9/27/2016

Delta Beverage
Group, Inc.

Group 5
Haci Mustafa Sahin 2543058
Tarik Egirgen 2543060
Morsal Sarwarzadeh - 2539387

In this report we will give insight in the current financial situation of Delta Beverage Group, Inc.
Furthermore, we will advise you regarding the problems and short comings of the company. Firstly, we
will be pointing out the key problems by analyzing the business and financial risk of Delta Beverage in
the soft drinks industry. Next we will discuss a hedging program using aluminum futures contracts, this
will be done by a scenario analysis. In the end we will give Mr. Bierbaum an advice on whether he should
hedge aluminum using futures contract or not.
Business risk
Delta Beverage is a large bottling company and a part of the PepsiCo franchise. Looking at the sales we
see that Delta Beverage is a large company. The sales volume has increased the past few years,
especially due to the taken number of acquisitions. Competition became a problem in 1989 when CCE
succeeded in buying some of the competing brand franchises in the same areas. A new management
team had been hired which succeeded in stopping the fall in prices and the dwindling market share and
also increased the margins by attacking the cost structure.
Despite the positive impact of the recapitalization plan in 1993, net income is still negative due to the
high interest expenses, although it increased by almost 100 percent. Its important to still focus on the
cost structure, so that the company will be able to make profits. As told before Delta Beverage is a
franchise of PepsiCo. One of the obligations of being a franchise is that Delta Beverage has to buy its
concentrates and syrups from PepsiCo only. This means Delta Beverage is not able to influence the given
price, so it should focus on the cost structure of the bottles and cans. Further, the price of aluminium,
which is a core raw material, had risen 30 percent on the London Metal Exchange during the first half of
1994. As a result of this there is a high chance the price of aluminium cans rises. This will have a high
impact on the cost of goods sold because these aluminium cans are a key cost component. This situation
will again lead to continuing losses. To hedge against this risk, we will consider a hedging program using
aluminium futures
To give a good view on the several calculated ratios its important to know in which phase of the product
life cycle soft drinks are situated. Delta Beverage operates in the soft drinks industry, which shows
diminishing growth in the US industry. Remarkable is the relatively high consumption of soft drinks in
the South areas of the US. Considering the diminishing growth of the whole US soft drinks industry and
the high leverage of Delta Beverage (see exhibit 1), we conclude that the company is in the maturity
phase of the product life cycle, which mostly indicates a high leverage level.
Long term financing risk
Exhibit 1 shows the long term financing risk Delta Beverage has to deal with. The debt to equity ratio
increased extremely during the period of 1989-1992. The 1993 recapitalization plan has caused a sharp
decrease, but the ratio is still excessive. The debt ratio also shows the high leverage of Delta Beverage.
For a company which is in the maturity phase of the product life cycle its normal to have a higher debt,
but the debt ratio is still extreme in this case. Although the 1993 recapitalization plan lowered the debt
level, it still shows a high financing risk which make it less attractive for shareholders to invest in the
company. In case of bankruptcy shareholders will lose all their money because the debtholders will be

paid first. Also this high long term financing risk leads to a situation where the company cant get any
additional borrowing funds and has to deal with less financial flexibility. So maintaining the 2.00 interest
coverage ratio is key since attracting new additional long term debt is hard.
Exhibit 1: Long term financing risk
Debt
Equity
Debt to equity ratio
Total assets
Debt ratio

1989
188484
34851
541%
223335
84%

1990
181543
28526
636%
210069
86%

1991
186262
17737
1050%
203999
91%

1992
206752
3686
5609%
210438
98%

1993
166572
47134
353%
213706
78%

Short term financing risk

Exhibit 2 shows the short term financing risk over the past few years. The working capital ratio and the
quick ratio gives an indication whether delta beverage is able to meet its short term obligations. Its
important to have a working capital ratio and quick ratio of 1 (or higher). We see that the working
capital ratio had decreased during the period 1989-1992. Due to the 1993 recapitalization plan the
working capital ratio increased by 82.3 percent. A ratio of 2.77 indicates that the company is able to
meet its short term obligations. The same applies to the quick ratio, which gives almost the same insight
as the working capital ratio but it deducts inventories from the current assets.
Based on exhibit 2 we conclude that the short term financing risk of delta beverage is low, which
indicates a strong liquid position where Delta Beverage is able to meet its short term obligations.
Exhibit 2: Short term financing risk

Current assets
Current liabilities
Net working capital
Working capital ratio
Inventories
Quick ratio

