The company and the assumptions of the analysis
What is CHOCOLINE CORP? Company that produces chocolates and sweet delicacies of an artisanal nature. It is a family business, organized as SA in Córdoba (Argentina) since 1990, but with beginnings 20 years before. Several of his chocolate masters are masters in chocolate in Germany, which speaks to valuable know-how. Today it has approximately 50 employees, and one of the most modern plants in the country, but a level of idle capacity of 60%, since they chose, at a bad macro moment for the country (1999), to expand their productive capacity. Until 2002 it had only regional reputation marks; the national and international was only marginal in the core of the company, a situation that changed radically from 2003 (turn around).
NOTE: the numbers are fiction, but are derived from a real case.
a-case-of-corporate-finance-the-turn-around-of-chocoline-corpPorter's 5 Forces and the Macro Environment (1999-2005) for CHOCOLINE
Suppliers: (1999-02) not qualified except packaging material. Cocoa is brought from abroad (risk in case of devaluation), but it has little influence on the cost structure. For (2003-05) there is a certain improvement in the quality of some inputs, but with little impact on costs, which improves the gross margin given the best prices ABC1 pays for the finished product.
Current competitors: at the regional level, only LA CABAÑA in what is artisan chocolate (Córdoba and Mendoza). At the national level, stronger and quality competition (FENOGLIO, BONAFIDE, HAVANNA, EL TURISTA).
Potential competitors: low expectation of entry of pure artisan chocolate companies. However, there are strong players in mass chocolate (CADBURY, ARCOR, etc.) who are always looking towards the artisan market.
Clients: 30% individual, 70% corporate (mainly supermarkets) between 1999-2002. For 2003-05 it goes to a 70/30 in favor of individuals, which increases the gross margin on sales.
Substitutes: similar products but light wave, concept not yet worked by CHOCOLINE.
Macro environment: Between 1999 and 2002, the country's macroeconomy was poor in terms of growth, which drove CHOCOLINE sales downwards. Quite the contrary between 2003-05, with the famous Chinese growth rates K and the improvement in the real exchange rate.
Analysis of ratios for the fall period (1999-2002)
- Between 1999 and 2002, both EBITDA and EBITDA / Sales show a significant drop, mainly explained by:
A significant drop in gross profit (from 48% in 1999 to 34% in 2002, both as% of sales), especially as a consequence of CHOCOLINE's unfavorable bargaining power with its corporate marketing channel (70% of the mix company sales);
An increase in the share of fixed marketing costs as% of sales (going from 11% in 1999 to 24% in 2002), denoting CHOCOLINE's greater commercial efforts to sell in recessive years (as it was between 1999-02), which is also reflected in the increase in its collection cycle (from 62 days in 1999 to 112 days in 2002);
Also, this increase in fixed costs / sales reflects the lack of scale of the company, particularly due to the fact that it is over-invested in a fixed structure (only 40% of the plant capacity used), supporting during the period the incidence of high salaries of qualified personnel (which the company has tried not to lay off due to its potential to generate future value);
As a consequence of all the aforementioned, EBITDA fell from 31% (1999) to 3% (2002) of sales, which shows a very high degree of alert for CHOCOLINE CORP, since its core business after these 4 years was "In a tailspin", although a little mitigated by the acute recession prevailing in our country, which later, for 2003-05, would change radically.
