Financial Analysis of Big Rock and Brick Brewing - Case Study Example

Financial Analysis of Big Rock and Brick Brewing Financial Analysis of Big Rock and Brick Brewing 1. Full Name and Head Office Addresses of the Companies In this report, following companies have been selected for analysis: Name of the Company Head Office Address 1 Brick Brewing Company Limited 400 Bingemans Centre Drive, Kitchener, ON N2B 3X9 2 Big Rock Brewing Incorporation 555 - 76th Ave. SE, Calgary, AB 2. Description of Industry The companies selected for analysis are Big Rock Brewery Inc. and Brick Brewing Co. Limited. Both companies are based in Canada and are operating in Canada’s craft beer market. The overall industry of these companies is consumer products and sub-industry is beverages (alcoholic brewery). Almost 90% of the domestic production is consumed within Canada. The brewery industry is the largest portion of the alcohol beverage industry of Canada. Over the years, this industry has boosted the Canadian economy by generating tax revenues and employing a large workforce (Agriculture and Agri-Food Canada, 2013). Both companies operate under licenses authorized by respective states of incorporation. Big Rock Brewery Inc. is registered in Calgary, Canada. In case of Brick Brewing Co., its head quarters are located in Kitchner, Ontairio, and the production and distribution of beer is made under the license provided by Ontario. 3. Strategies of the Companies Big Rock Brewery Inc. strategically focuses on marketing its products throughout Canada. The company has divided its sales and marketing efforts on the basis of geographical allocation of the entire Canadian market. The company follows specific marketing strategy for each region. (Big Rock Brewery, 2013) The company is also presently focused on repackaging of the brand in order to renew its presence in the consumer market (Toneguzzi, 2014). This is part of the company’s overall re-positioning strategy as it aims to achieve growth in sales by targeting new and young customers. Brick Brewing Co.’s strategy is focused on optimizing its production. The company still has excess production capacity and it aims to make an efficient use of its production facilities. Furthermore, the company is currently facing a downward trend in its earnings led by due to increasing selling, distribution, and administrative expenses, finance costs, and increase in provisional taxes in Ontario region. The company also aims to cut down its costs of operations. The company is focusing to relaunch its brand, and it has acquired rights to distribute Seagram blends to Canada. This will help the company in achieving organic growth as it will fulfill its excessive production capacity. As opposed to Big Rock Brewery Inc., the company has its principal focus on sales in Ontario region (Brick Brewing Co. Ltd., 2013). 4. Comparative Data for Three Years and Year-end Dates For both companies, financial statements pertaining to the financial years 2010, 2011 and 2012 have been obtained from their respective websites. The year end date for each of the companies in each of the three years under consideration are as follows: Company Year end for 2010 Year end for 2011 Year end for 2012 Brick Brewing Company Limited January 31 January 31 January 31 Big Rock Brewing Incorporation December 30 December 30 December 30 5. Profitability Ratios Big Rock Brewery has been able to show considerable improvements in its profitability owing to the increase in its net income during 2012 as compared to previous years. The company also managed to report higher revenues and control its operating costs which ultimately influenced the profit margin, return on its assets and equity. On the other hand, Brick Brewery’s profitability has declined significantly in 2012 as compared to previous years. This decline has been due to increase in operating and other expenses of the company.   