Assess the Business and Financial Risks of Ust. What Do You Think About Ust’s Capital Structure? What Are the Benefits of Debt in Ust’s Case?

1. Assess the business and financial risks of UST. What do you think about UST’s capital structure? What are the benefits of debt in UST’s case?

Business Risk

UST’s main concerns on the business side stem from the rise of small, value-proposition competitors, and from the uncertainty behind the regulatory decisions. During the past years, a series of rising firms have entered the growing smokeless tobacco market. Because of the increase prevalence of smoking bans, the mounting evidence linking cigarettes with cancer and the lack of it with regards to smokeless tobacco, this segment grew at an aggregate rate of 3,7% over the previous 17 years. This made, together with the progressive shift of its image and the diversification of its consumer base, this market portion particularly attractive for new entrants. UST’s reaction to this phenomenon was not what analysts expected or advised. In 1991 the Smokeless Tobacco Market was composed by two sub-segments: Premium and Price Value. The first accounted for 99% of the total, while the second one accounted for a meagre 1%. In the same year, UST held an 86,2% market share of the Premium segment. In the following seven years, due to the market’s expansion and diversification, the Price Value segment grew at a CAGR of 40,5%. In 1998 the split between the two segments was 90% for the Premium and 10% for the Price Value. UST’ lack of action brought the company’s Premium share to 77,2% in 1998, while having virtually no share in the Price Value. Compared to other companies, UST moved too late into the Price Value segment, not recognizing that it was growing constantly. All considered, UST is still the overall market leader, however its lack of presence in the Price Value segment could signify problems in further years, especially if this segment continued to grow in proportion to the Premium one.

The second Business Risk UST is facing regards the regulation and the lawsuits heckling the tobacco industry. Because of the milder evidence linking chewing tobacco to cancer, especially compared to cigarettes, the smokeless tobacco segment has enjoyed less painful lawsuits compared to its counterpart. UST and its other competitors where not, in fact, subject to the 206 Billion USD settlement of the cigarette companies with the US National Healthcare System. This does not mean that the segment is refractory to such problems. Although not part of the aforementioned deal, UST negotiated and signed separately the Smokeless Tobacco Master Settlement with the state’s Medicaid. In this agreement the company promised to pay 100 to 200 million USD over 10 years. It also agreed to restrictions on advertising and promotional campaigns, especially the ones targeted at a younger public. Even though 1998 carried a series of legal and political developments favourable to the Tobacco industry, further crackdowns by regulators are to be expected. To this we must also add the number of lawsuits filed by private citizens and category associations against the single companies.

Further Business Risks: Inability to expand internationally, insufficient market segmentation, resignation of CFO and President of Tobacco Unit, both key figures.

Financial Risks

        On the financial side UST enjoys a much better situation compared to its Business Operations. The company in fact is one of the top all-around performers in the US Stock Market. In ’97 and ’98 it was nominated by Forbes the top company in terms of profitability, with a 5-year return on capital of 92,1%. The company also achieved a CAGR over the previous 10 years of Sales, earnings and cash flows of respectively 9%, 11% and 12%. It also managed to maintained enviable margins with average gross profits, EBITDA, EBIT and net margins of 77%, 53%, 50% and 31% respectively. The company, due to its capital structure composed of virtually zero debt, presents also extremely favourable liquidity and debt coverage ratios. Considering its capital structure and its financial situation, it is hard to point to risks stemming directly from the company’s financial management. We could however consider a reduced cash inflow, because of the new entrants in the market, a possible (minor) threat to the company’s future financial stability.