1989
39254
22733
16521
1,73
8893
1,34

1990
33196
19233
13963
1,73
6726
1,38

1991
36204
21998
14206
1,65
9808
1,20

1992
41349
27291
14058
1,52
10607
1,13

1993
50192
18147
32045
2,77
10104
2,21

Scenario analysis
The debt of the company is restructured with the 1993 Recapitalization Plan. With these new senior
notes, the company has to meet new loan covenants. These covenants include to maintain a certain
senior leverage ratio, a total leverage ratio and an interest coverage ratio.
The biggest concern of the company should be the aluminium prices. Aluminium packaging is 49% of the
costs for a can, while these cans also contribute for 60% of the sales. The can manufacturers are
suffering from higher aluminium prices; however, it isnt clear how this will affect the company. We
expect that it can have a big impact due to the high weight of aluminium packaging in the cost of goods
sold. By hedging this risk can be mitigated. Since an operational hedge is not an option, a financial hedge

should be considered by using futures for the aluminium prices since there are no futures available for
fructose concentrate and other raw materials.
We calculated the required rates for the covenants from 1993-1996 in different scenarios to predict the
expected impact of the price. A summary of these situation and the impact on the required ratios can be
found in Exhibit 3, a more detailed view is on Exhibit 4 and 5 at the end of the report. For the
calculations a couple of assumptions have been made. We expected a 4% growth. First we calculated
two scenarios where no hedging takes place and the prices increase by 22.5% and 15%. You can
immediately observe that a price change of 22.5% will affect the ratios heavily, bringing it to a level
below the required levels of the covenants. In the scenario with a price increase of 15% everything
seems fine, however it is still a risky scenario. Next we created two scenarios with fully hedging, both
seem to satisfy the covenants significantly. We hedged for the years 1995 and 1996 since in 1994 the
prices were fixed due to the co op. However, by hedging fully we excluded possibly situations where the
prices will drop below the expected levels with hedging. This way we might miss on some opportunities
that come with a price drop. That is why we created one last scenario where we decided to hedge
partially. By hedging for 46% and a price increase of 22.5% the interest coverage ratio will be breakeven,
while satisfying the other covenants. However, this still might be a bit risky in case the price increases
even higher than 22.5% due to the high volatile market. So our advice to Mr. Bierbaum is to hedge
partially. Between 50-60% seems reasonable and will leave a significant amount open for possible price
drops that might affect the firm advantageously.

Exhibit 3: covenant requirements

Scenario:
Ratio
Required levels
Interest Coverage >
Total Leverage <
Senior Leverage <
22.5% Price increase
Interest Coverage
Total Leverage
Senior Leverage
15% Price increase
Interest Coverage
Total Leverage
Senior Leverage
Hedging 15M
Interest Coverage
Total Leverage
Senior Leverage
Hedging 27M
Interest Coverage
Total Leverage
Senior Leverage
Partial 46% Hedging
Interest Coverage
Total Leverage
Senior Leverage

1993
2,00
6,40
5,15
2,12
5,70
4,24
2,12
5,70
4,24
2,12
5,70
4,24
2,12
5,70
4,24
2,12
5,70
4,24

1994
2,00
6,25
5,00
2,49
4,86
3,58
2,49
4,86
3,58
2,49
4,86
3,58
2,49
4,86
3,58
2,49
4,86
3,58

1995
2,00
6,25
5,00
1,62
7,45
5,40
2,00
6,06
4,39
2,43
4,99
3,61
2,31
5,24
3,80
2,00
6,06
4,39

1996
2,00
5,75
4,50
1,80
6,73
4,78
2,20
5,49
3,91
2,67
4,53
3,22
2,54
4,76
3,38
2,20
5,49
3,91

Recommendation
Mr. Bierbaum has a difficult decision to make, so we provided him different scenarios. By taking a quick
look we can see that a 15M hedge seems to offer the best result. However, if we look closely to the cash
and future price differences we notice a 6-8% difference. Futures being higher. That is why we
recommend Mr. Bierbaum to not hedge fully. In our calculations we have made it clear that by hedging
for 46% and increase of prices by 22.5% the interest coverage ratio will be exactly 2.00 which satisfies
the required level of the covenant. Due to volatile aluminium prices it would be better to hedge a larger
part of the prices. Our advice is between 50-60% so a slightly higher price increase than 22.5% wouldnt
exceed the interest coverage covenant. Although we have mentioned the volatile prices mostly as a
negative risk it might be a positive risk as well. The high volatility of the aluminium prices can cause the
prices to drop under the futures level which might be more advantageous then a fully hedged scenario.
So by hedging partially Mr.Bierbaum can mitigate the impact of the volatile aluminium prices on his
business, but still have opportunity to take advantage of the same volatile prices.