Big Rock Brewery Brick Brewery Profitability Ratios 2010 2011 2012 2010 2011 2012 Return on Assets on reported amounts 17.8% 5.6% 8.9% 4.5% 8.5% 1.5% Return on Common Equity on reported amounts 31.9% 2.5% 4.1% 3.9% 8.5% 1.9% Net income/Revenues 13.6% 5.6% 9.0% 4.5% 9.8% 1.9% 6. Liquidity Ratios The current ratio for the two companies indicate that the current assets are able to cover short term obligations of the company. Similar is the case with quick assets too, although there has been a significant decline in the quick ratio for Brick Brewery in 2012. On the other hand, the operating cash flows generated by the two companies have been sufficient enough to cover their respective short term obligations.   Big Rock Brewery Brick Brewery Liquidity Ratios 2010 2011 2012 2010 2011 2012 Current ratio 1.71819 1.45094 1.72444 1.44495 1.72923 0.9073 Quick ratio 0.68371 0.6565 1.10842 0.56125 0.88602 0.50102 Operating Cash Flow to Current Liabilities 1.78852 1.11229 1.65464 0.5798 0.31137 0.45569 7. Solvency Ratios The solvency position of Big Rock is much better than Brick Brewing, as its total liabilities and total long term debt is considerably lower than the other and there is a consistent decline noted in the same over the past three years. Moreover, the company has shown remarkable potential to cover its finance costs through its profits, which in case of Brick Brewing is not satisfactory.   Big Rock Brewery Brick Brewery Solvency Ratios 2010 2011 2012 2010 2011 2012 Total Liabilities/Total Assets 26% 16% 17% 24% 27% 37% Long-term Debt to Long-term Capital 14% 2% 1% 3% 9% 17% Interest Coverage Ratio on reported amounts 41.6122 17.9645 44.4624 9.80052 19.8805 0.88272 8. Activity Ratios As far as the activity ratios of the two companies are concerned, Brick Brewing has shown better operating efficiency than Big Rock, as far as the recovery of amounts receivable from customers. However, the turnover for accounts payable indicates that Brick Brewing has made payments to its suppliers earlier as compared to Big Rock.   Big Rock Brewery Brick Brewery Activity Ratios 2010 2011 2012 2010 2011 2012 Accounts Receivable turnover 25.2264 16.2062 19.5322 12.6922 6.66112 7.43189 Days in receivables 14.469 22.5222 18.6871 28.7578 54.7956 49.1127 Inventory turnover 10.0939 10.2016 11.8338 5.6965 5.68807 8.60213 Accounts Payable turnover 6.44 5.84 5.32 7.13 4.18 4.18 9. Forecasted Income Statement and Balance Sheet The forecasted income statement and balance sheets for the two companies for the next five years have been developed while using certain assumptions. These assumptions are listed in the next section of this report. The forecasted financial statements for both companies can be found at the end of this report in the Appendix. 10. Explanation of Assumptions There are various assumptions used while forecasting the income statement and balance sheet of Big Rock and Brick Brewing for the next five financial years. These assumptions are explained as followed: Assumptions 1 Sales are expected to grow at the rate of 10 percent each year during the next five year. 2 The proportionate change in the remaining items in the income statement are based on the per cent values based on sales amount for each income statement item. 3 Current assets will grow at the same rate (10%) as the sales revenue will grow in the coming years. 