This case was written by a group of masters students in Business Administration, made up of Loweski Luciano, Rita Rojas, Milagros Salvador, Edy Rodríguez and Noris Trejo, to be presented at the end of the class on Financial Management, which we hope can serve as reference material for future promotions.
The solutions and alternatives issued in it are not unique, that is, they can have another approach and multiple alternatives.
Written in the month of November, 2002.
FERRETERIA DEL ATLANTICO, SA
Ing. Luciano, general manager of the Ferretería del Atlántico, SA, a company based in the province of Puerto Plata, arrived at his office earlier than usual, anticipating what awaited him that day, because he had to present to the Board of Directors of the company a report on the situation they had been facing to meet their financial commitments. In previous meetings, the financial department had disclosed the cost that the company was assuming for the use of credit lines in order to meet its commitments, of which payments to the bank constituted an appreciable part. Some measures had been taken that were not effective enough to eradicate the problem, even though they had had a positive impact.
It was time to make definitive decisions to solve the problem, for which Eng. Luciano had all the information offered by the different departments, based on which he had to analyze different alternatives, and finally propose to the Board of Directors what understood the best.
To prepare his proposal, Eng. Luciano carried out an analysis of the evolution of the company in the last three years, both from an operational point of view and from a financial point of view, this last aspect being the most relevant in his analyzes, especially regarding the capital structure that the company had at that time. Based on his analysis, Engineer Luciano asked himself the following questions:
-What alternatives should you consider in order to combat the situation you were in?
-What will be the optimal debt structure?
-Will it be necessary to take some long-term financing to meet your short-term commitments?
-Will it be necessary to reduce the size of the business?
All these investments have been made with short-term bank loans and at high interest rates. Although some of these assets are considered short-term, such as cargo trucks, their useful life is much longer than the period considered for financing purposes.
Industry Facts
HARDWARE SECTOR IN THE PROVINCE OF PUERTO PLATA
The hardware sector has constituted one of the most dynamic of commerce in the province of Puerto Plata, being highly favored with the boom that the construction sector acquired in the period between 1997 and 2001. For 2002 the province had about 40 establishments and the municipality of Puerto Plata with about 20, which is where the company under study is located. The size of these businesses ranged from large companies to small family subsistence businesses.
Most hardware stores were engaged in both the sale of construction materials and the sale of hardware items in general. Some of them only sold hardware items and others only sold construction materials. Very few, as is the case of the Ferretería del Atlántico, had its own block factory and its own means of transporting cargo. Most used private transportation to source materials such as aggregate, cement, rod, etc., and sold blocks both locally made and brought from Santiago.
The economic development of the province of Puerto Plata, and therefore the hardware sector, had come hand in hand with the tourism sector, so it was greatly affected by the decrease in the flow of tourists to the province, reflected in a considerable drop in sales levels and stagnation. This sector, like the other commercial sectors of the province, was negatively impacted by other factors, such as: the economic recession that the country was going through, the high interest rates prevailing at that time, the instability in the supply of electric power, government tax policy and price instability.
In order to face the aforementioned problems, the hardware stores decided to organize themselves through the Association of Hardware Stores of the Province of Puerto Plata (AFEPLATA), which brought together most of the hardware stores in the province. This Association was founded on December 2, 2001. Grouped in this association, the hardware dealers of Puerto Plata were able to improve their situation vis-à-vis the suppliers, because together they managed to increase their purchasing capacity, and thereby obtain better prices.
This placed him in a better position to compete with a large capacity market such as the Plaza de Santiago de Los Caballeros, where there were large hardware stores that offered their products in the province of Puerto Plata at a lower price than what the market could offer. local.
The competition of the hardware stores in Santiago was one of the great challenges that the hardware sector of the province of Puerto Plata was forced to face, which prompted the entrepreneurs of this province to make large investments in order to reduce competitive advantages and so we can stay on the market. Those who were unable to make those investments had to go out of business. This together with the other problems in the sector caused the closure of some 10 hardware stores in just two years.
In order to determine the behavior of the industry in the period between 1997 and 2001, and thus be able to compare the position of the Atlantic Hardware with respect to the rest of the industry, we conducted interviews with the executives of three of the main hardware stores in the province of Puerto Plata, during which we were able to obtain information regarding the following aspects:
Sales behavior
The hardware sector experienced great growth in the late 1990s, due to the boom in the construction sector motivated by price stability and the low interest rates that banks were offering to finance housing. This trend had begun to reverse as of the year 2001, with the stagnation of the construction sector, as a result of the instability in prices and the high interest rates offered by banks. This situation has led the hardware sector to a crisis of such magnitude that many hardware stores have had to close their doors.
Infrastructure growth
The hardware sector has not experienced great growth in its infrastructure.
Behavior of price levels
One of the main problems raised by the hardware stores consulted is the continuous increase that they had been experiencing due to the prices of hardware items. These increases were taking place at a time when the economy had been in a state of stagnation, making it difficult for the sector to pass these increases on to the consumer, for fear of a sharp decrease in sales levels.
Impact of interest rates
The increase in interest rates offered by banks has negatively impacted the hardware sector, as they have seen their expenses increase considerably. On the other hand, they have seen their profit margins decrease, due to the fact that it has not been possible to charge the merchandise both the increase in prices and the financial cost implied by high interest rates.
