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BEGA CHEESE LIMITED COMPANY ANALYSIS REPORT FOR 2014 - 2106

Accounting ACC1007 Assignment 3

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Executive Summary: The purpose of this report is to analyse Bega Cheese Ltd.’s performance in key areas for the period 2014 to 2016. Whilst the primary methodology has been analysis of key financial ratios, non-financial information has also been utilised to provide a more holistic view and assessment of Bega’s economic and operational accomplishments. The requirement to utilise non-normalised financial reports, particularly for 2015 where revenue was boosted by Bega’s sale of WBH shares requires caution in financial ratio analysis. Nevertheless Bega has shown improvement in many key areas of profitability, efficiency, liquidity and gearing overall. Comparison with all reported ratios has been made against major rival Devondale Murray Goulburn for 2016. Bega continues its strategy of market expansion, product diversion/acquisition to strengthen its position as a major consumer staples manufacturer.

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Contents Executive Summary:..............................................................................................................................................2 Introduction and purpose of Analysis:..................................................................................................................4 Company and industry background:....................................................................................................................5 ANALYSIS OF FINANCIAL REPORT DATA.................................................................................................................6 PROFITABILITY...................................................................................................................................................6 Return on shareholder’s equity (ROE)...........................................................................................................6 RETURN ON ASSETS.......................................................................................................................................6 NET PROFIT MARGIN.....................................................................................................................................7 GROSS PROFIT MARGIN.................................................................................................................................7 EFFICIENCY........................................................................................................................................................8 Inventory turnover & accounts receivable turnover......................................................................................8 Accounts payable turnover............................................................................................................................8 Asset Turnover ratio......................................................................................................................................9 LIQUIDITY RATIOS............................................................................................................................................10 Current Ratio & Quick Asset ratio................................................................................................................10 Operating Cash Flow...................................................................................................................................10 CAPITAL STRUCTURE & GEARING....................................................................................................................11 Gearing ratio...............................................................................................................................................11 Interest coverage ratio................................................................................................................................11 Debt to asset ratio.......................................................................................................................................11 CONCLUSION:......................................................................................................................................................12 Appendix A BEGA CHEESE LTD – INDUSTRY OVERVIEW...................................................................................13 Appendix B: Financial ratios summary & Murray-Goulburn 2016 Comparison...............................................14 APENDIX C: FINANCIAL RATIOS........................................................................................................................15 Appendix D – Vertical Analysis........................................................................................................................21 ............................................................................................................................................................................ 21 References...........................................................................................................................................................22

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Introduction and purpose of Analysis: This report provides an overview of Bega including its position in the market against major rivals. Within this context the financial analysis of Bega uses conventional performance ratios to identify change and analyse what has driven changes over the review period. This analysis “personalizes” ratio changes to assess Bega’s performance and any underlying concerns for the short/medium term. As required, all financial ratios have been calculated using non-normalised financial reports resulting in significant impact on some ratios due to non-operating financial transactions.

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Company and industry background: Established in 1899 in Bega NSW as a dairy farmers’ cooperative, processing milk products , the Bega Co-operative Creamery Company has expanded to become an ASX top 200 company; one of only 2 dairy product companies in the consumer staples sector. Through acquisition and diversification Bega (Cheese Ltd expanded its product range, operations and markets. Notable events include its 1997 cheese processing development to supply cheese to Australian and International markets and in 2007 the acquisition of a 70% shareholding in Tatura Milk Industries Limited before acquiring the remaining 30% after Bega was listed on the Australian Securities Exchange in 2011 (Bega, 2018). Despite its ASX listing, close to 50% of shares are still held by Bega’s farmer suppliers (Binsted, 2018) In January 2017, Bega acquired most of Mondelez International’s grocery/ cheese business in Australia and New Zealand in a $460M deal including the license to manufacture Kraft cheese, peanut butter, Vegemite and Bonox. Bega moved from a company mainly reliant on the volatile, low-margin bulk food ingredients market to a diversified consumer-goods company (Ibisworld, 2018) . Bega has developed significant supply relationships with major supermarkets in a competitive environment. While losing its contract in 2106 with Coles to produce Coles branded cheeses to major rival, Murray Goulburn Devondale it acquired the contract with Woolworths in the same year from Murray Goulburn for the supermarket’s own branded cheeses (Ibisworld, 2018). Notable partnerships include Bellamy’s and Blackmores as Bega saw a 50% increase in 2016 in its nutritionals business (Bega Cheese, 2016). Adequate milk supply is essential for much of Bega’s products whilst remaining competitive with major local rivals, Fontera, WCB, Murray Goulbourn and Lion Pty Ltd as well as importers (appendix 1). Local demand as well as global commodity market volatility set a market environment that provides both opportunity and uncertainty (Ibisworld, 2018).