4 The increase in revenues will be followed by expansion of the production facilities, such that there will be an increase in the property, plant and equipment by 10%. 5 The expansion in production facilities will be attained through increase in borrowing by 10% and the remaining balance will be obtained through equity. 6 There will also be an increase in the accounts payable, which will be equal to the rate at which cost of sales will increase, i.e. 10%. 7 The changes in equity will also include increase in retained earnings after adjusting for dividend payments. b. Justification of Assumptions The above mentioned assumption related to growth rate in sales is based on the growth expected in future due to improving economic conditions in Canada. On the other hand, income statement items other than the sales revenue have been forecasted on the proportionate basis of their respective growth rates in the last year. Moreover, the assumption related to growth in current assets has been based on the growth rate in sales. Since increased sales revenues will be earned in future years, therefore the manufacturing facilities will need to be expanded and as a result of this the capital expenditure will grow at 10 percent. Since cost of sales will increase by 10%, a corresponding increase in accounts payable is therefore expected. 11. a. Weighted Average Cost of Capital (WACC) Big Rock Brewery Inc. Brick Brewing Co. Limited Interest Expense 93 743,823 Total Debt (Long Term + Current) 2,042 9,577,678 Total Equity 32,071 27,498,144 Tax Rate 25.10% 30.70% D+E 34,113 37,075,822 Return on Market 11.92% 11.92% Risk Free Rate 0.95% 0.95% Beta 0.67 0.74 Cost of Equity 8.30% 9.07% Cost of Debt 4.55% 7.77% After-tax Cost of Debt 3.41% 5.38% WACC 8.01% 8.12% Source of Data: (Bank of Canada, 2014; Reuters, 2014a; Reuters, 2014b; Brick Brewing Co. Ltd., 2013; Big Rock Brewery, 2013). b. The WACC is the cost of acquiring funds for new investment for the company. If the expected return on capital invested (ROCE) is greater than WACC then the company can expected to generate positive cash flows from the investment and creation of value.   Big Rock Brewery Inc. Brick Brewing Co. Limited ROCE 10.34% 1.96% Net Profit 4,135 656,588 Capital Employed 39,982 33,570,421 Total Assets 46,300 43,321,127 Current Liabilities 6,318 9,750,706 ROCE is greater than WACC for Big Rock Brewery, which implies that it can expect value creation from further investment. On the other hand, Brick Brewing Co. Ltd has ROCE that is less than WACC. c. Both companies have almost equal WACC that implies that companies operating in Canada have access to similar sources of funding. d. If I own a company then I would not be able to use the same WACC because access to funds and their relevant costs vary with the type and size of business. If my business is comparable to businesses under consideration and if I do not have any previous data then I can use this information. 12. a Discounted Cash Flow Method Big Rock Brewery Inc.   2010 2011 2012 Average Growth Rate Net Income 6,117.00 2,533.00 4,135.00       -58.6% 63.2% 2.33% 1 2 3   2013 2013 2014 Cash Flows 4,707 5,358 6,098 Discount Factor 0.93 0.86 0.79 PV of Cash Flows 4,357.83 4,583.46 4,825.61 Equity Value 13,766.89     Brick Brewing Co. Limited   2010 2011 2012 Average Growth Rate Net Income 1,347.00 2,744.00 657.00       103.7% -76.1% 13.8%   2013 2014 2015 Cash Flows 748 851 969 Discount Factor 0.92 0.86 0.79 PV of Cash Flows 691.71 728.25 766.73 Equity Value 2,186.69     b. Abnormal Earnings Growth Model Big Rock Brewery Inc. Year Expected Beginning Book Value Expected Earnings Capital Charge Expected Abnormal Earnings PV Factor PV of Expected Abnormal Earnings 1 33,729 