 2,12 2,30 2,26 2,38



WITH FUTURES 1993 1994 1995 1996
Total revenues 231207 244926 259458 274853
Sales mix


Cans 138724 146955 155675 164912
Bottles 60114 63681 67459 71462
Contract sales 32369 34290 36324 38479



Total revenues 231207 244926 259458 274853



Cans 101269 107277 113643 120386
Bottles 37271 39482 41825 44306
Contract sales 17479 18516 19615 20779
total cogs 156018 165276 175082 185471



Gross profit 75189 79650 84376 89382



General expenses 20561 21907 23341 24868
Selling expenses 36791 39169 41701 44396
EBIT 17837 18574 19335 20118



Tons of Aluminium 7938 8256 8812 9406
8256/1.04

Average volume growth rate 6.3%






Futures needed 318 330 352 376



Scenario 1: Hedge with 15 month futures
(1,553/1,461)-
1=6,3% 16,80%

1993 1994 1995 1996

COGS-aluminium packaging 101269 109448 110589 122998

Gross profit 75189 81261 87429 86770

EBIT 17837 20185 22388 17506

Depreciation&amortization 10894 10083 9333 8638

EBITDA 28731 30269 31721 26144





Debt 141149 137149 131149 125149

Interest expense 13550 13166 12590 12014





Interest coverage ratio 2,12 2,30 2,52 2,18





Scenario 2: Hedge with 27 month futures (1,588/1,461)=8,7% 0%

1993 1994 1995 1996

COGS-aluminium packaging 101269 109448 111851 111851

Gross profit 75189 81261 86168 97917

EBIT 17837 20185 21127 28653

Depreciation&amortization 10894 10083 9333 8638

EBITDA 28731 30269 30459 37291





Debt 141149 137149 131149 125149

Interest expense 13550 13166 12590 12014





Interest coverage ratio 2,12 2,30 2,42 3,10