Impact of fiscal measures
The hardware stores interviewed have pointed out that in addition to the fiscal measures that affect the sector indirectly, which causes the increase in prices, there are measures such as the 1.5% minimum tax on gross sales that have represented a severe blow to the sector, since they have had to be paying a tax that they are not earning.
COMPANY OBJECT
The Atlantic Hardware Store is located in the southern part of the city of Puerto Plata, surrounded by populous sectors in full urban development. This positioning guarantees this company a captive clientele, since there is no competition for around 500 meters. In addition to having a very wide range of products capable of satisfying not only the needs of the surrounding sectors, but of this entire city.
This company began its operations in 1995 with the production of some 50,000 units of monthly block, which it sold at retail at the same place of production. A year later the sale to the public of the materials with which he made the blocks began; cement and aggregates. A few months later, he continued to introduce other complementary materials such as construction rods and plain wire. The customer demand for new products was motivating the executives of the company and by 1997 it was offering all the construction materials.
As the company developed and became known in the city of Puerto Plata, its sales continued to increase considerably, even with limitations in the range of products available, but always with a clear criterion regarding the quality of the service that it had been offering to its clients. It is important to note that at that time the construction sector was experiencing the highest growth previously occurred in the province of Puerto Plata.
That is why its owners made the decision to expand the range of products they had been offering and turn the business into a complete hardware store. For these purposes, a modern building was built to house all of its facilities, which was inaugurated in September 1998. From that moment on, the company saw its sales levels increase considerably, reaching a average of 30% during the years 2000 and 2001, outlining itself as one of the main hardware stores in the province of Puerto Plata, known mainly for the quality of the block it manufactured.
In order to offer the highest quality service, the hardware store was divided into clearly identified departments, each with an independent exhibition area, such as: ceramics and bathrooms, wood, cement and aggregates, block, plumbing, painting, electricity and various hardware items. This has allowed the company to monitor the behavior of each department and know which of them should be given more attention at any given time. To achieve the aforementioned growth, the company has had to venture into market segments, such as the hotel sector, which had been served by other hardware stores, mainly companies based in the city of Santiago.This threat has led the competition to use its comparative advantages and our company was forced to make large investments to counteract the effect that this was having. Until then, the company was using the service of private transport companies to transport the products to its facilities, which was very expensive. In addition to that there were delays in receiving the products.
Already by 2001, Ferretería del Atlántico had become one of the main companies in the sector in the municipality of Puerto Plata and throughout the province, characterized by quality service, since it was born with the motto "We Sell Services", and the company has honored this throughout its existence. Another of the characteristics of this business has been its permanent concern about never saying "no", in addition to the fact that its prices have always been competitive.
As a way to be closer to the client and thus be able to offer a better service, at the end of 2001 Ferretería del Atlántico opened a branch in the community of Cangrejo, located on the Puerto Plata-Sosua highway. This branch has had a higher growth than the parent during the year it has been in operation, which has contributed to the company maintaining certain sales levels. One year after opening said branch, the client can obtain any construction material, as well as hardware items in general.
Information about the Problem
In the last year, the company decided to expand its operations and had to make heavy investments in the purchase of land, expansion of its facilities, as well as the acquisition of a fleet of cargo trucks to transport materials to its warehouses and trucks to merchandise distribution. In addition, it has acquired some machinery and equipment, in order to make both its production processes and the marketing of its products more efficient. The total investment has amounted to the sum of RD $ 9, 514,750.00, as detailed below:
Land purchase RD $ 1,348,750.00
Expansion 700,000.00
Buy cargo trucks 5,900,000.00
386,000.00 power plant
Forklift 500,000.00
Mini loader 400,000.00
280,000.00 distribution truck
All this investment caused an illiquidity problem and at the close of 2002 there was a bank overdraft of RD $ 2,737,089.03 and short-term liabilities to be covered in 2003 for a value of RD $ 14,804,427.06. The capital cost was 23%.
The perspective was to determine the cash flow projections for the next five years and determine if the company has future capacity to generate the necessary cash to carry out its activities and cover liabilities, which may be a short-term debt restructuring with long-term debt or seeking new sources of capital.
In the development of its activities, benefits were generated that decreased from 2000 to 2002. However, the behavior of costs remained constant in proportion to sales.
In the last period, the decrease in benefits seemed to be related to the high cost of financial debts that amounted to RD $ 5,281,212.59.
The cash flow statement in the last year shows that cash from operations covered operating expenses but ended with a change in cash of RD $ 45,683.31.
Below are the company's financial statements for the periods 2000, 2001 and 2002.
Options:
We had to make an assessment of the company's financial position by analyzing the financial ratios, trends and integral percentages (Annexes 1 and 2). As well as a projection of the results of the next five years (See Annex 3), and we consider that the options we have are:
- Maintain current growth rate
- Achieve adequate cost control so that they remain within budgeted margins. Request short-term loan restructuring with our bank.
Decision Approach.
We prepare a cash projection for the next five years based on the loan obtained with Banco BHD at a rate of 22% per year and 48 months for the payment of principal (See Annex 4).
As a result of this projection, we determined that the company had sufficient payment capacity and, in addition, the debt ratio decreased as of 2003. In other words, its debt capacity increased and therefore, its liquidity ratios also increased, since the debts currents became, to a large extent, long-term debt. In other words, the most viable option was to restructure the short-term and long-term loan in order to solve the liquidity problems in which the Atlantic Hardware Store was immersed.
The cost of the debt was 23%, an option with which the company lowered its cost of debt to 21%.
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