4,707 2,799 1,907 0.926 1,766 2 32,053 5,358 2,660 2,697 0.856 2,307 3 30,377 6,098 2,521 3,577 0.791 2,831 Equity Value 6,903.96 Brick Brewing Co. Limited Year Expected Beginning Book Value Expected Earnings Capital Charge Expected Abnormal Earnings PV Factor PV of Expected Abnormal Earnings 1 17,134 748 1,422 (674) 0.925 (623.67) 2 16,515 851 1,371 (520) 0.856 (444.45) 3 15,897 969 1,319 (350) 0.791 (277.30) Equity Value (1,345.42) Source of data: (Brick Brewing Co. Ltd., 2013); (Big Rock Brewery, 2013) For this mode, straight-line method of depreciation has been assumed for determining the book value of fixed assets. Dividend discount model could not be used because Brick Brewing Co. Limited did not pay any dividend. c. The equity value obtained from both methods is very different from each other. The consequence of low earnings of Brick Brewing Co. Limited is that its expected abnormal earnings have become negative that has made the outcome AEG model less meaningful. In this way, DCF model seems more appropriate model to be used for valuation of companies with small or negative earnings. 13. Altman Z Score a. The Altman Z Score for the two companies has been determined to be as follows:   Big Rock Brewery Brick Brewing Altman Z Score 113.22 2.32 b. This score tells that Big Rock Brewery is in the safe zone, as its score is over and above 3, which is considered as the score where there is no or minimum risk of bankruptcy. On the other hand, Brick Brewing’s score tells that the company is more likely to be bankrupt in comparison with Big Rock. c. The debt levels of the two companies are significantly different from each other. Moreover, the trends noted in the long term debts of the two companies indicate that Brick Brewing has considerably increased its long term debt and thus gearing level as compared to Big Rock.   Big Rock Brewery (‘000’) Brick Brewing   2010 2011 2012 2010 2011 2012 Long term debt 2,683 1,983 1,342 1,158,395 3,026,731 5,890,379 This scenario raises concerns over the liquidity and financial strength of Brick Brewing in future also. d. Keeping in view the above discussion, Big Rock can be considered to be a better investment option, as the company has been successful in managing and bringing down its debt level and it is not on the verge of bankruptcy as per Altman Z Score calculation. Reference List Agriculture and Agri-Food Canada. (2013, November 6). The Canadian Brewery Industry. Retrieved March 25, 2014, from http://www.agr.gc.ca/eng/industry-markets-and-trade/statistics-and-market-information/by-product-sector/processed-food-and-beverages/the-canadian-brewery-industry/?id=1171560813521 Bank of Canada. (2014). Selected Treasury Bill Yields . Retrieved March 25, 2014, from http://www.bankofcanada.ca/rates/interest-rates/t-bill-yields/ Big Rock Brewery. (2013). Annual Report 2012. Calgary: Big Rock Brewery. Brick Brewing Co. Ltd. (2013). Annual Report 2012. Toronto: Brick Brewing Co. Ltd. Reuters. (2014a). Big Rock Brewery Inc (BR.TO). Retrieved March 25, 2014, from http://www.reuters.com/finance/stocks/overview?symbol=BR.TO Reuters. (2014b). Brick Brewing Co. Ltd (BRB.TO) . Retrieved March 25, 2014, from http://www.reuters.com/finance/stocks/overview?symbol=BRB.TO S&P Dow Jones Indices. (2014). S&P/TSX COMPOSITE (CAD) . Retrieved March 25, 2014, from http://us.spindices.com/indices/equity/sp-tsx-composite-index Toneguzzi, M. (2014, January 17). Big Rock Brewery returning to roots as craft beer company . Retrieved March 25, 2014, from http://www.calgaryherald.com/life/Rock+Brewery+returning+roots+craft+beer+company/9401046/story.html Appendix – Forecasted Income Statement and Balance Sheet