- The BAIT between 1999-02 follows a trend very similar to EBITDA, both in absolute values and on sales, which explains why ROA, that is, the profitability generated by the invested asset (not including the free one), falls from 5, 22% in 1999 to -1.84% in 2002. The causes of the fall in ROA are practically the same as those explained by EBITDA / Sales;
Statement of income
(See PDF)
More crash ratios: 1999-02
In addition to the problems with the marketing channels and the increase in fixed costs, an aggravating situation in the period was CHOCOLINE's unfortunate decision to borrow US $ to increase production capacity (the macro positive expectations factor influenced post Menem, which later De la Rúa did not comply with), which meant taking off his shoes in foreign currency (the company exported very little between 1999-02) and also bearing the burden of paying off a loan (application of funds) in a period of recessive sales;
But the company's short-term debt (with banks) also increased, going from representing 9% (of total financing needs) in 1999 to 57% in 2002, mainly reflecting the worsening of the net operating cycle (collection-stocks and payments), which went from -289 days (1999) to -437 days (2002). Additionally, non-onerous financing (providers) practically disappears around 2002;
This greater short-term debt with banks, resulted in an exponential increase in the interest / sales ratio, which went from 3% (1999) to 77% (2002); which implied that when going from BAIT to BAT and BDT, the latter indicator became very low and even negative, resulting in extremely low levels of ROE for the period (from 5.93% in 1999 to -323.94% in 2002), that is, very low and even negative returns for shareholders, which led more than one of them to think about thoroughly restructuring the company or selling;
Finally, the EVA also reflects the bad situation of the company between 1999 and 2002, this indicator being negative throughout the period, that is, illustrating not only that CHOCOLINE did not add economic value for the shareholder in the period, but also did not cover the minimum expected return on equity, that is, destroyed economic value.
Analysis of ratios for the period of “turn around” (2002-05)
Although the macro situation improved (Chinese growth rates during the K era), driving sales upwards, there is no need to detract from CHOCOLINE CORP, which from 2003 made a change in business strategy that was key for the The company returned to show EBITDA / Vtas, ROA, ROE and EVA (among other profitability indicators) at levels consistent with those of a company with a long life horizon, and not nearly perishing as it seemed between 1999-2002;
- The causes of this "turn around", broadly speaking, were:
Bank debts were refinanced (longer repayment terms), and there was even transitory capitalization of the banks (for said debts), pari pasu, higher contributions from shareholders;
Sales tripled, based on a segmented differentiation strategy towards fine chocolate (ABC1), which has a higher gross profit margin. The target market (within Argentina) is now made up of the country's main urban centers, previously they were mainly 1 or 2 regions;
The sales mix went from 70/30 in favor of the corporate to 70/30 in favor of individuals (that is, the participation of supermarkets fell), which also increased the gross margin on sales;
Exports increased, under a macro environment of high real exchange rate, and taking into account the higher levels of consumption per capita abroad;
The level of operations went from 40% to 90% of the capacity used, which produced economies of scale (since there was little increase in staffing), and therefore lowered fixed costs / sales.
Statement of income
(See PDF)
The Turn Around: conclusions
- As a consequence of the change in strategy, the indicators showed:
EBITDA / Vtas increased tenfold, going from 3% (2002) to 32% (2005), that is, sustainable core business again, but now targeting another segment (ABC1);
Thanks to the financial restructuring (short-term liabilities), interest / sales went from 77% (2002) to 8% (2005), which influenced the improvement in ROE;
And in general, as a consequence of all the aforementioned business strategy change measures, the ROA, ROE and especially the EVA increased, which was positive by 2004-05, showing that CHOCOLINE was once again generating added economic value, that is to say returns above the minimum profitability required by its financiers (third parties and shareholders);
Financial indicators also improved comfortably, since for example the net operating cycle (collection-stocks and payments), fell from -437 days (2002) to -124 days (2002), which added to the increase in the relative participation of financing free (suppliers) in the total sources of financing (own + third parties), which went from 10% (2002) to 55% (2005), implied that less and less bank financing was needed for working capital, which undoubtedly added value to the company, since by lowering the interest / sales ratio, the ROE, the EVA and of course the value of the company as a going concern increases;
IN BRIEF, THE COMPANY PASSED FROM DESTROYING ECONOMIC VALUE (NEGATIVE EVA) TO GENERATING ADDED ECONOMIC VALUE FOR ITS SHAREHOLDERS, WHICH IN THE MANAGEMENT JERGA IS A TRUE TURN AROUND (IN CASTELLANO SYMBOLIZES THE PASSAGE OF BEING TO THE BORDER OF THE ABORD OF THE ABORD AGAIN, CHANGING THE FOCUS OF THE BUSINESS, IS TO SAY WHAT CHOCOLINE DID SINCE 2003)
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