Hill Country Snack Food Co. Case Solution

FM-1 ASSIGNMENT

ON

Hill Country Snack Food Co.

BY

MITRAPUTRA GANGULI

BM SECTION B

B17090

CASE BACKGROUND

Hill Country Snacks Foods manufactured, marketed and distributed variety of snacks such as churros, tortilla chips, pretzels, popcorn etc. Their major channels of sales were supermarkets, wholesale clubs, convenience stores and other such distribution outlets. Some of the major factors that were helpful in the success of Hill Country Snacks Foods were operational efficiency, good quality of the products, positioned itself in the Txas region where the population was not only growing in size but also in spending power. It was also able to expand into non-conventional channels of sales such as movie theatres, sporting events etc where customers are more likely to be inclined to purchase snacks.

The corporate culture of Hill Country Snacks Foods can be basically described in three components. Firstly the company is extremely shareholder value focussed. CEO Howard Keener and top level management themselves held about one-sixth of the 33.9 Million outstanding shares which meant they also had personal interest involved to some degree. Secondly the company was strongly committed towards efficient operations and cost reduction. They couldn’t afford to increase the price of their products in presence of stiff competition from giants like PepsiCo as well as smaller competitors like Snyder’s-Lance hence they had to rely on their operational efficiency to make their business profitable. Finally the company is very cautious and risk averse as far as managing their finance is considered. They refused to make high-risk high return situations and instead went with low risk and steady growth opportunities.

As far as their financial position is concerned they were producing strong results, but it was mostly result of their operational efficiency and product development rather than financial management. Due to their good profit margins and more than necessary cash in hand they were able to pay decent amount of dividend to their shareholders. Even though they were financially well off they were not managing their resources properly as they had too much liquidity causes very low return from the invested cash and too low debt and hence large component of equity causing low return on equity.

Recently a financial analysis was performed and a change in the present capital structure to a more aggressive capital structure was proposed. Various different structures were considered and analysed, as a result it was obvious that the change in the structure would improve their financial leverage but it was difficult to convince the management as the company was by default extremely risk averse.

PROBLEM STATEMENT

1. Too much liquidity

• Hill Country Snacks Foods had a conservative capital structure and the company’s cash position actually had negative impact on the company’s financial performance measures.
• This company had accumulated too much cash in hand from their profitable operations in the past years.
• Their cash balance was 18% of their total assets and 13% of their total market capitalization.
• The cash was not earning any significant interest rate and hence contributing almost nothing to their net income.
• Moreover the enormous amount of accumulated cash increased their total liquid assets.
• The only positive aspect of this was that the company had a lot of safety cushion from the large cash balance.

1. Zero debt finance capital structure

• Hill Country Snacks Foods had a very conservative and risk averse attitude towards financial decisions that reflected in their capital structure and their investment decisions.
• Their zero debt finance capital structure was almost unique, especially in its industry.
• This lead to them having too much of equity capital component and hence resulted in low return on equity.
• Debt is considered less expensive than equity due to the contractual nature and priority claim.
• The interest paid on the debt is also beneficial in terms of tax benefits which Hill Country Snacks Foods was missing out.
• The interest to be paid on bonds were also very low in 2012 with A rated bonds to pay just under just 3.8% yields to maturity hence leaving them no logical reason for not having debt in their capital structure.

1. Competition in the industry

• The snack foods industry was very competitive and Hill Country Snacks Foods faced stiff competition from giants such as PepsiCo as well as smaller companies like Snyder’s-Lance.
• They had unfavourable cost variances and even when the cost increased they had to bring the costs back into line as they couldn’t afford to increase the price in such a competitive market.
• The other companies were utilizing their financial leverage to the maximum possible limits with PepsiCo having a debt to capital ratio of 49.6% and still maintaining AA rating from Moody’s and A rating from S&P. Even smaller competitors such as Snyder’s-Lance had a debt to capital ratio of 23.5% although none of their debt was publicly held.

1. No clear consensus among the stakeholders

• Some of the investors were getting frustrated by the company’s excess liquidity and zero debt policy.
• They felt even modest reduction in cash and a little increase to the debt would significantly improve the return on equity of the company.
• But there were others who were against this as they were worried about implementing changes on an already successful company.

1. Difficult to implement the suggested changes

• Even though the financial analysis showed that the company could benefit from the new and more aggressive capital structure the risk averse management will be difficult to convince and implement the proposed financial changes.
• CEO Howard Keener felt companies may go into trouble due to excessive debt but equity is safe.
• However with the pending retirement of CEO Howard Keener it might be possible to bring about the changes.

CASE ANALYSIS

Analysis of Present Financial Condition:

• Hill Country Snacks Foods had accumulated approximately 181.1 Million USD of cash and cash equivalents and have always maintained a high liquidity strategy.
• This has greatly helped them in the past especially during the recession between 2007 and 2009 in maintaining stability of business and quickly improving once the recession was over.
• But they were earning almost 0% interest on the invested cash and cash equivalents suggesting this was not contributing towards the earnings of the company and could be used elsewhere.
• The annual growth rate for Earnings per share has also slowed down over the years after the end of the recession, presently it is much lesser than their competitor PepsiCo who has close 4.08 dollars of EPS compared to Hill Country Snacks Foods’ 2.88 Dollars EPS.
• The company still enjoyed a 10% total asset turnover which is more than Snyder’s-Lance as well as that of PepsiCo, still it needs to be monitored closely as their total asset was increasing greatly due to accumulated cash and cash equivalents.
• Even though they have a steady top line growth rate, their 5 year compounded annual growth rate of 5.8% is much lesser than their nearest competitor, Snyder’s-Lance who has the same at 17.5% and also lesser than PepsiCo’s 13.6%.
• It is not fair to attribute this low compound growth rate to just recession but the main reason behind this would be the slow and steady risk averse policy of the company where it refuses to take high risk high return opportunities of growth.
• A net profit margin of 7.2% which is much better than their nearest competitor Snyder’s-Lance’s 2.3% signifies they are good at maintaining efficient operations. Even though PepsiCo has more net profit margin of 9.7% it is probably a result of their buying power while Hill Country Snacks Foods chooses to retain cash internally to fund growths.
• Hill Country Snacks Foods also have a much better current ratio of .73 when compared to PepsiCo’s .47 and a quick ratio of .44 compared to PepsiCo’s .35. This means they have much lesser current liabilities as well with comparison to their total assets.