Big Rock BIG ROCK BREWERY INC BALANCE SHEET 12/31/2012   Year 1   Year 2   Year 3   Year 4   Year 5 Assets Cash And ST Investments 4,281,000.00 10% 4709100 10% 5180010 10% 5698011 10% 6267812.1 10% 6894593.31 Receivables (Net) 2,358,000.00 10% 2593800 10% 2853180 10% 3138498 10% 3452347.8 10% 3797582.58 Total Inventories 3,892,000.00 10% 4281200 10% 4709320 10% 5180252 10% 5698277.2 10% 6268104.92 Other Current Assets 364,000.00 10% 400400 10% 440440 10% 484484 10% 532932.4 10% 586225.64 Current Assets - Total 10,895,000.00 10% 11984500 10% 13182950 10% 14501245 10% 15951369.5 10% 17546506.45 Property Plant & Equipment - Gross 44,375,000.00 10% 48812500 10% 53693750 10% 59063125 10% 64969437.5 10% 71466381.25 Accum. Depreciation 9,098,000.00 10% 10007800 10% 11008580 10% 12109438 10% 13320381.8 10% 14652419.98 Other Assets 128,000.00 10% 140800 10% 154880 10% 170368 10% 187404.8 10% 206145.28 Total Assets 46,300,000.00   70,945,600.00   78,040,160.00   85,844,176.00   94,428,593.60   103,871,452.96 Liabilities & Shareholders Equity Accounts Payable 3,978,000.00 10% 4375800 10% 4813380 10% 5294718 10% 5824189.8 10% 6406608.78 ST Debt & Current Portion of LT Debt 700,000.00 10% 770000 10% 847000 10% 931700 10% 1024870 10% 1127357 Other Current Liabilities 1,640,000.00 10% 1804000 10% 1984400 10% 2182840 10% 2401124 10% 2641236.4 Current Liabilities - Total 6,318,000.00 6949800 7644780 8409258 9250183.8 10175202.18 Long Term Debt 1,342,000.00 10% 6949800 10% 7644780 10% 8409258 10% 9250183.8 10% 10175202.18 Deferred Taxes - Credit 6,331,000.00 Other Liabilities 238,000.00 Total Liabilities 14,229,000.00 13899600 15289560 16818516 18500367.6 20350404.36 Shareholders Equity Common Equity 32,071,000.00 57,046,000.00 62,750,600.00 69,025,660.00 75,928,226.00 83,521,048.60 TotalLiabilities & Shareholders Equity 46,300,000.00   70945600   78040160   85844176   94428593.6   103871453 INCOME STATEMENT 12/31/2012   Year 1   Year 2   Year 3   Year 4   Year 5 Net Sales or Revenues 46,057,000.00 100.0% 50662700 100.0% 55728970 100.0% 61301867 100.0% 67432053.7 100.0% 74175259.07 Cost of Goods Sold 18,279,000.00 39.7% 20106900 39.7% 20106900 36.1% 18279000 29.8% 15106611.57 22.4% 11349820.86 Depreciation, Depletion & Amortization 3,228,000.00 7.0% 3550800 7.0% 3550800 6.4% 3228000 5.3% 2667768.595 4.0% 2004334.031 Gross Income 24,550,000.00 53.3% 27005000 53.3% 27005000 48.5% 24550000 40.0% 20289256.2 30.1% 15243618.48 Selling, General & Admin Expenses 18,932,000.00 41.1% 20825200 41.1% 20825200 37.4% 18932000 30.9% 15646280.99 23.2% 11755282.49 Operating Income 5,618,000.00 12.2% 6179800 12.2% 6179800 11.1% 5618000 9.2% 4642975.207 6.9% 3488335.993 Other Income/Expense - Net 204,000.00 0.4% 224400 0.4% 224400 0.4% 204000 0.3% 168595.0413 0.3% 126667.9499 Earnings Before Interest And Taxes (EBIT) 5,822,000.00 12.6% 6404200 12.6% 6404200 11.5% 5822000 9.5% 4811570.248 7.1% 3615003.943 Interest Expense On Debt 93,000.00 0.2% 102300 0.2% 102300 0.2% 93000 0.2% 76859.50413 0.1% 57745.68304 Pretax Income 5,729,000.00 12.4% 6301900 12.4% 6301900 11.3% 5729000 9.3% 4734710.744 7.0% 3557258.26 IncomeTaxes 1,594,000.00 3.5% 1753400 3.5% 1753400 3.1% 1594000 2.6% 1317355.372 2.0% 989748.589 Net Income Before Extra Items/Preferred Div 4,135,000.00 9.0% 4548500 9.0% 4548500 8.2% 4135000 6.7% 3417355.372 5.1% 2567509.671 Net Income Before Preferred Dividends 4,135,000.00 9.0% 4548500 9.0% 4548500 8.2% 4135000 6.7% 3417355.372 5.1% 2567509.671 Net Income Available to Common 4,135,000.00 9.0% 4548500 9.0% 4548500 8.2% 4135000 6.7% 3417355.372 5.1% 2567509.671 Brick Brewing BRICK BREWING CO. LIMITED BALANCE SHEET 1/31/2012   Year 1   Year 