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ANALYSIS OF FINANCIAL REPORT DATA PROFITABILITY DMG 2016 15% 1.7% 1.23% 14.8% (note: all calculated ratios compared with Devondale Murray Goulburn (DMG) for 2016. DMG selected for comparison on basis of strong market segment competition – see Appendix A).

Return on shareholder’s equity (ROE) As a measure of Bega’s profit generation from shareholders entity, ROE comparison for the review periods is significantly distorted by extraordinary income in 2014 from the WCB share sale for $62.06M. This sale increased net profit by $43.69M (Bega Cheese, 2018) and so without it, net profit reduces to $22.4M giving a 2014 ROE of 7.77% Despite this, ROE improved overall from 2014 to 2016 with a significant increase in retained earnings in 2016 to improve overall equity.

RETURN ON ASSETS Return on assets was also inflated by the WCB shares income but nevertheless shows improved wealth creation from the entity’s assets by generating profit. Operating revenue increased by $83.3M in 2016 with improved profit. Horizontal analysis for the review period shows an increase of 4.04% in sales for 2015 and 11.83% increase for 2016 both compared to 2014.

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NET PROFIT MARGIN As a measure of overall profitability, analysis of profit for operations is again biased by the WCB share sales. The more regular operating revenue for 2014 & 2105 show a solid increase in the net profit margin from 1.8% to 3.66% demonstrating very successful improvement in sales whilst containing operating costs.

GROSS PROFIT MARGIN As the only profit ratio not impacted by the share sale, the trend in this ratio is clearer showing an overall improvement in Bega’s performance in revenue (sales) relative to the cost of those sales. Whilst efficiency fell in 2015 it improved significantly in 2016, demonstrating Bega’s capacity to increase sales revenue with effective management of cost of sales.

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EFFICIENCY DMG 2016 29.87 days 17.29 days 22.78 days 264 days

Inventory turnover & accounts receivable turnover Bega’s inventory turnover ratio increased overall from 66.62 days to 67.79 days which could indicate a reduction in stock management efficiency, noting the progressive increase in closing inventory for each period. It could signal however that its revenue growth from nutritionals and more complex products require a longer period of manufacture increasing stock of raw products and goods in process. In comparing the inventory turnover with the accounts receivable turnover there has been a consistent increase in turnover over the 3 year review period; 3.8% increase from 2014 to 2015 and 7.87% increase from 2015 to 2106 with an overall increase of 11.19%. In the absence of improvements resulting from this trend (e.g. increased sales, market penetration, response to increased competition) this trend is of significant concern. This turnover should be closely managed given its significant impact on cash flow.

Accounts payable turnover Accounts payable turnover reduced each year in the review period indicating improved performance in paying creditors. Whilst this trend is primarily considered positive it does however reduce Bega’s access to free financing for inventory purchasing at a time of increased inventory holdings. The trend of lower average accounts payable has been matched with increased credit purchases for each year to give an overall change from 2014 to 2016 of -10.10%. This trend warrants further investigation and could relate to Bega’s milk security program, noting the record of this item as a form of prepayment for farm gate purchases.

Asset Turnover ratio Bega’s use of available assets to generate Sales improved significantly between 2015 and 2016 from 186.52 days to 173.85 days (7.29%). While overall assets increased marginally, overall sales showed solid improvement of 7.49%. Possible contributors to this improved efficiency can be found in the 2016 Annual Report including, increased production efficiency (p15), improved market prices (p4) and new higher priced product lines (p4).

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LIQUIDITY RATIOS BMG 2016 1.90 times 0.20 times 1.54 times

Current Ratio & Quick Asset ratio. The current ratio improved overall from 1.52 times coverage of current liabilities to current assets to 1.65 meaning improved capacity to repay short term debt from available current assets. This ratio showed significant improvement in 2015 noting the positive impact of a reduction in current tax liabilities from the previous year of $21.24M. In 2014 this item represented 10.57% of current liabilities whilst accounting for only 0.67% in 2015. The improvement in 2016 is largely due to the significant increase in accounts receivable previously mentioned in the reduced efficiency turnover of this item. The quick asset ratio or “acid test” shows the significant impact in Bega’s liquidity with the removal of inventory and prepayments, noting a significant comparative improvement from 2014 to 2016 of 17.75%. This ratio highlights the need for Bega to carefully manage its cash flow to match short term obligations.

