This report provides an analysis and evaluation of the current and forecasted profitability, liquidity and financial stability of Alliance Concrete. Methods of analysis include forecasting the income statement and balance sheet to calculate financial ratios and profitability ratios. The key drivers for the income statement was management’s assumption about the sales environment surrounding Alliance Concrete. All calculations can be found on the attached document. Results of data analyzed show that Alliance Concrete is experiencing sales decline, profitability decline, but is relatively financially stable for the most part.
The report finds the prospects of the company in its current position are not positive. The major area of weakness revolve around obtaining external financing. Our recommendation discussed involves making capital investments, making the dividend payment to National, and obtaining the essential additional funding from the bank by renegotiating terms with them. Problem Recognition: Alliance must choose either between making the principal repayment to the bank, making capital investments or making the dividend payment to National.
In other words, Alliance’s recent success and clear signs of continued growth were not sufficient enough for the necessary capital improvements, bank obligations and expected divided payment to National. With rising increase in cement costs, the tremendous growth of China’s infrastructure isn’t enough to keep other costs down. Costs of energy prices had increased the cost of manufacturing cement and ocean shipping costs, rail disruptions and port congestion had caused widespread shortages even though there were other internal sources which then caused the share of import cement to rise by 2.3% YoY.
Lastly, the cost of cement was 11% higher YoY according to the U. S. Labor Dept. Producer Price Index and the biggest factor responsible for the rise in price was the diesel fuel spike. This made fixed budgets tight and demand for certain projects fluctuated down. In continuation, the bank stated it was unwilling to lend more than three times the prior year’s EBITDA and would inquire about the effects of the recent real estate slowdown and impact on the company. Assumptions: Based on the sales manager’s research, he predicted 2,200,000 yards to be sold.
In our financial model, we factored in a 7% increase in the average price per yard and a 10% increase in the average cost per yard, both of which the sales manager projected with confidence. The key underlying assumption this lead to was a 12. 90% increase in revenue. Next, we averaged the past four years SG&A margin (SG&A/Sales) because this will serve as an adequate proxy for the forecasted SG&A expense. Although 2004 SG&A expense was an anomaly, we felt that it must be calculated in the average to accommodate for any shifting trends towards higher SG&A costs.
Calculating interest expense was simple because we were given that Alliance Concrete pays 8. 5% on outstanding debt. Our assumption for the tax rate came from the average tax rate the firm has paid out over the past 4 years, which was 34. 81%. Moving onto the balance sheet, it is safe to assume that the cash position in the firm will increase the rate of the sales growth going forward. In actuality, cash has historically increased faster than the growth of revenue with 2004 being an exception.
To calculate the assumption for accounts receivable, inventory, and accounts payable, we averaged the four years worth of data for days receivables, days inventory, and days payable respectively. The plant and equipment account increased by $16 million due to capital spending, but also decreased by $7. 5 million due to depreciation. The next big assumption we made was owners’ equity where we assumed $3,000,000 will be paid in dividends from the projected net income of $9,904,000, leaving $6,904,000 to add back into owners’ equity.
And finally, we plugged in long-term debt until we got total assets to equal total liabilities and owners’ equity. Financial Analysis: At first look, 12. 9% sales growth looks fantastic. In fact, the predicted sales growth is lower than the 2005 revenue growth and comes in at 5 basis points below the past 3 years growth rate. The industry overall is experiencing headwinds on costs due to the fact that cement costs worldwide are increasing. To quantify this, Alliance is forecasted to experience gross margin contraction (proxy for COGS and sales) by nearly 218 basis points.
When you analyze a more holistic view of the income statement, one can infer that that reduction in gross margins will also lead to a decrease in net margin. Alliance is projected to have net margin decrease by 173 basis points to a company’s 4 year historic low of 4. 72%. The overall margin analysis on Alliance is generally worrisome because they are experiencing costs increase by 10% but they can only increase prices by 7%, leaving them a 3% increase in expenses that cannot be covered and as a result, will deteriorate their bottom line. Situation Analysis:
Alliance should approach the bank by demonstrating their financial stability in order to leverage their balance sheet. The bank is willing to lend up to three times the prior year’s EBITDA, which Alliance needs to stress. As of 2005, debt to EBITDA ratio is 2. 8 and with our forecasted assumptions, it comes down to as low as 2. 3 in 2006. If we were to raise it to 3. 0, Alliance could take on an additional 30% increase in total debt to bring the total long-term debt to $90,999,000. This would give Alliance sufficient cash to fund their expected CapEx for FY’06.
In addition, the $16M CapEx is inevitable because it is essential to operate and avoid unexpected costs tied to breakdowns of machinery. With their current finances, Alliance is demonstrating a healthy balance sheet within which their profit margin for 2005 is 6. 45% and with our forecast, it remains strong at 4. 72%. Their ROA for 2005 is 8. 92% and ROE is 26. 04% comparing with our 2006 forecast, ROA and ROE decreases to 6. 76% and 18. 71%. Next, the cash coverage ratio remains relatively consistent with FY’05 at5. 51 and forecasted at 4.83 which represents how many times the company can cover their interest.
In this case, Alliance will have no financial struggle at covering their obligation. As far as the liquidity ratios go for Alliance, their current ratio only drops by . 02 from 2005 to 2006 (1. 70,) forecasted quick ratio is 1. 46 and their cash ratio remains the same at . 20. All of these ratios signify the company’s ability to turn short term assets into cash. On the other hand, solvency ratios come in consistent for 2006 with . 64 (. 02 decrease YoY) for the total debt ratio, and the equity multiple at 2.32 which ties back into the overall health of Alliance’s Balance Sheet.
In conclusion, Alliance Concrete ratios and financials remain fairly within the same ranges and do not fall below alarming levels. With the inevitable CapEx, they are financially stable to proceed with leveraging their balance sheet to meet the required needs and continue their business. Another minor concern for Alliance is making their dividend payment although, if Alliance increases their debt up another 30%, they would have enough money to meet their CapEx and dividend payments without having to push the bank off.
All of the liquidity ratios support our assumptions and our forecast for 2006 demonstrates a healthy enough balance sheet. Conclusion: At initial glance, Alliance Concrete seems to not be in a very secure financial position; however, this simply is not true because they can still lever-up to meet business demands. In the long-term, improvements in every area of the firm are needed if the company is going to survive and grow in a profitable manner.
The key areas of reform are maintaining the liquidity of the company while increasing profitability measures like gross margins and net income margins. It must be noted that the analysis of our projections is very limited and on the conservative side because we accounted for higher SG&A costs, leaving us some wiggle room with net income. Investors should be concerned with current needs for external financing and should become weary if Alliance is not able to obtain the bank loans because this will most likely warrant a dividend cut.