2   Year 3   Year 4   Year 5 Assets Receivables (Net) 4,585,333.00 10% 5043866.3 10% 5548252.93 10% 6103078.223 10% 6713386.045 10% 7384724.65 Total Inventories 3,961,542.00 10% 4357696.2 10% 4793465.82 10% 5272812.402 10% 5800093.642 10% 6380103.006 Other Current Assets 299,919.00 10% 329910.9 10% 362901.99 10% 399192.189 10% 439111.4079 10% 483022.5487 Current Assets - Total 8,846,794.00 10% 9731473.4 10% 10704620.74 10% 11775082.81 10% 12952591.1 10% 14247850.2 Property Plant & Equipment - Gross 30,946,991.00 10% 34041690.1 10% 37445859.11 10% 41190445.02 10% 45309489.52 10% 49840438.48 Accum. Depreciation -13,193,816.00 10% -14513197.6 10% -15964517.36 10% -17560969.1 10% -19317066.01 10% -21248772.61 Other Assets 13,864,158.00 10% 15250573.8 10% 16775631.18 10% 18453194.3 10% 20298513.73 10% 22328365.1 Total Assets 40,464,127.00   44,510,539.70   48,961,593.67   53,857,753.04   59,243,528.34   65,167,881.17 Liabilities & Shareholders Equity Accounts Payable 6,245,305.00 10% 6869835.5 10% 7556819.05 10% 8312500.955 10% 9143751.051 10% 10058126.16 ST Debt & Current Portion of LT Debt 3,505,401.00 10% 3855941.1 10% 4241535.21 10% 4665688.731 10% 5132257.604 10% 5645483.365 Current Liabilities - Total 9,750,706.00 10725776.6 11798354.26 12978189.69 14276008.65 15703609.52 Long Term Debt 5,890,379.00 10% 6479416.9 10% 7127358.59 10% 7840094.449 10% 8624103.894 10% 9486514.283 Deferred Taxes - Debit -2,857,000.00 Other Liabilities 181,898.00 Total Liabilities 12,965,983.00 17205193.5 18925712.85 20818284.14 22900112.55 25190123.8 Shareholders Equity Common Equity 27,498,144.00 27,305,346.20 30,035,880.82 33,039,468.90 36,343,415.79 39,977,757.37 TotalLiabilities & Shareholders Equity 40,464,127.00   44510539.7   48961593.67   53857753.04   59243528.34   65167881.17 INCOME STATEMENT 01/31/12 Year 1   Year 2   Year 3   Year 4   Year 5 Net Sales or Revenues 34,077,705.00 100.0% 37485475.5 100.0% 41234023.05 100.0% 45357425.36 100.0% 49893167.89 100.0% 54882484.68 Cost of Goods Sold 24,083,453.00 70.7% 26491798.3 70.7% 29140978.13 70.7% 32055075.94 70.7% 35260583.54 70.7% 38786641.89 Depreciation, Depletion & Amortization 2,365,975.00 6.9% 2602572.5 6.9% 2862829.75 6.9% 3149112.725 6.9% 3464023.998 6.9% 3810426.397 Gross Income 7,628,277.00 22.4% 8391104.7 22.4% 9230215.17 22.4% 10153236.69 22.4% 11168560.36 22.4% 12285416.39 Selling, General & Admin Expenses 6,078,003.00 17.8% 6685803.3 17.8% 7354383.63 17.8% 8089821.993 17.8% 8898804.192 17.8% 9788684.612 Operating Income 1,550,274.00 4.5% 1705301.4 4.5% 1875831.54 4.5% 2063414.694 4.5% 2269756.163 4.5% 2496731.78 Extraordinary Charge - Pretax 78,165.00 0.2% 85981.5 0.2% 94579.65 0.2% 104037.615 0.2% 114441.3765 0.2% 125885.5142 Other Income/Expense - Net -133,863.00 -0.4% -147249.3 -0.4% -161974.23 -0.4% -178171.653 -0.4% -195988.8183 -0.4% -215587.7001 Earnings Before Interest And Taxes (EBIT) 1,338,246.00 3.9% 1472070.6 3.9% 1619277.66 3.9% 1781205.426 3.9% 1959325.969 3.9% 2155258.565 Interest Expense On Debt 665,658.00 2.0% 732223.8 2.0% 805446.18 2.0% 885990.798 2.0% 974589.8778 2.0% 1072048.866 Pretax Income 672,588.00 2.0% 739846.8 2.0% 813831.48 2.0% 895214.628 2.0% 984736.0908 2.0% 1083209.7 IncomeTaxes 16,000.00 0.0% 17600 0.0% 19360 0.0% 21296 0.0% 23425.6 0.0% 25768.16 Net Income Before Extra Items/Preferred Div 656,588.00 1.9% 722246.8 1.9% 794471.48 1.9% 873918.628 1.9% 961310.4908 1.9% 1057441.54 Net Income Before Preferred Dividends 656,588.00 1.9% 722246.8 1.9% 794471.48 1.9% 873918.628 1.9% 961310.4908 1.9% 1057441.54 Net Income Available to Common 656,588.00 1.9% 722246.8 1.9% 794471.48 1.9% 873918.628 1.9% 961310.4908 1.9% 1057441.54 Read More