Case study: Debt Policy at UST Inc.

Topics: Dividend yield, Revenue, Finance Pages: 18 (1842 words) Published: January 9, 2008
FIN 5204

MANAGING CORPORATE CAPITAL INVESTMENT AND CAPITAL STRUCTURE

FALL 2007

DEBT POLICY AT UST INC.

1. WHAT ARE THE PRIMARY BUSINESS RISKS ASSOCIATED WITH UST INC.? WHAT ARE THE ATTRIBUTES OF UST INC.? EVALUATE FROM THE VIEWPOINT OF THE BONDHOLDER.

Over the years, UST has been a dominant producer in the tobacco industry, specifically the moist tobacco industry. Even though the past strategy with UST has entailed raising the prices of its products on a regular basis, the company still shows signs of positive growth. Additionally, there have been recent issues with smokeless tobacco products, such as lawsuits. However, there remains a constant consumer demand for UST products. When evaluating the business risk of a company, one of the primary drivers of its business risk stems from the price elasticity of its products. Thus, these are a few reasons that illustrate that the smokeless tobacco industry (UST's most dominant EBIT contributor) has a relatively steep demand curve and should be considered as having an inelastic consumer demand. Also, it is important to note that UST has products outside of its core operations in the wine and premium cigar market. Also, UST has introduced products in the price value market as consumer demand has increased.

_Brand name and market position -_ superior

_Cash flow generating capacity_- superior

_Cyclicality of revenues_ - superior

_Product diversification_ - poor

_Geographic diversification_ - good

_Asset tangibility_ - good

_Litigation Risk -_ poor

Obviously, the two most troubling business risks associated with UST are its litigation and product diversification risks. The smokeless tobacco industry will always face potential lawsuits because of the ongoing health concerns. Also, even though UST has diversified into other markets (wine and cigars), these products are very minimally attributing to UST's EBIT. Nevertheless, UST products have a steady demand for their products, they produce positive cash flows year-to-year, and the company has a dominant market position and brand name with regard to their core business. For these reasons, it is determined that UST has a relatively low business risk.

2. DISCUSS UST'S PAST FINANCIAL PERFORMANCE. IS THE PAST PERFORMANCE EXPECTED TO CONTINUE IN THE FUTURE?

UST Historical Financial Performance

5-YEAR CAGR 10-YEAR CAGR

NET SALES 5% 9%

EBIT 6% 11%

EPS 9% 13%

5-YEAR AVERAGE 10-YEAR AVERAGE

GROSS PROFIT MARGIN 79.7% 77.3%

NET MARGIN 32.7% 31.3%

ROE 122.8% 89.1%

DIVIDEND PAYOUT 61.6% 57.8%

The historical financial data indicates that that compound annual growth per year has been declining in the past five year compared with the past ten years in Net Sales, EBIT, and EPS. Obviously, this is a sign of UST slowing down its financial performance due to factors such as an increase in competitors, less consumer demand, etc... Nevertheless, it is comforting that within the past five years, the operating data is generally not moving backwards and is still growing (at a much slower rate). When analyzing the 5-year and 10-year averages, the data indicates that UST financials are still steady and increasing.

Exhibit 2 suggests that the market share of UST has been slowly decreasing over the past 7-years.

Due to the fact that there has been increased competition in the premium smokeless tobacco market, UST is losing market share with products in its core operations. Furthermore, the price value products in the industry are showing a dramatic increase in market share, yet UST only shows a 0.6% market share in 1998 (late mover). For these reasons, UST needs to focus their efforts on attracting the growing demand with the price value smokeless tobacco products in order to strengthen their long-term financial performance. Thus, because of the increased competition in the smokeless tobacco industry, UST has to constantly look for innovative ways in order for them to be a driving force...
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