Operating Cash Flow As a measure of Bega’s ability to pay its current liabilities from the cash flow from operations there is an improvement from 2014 to 2016 from 0.29 to 0.30 times (3.45%), meaning the annual operations cash flow would cover 29% & 30% respectively of the average current liabilities. In 2015 cash flow from operations was negative; more cash was used than collected resulting in a concerning measure of -0.09 times. Clearly this situation is not sustainable and was rectified in the following year. In reviewing Bega’s statement of cash flow for 2015, it is clear that the significant contributing factor to negative operating cash flow was payments to suppliers and employees exceeding receipts from customers. Cash flow was further compounded by deterioration in the accounts receivable ratio and payment of the 2014 $22.425 tax liability.

CAPITAL STRUCTURE & GEARING BMG 2016 28.59% -1.45% 46.02%

Gearing ratio Bega relied more on debt financing for 2015 and 2016 than in 2014 with an overall increase of 100% between start and end of the review period (6.57% to 13.14%). With share capital only marginally increasing, total equity strengthened due to retained earnings, both in dollar value and percentage of total equity. The significant influence on this ratio change for 2015 and 2016 was increased borrowings. This increased reliance on debt funding should be assessed alongside the overall increase in retained earnings and cash flow sufficiency to evaluate the effectiveness and cost of greater debt burden, noting Bega’s significant reduction in long term debt in 2015 from 2014 ($90.3M or 81.87% financed in part with the proceeds of WCB share sales).

Interest coverage ratio Bega’s capacity to cover interest payments from net profit (before interest and tax) reduced significantly from 2014 to 2015 despite interest payments reducing by 43%. This reduced capacity was clearly driven by the significant reduction in profitability for 2015. Improved profitability in 2016 resulted in Bega’s interest coverage ratio rising approximately 200% from 2015. Overall figures evidence Bega’s strong capacity to maintain interest payments and this, backed by a strong balance sheet and growth in earnings support its capacity to attract debt funding.

Debt to asset ratio Bega showed a greater reliance on debt to finance its total asset base, which consecutive increases in this ratio in each year. Overall liabilities increased at a greater rate than overall assets noting liability growth in 2015 was primarily due to increased borrowings and included repayments due in the current year whilst 2016’s increase in debt also included increased trade and other payables which are interest free funding for business operations. Bega should pay careful attention to its overall management of debt funding whilst preserving retained earnings to ensure it is maximising its earnings on available funds.

CONCLUSION: Bega Cheese Ltd has demonstrated its ability to improve its financial and operational performance in a competitive, volatile market though both divestment and procurement of additional manufacturing capacity, securing ongoing product diversification both locally and overseas. Improved profit margins from higher value products will assist Bega’s ongoing attractiveness to investors and lenders. Analysis of Bega’s financial performance evidences sound company management whilst recognizing revenue uncertainty associated with high volume, low margin products. Whilst caution should be taken in direct comparison with major rival BMG, comparison of its 2016 ratios shows a significant different in efficiency ratios with 44% higher inventory turnover by BMG and 43% greater efficiency in accounts receivable settlement. Bega’s short to medium term future appears positive as it maintains its competiveness amongst rivals although it is recommended that liquidity and reserves are well managed to counteract market uncertainty.

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Appendix A BEGA CHEESE LTD – INDUSTRY OVERVIEW

MARKET SHARE IN KEY MANUFACTURING SEGMENTS Market Murray Fonterra Lion Market WCB Segment Share Goulburn Cheese 23.4% 14% 11.2% 6.9% 13.3% manufacturing Butter & dairy 4.6% 16% 12.4% 5.7% products Milk powder 3.9% 9.8% 41.8% 32.3% (data sourced from Ibisworld, 2018)

Others 31.2% 52.2% 16.1%

KEY SAFETY & ENVIRONMENTAL ACHIEVEMENTS 2015 Safety reduced by 17% Workplace injuries Environmental Reduced by 4.2% Energy use Farm Sustainability Ongoing for over 10 Program years Milk Sustainability Onogoing since $25M Program Injection in 2014 (data sourced from Bega, 2018)

2016 reduced by 69%

Reduced by 7.9%

KEY MARKET FACTORS FOR BEGA AND OTHER COMPETITORS: Competition is high in all market segments. Australian cheese manufacturers compete against each other and foreign cheese producers in both domestic and international markets. Competitive advantages can arise from manufacturing efficiencies and downstream demand. Globalisation is high in all market segments and expected to continue. 13

Secure milk supply is critical to product manufacturing. (information sources from Ibisworld, 2018)

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Appendix B: Financial ratios summary & Murray-Goulburn 2016 Comparison

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APENDIX C: FINANCIAL RATIOS PROFITABILITY RATIOS Return on Shareholders’ Equity

2014

(

Net profit after tax x 100 % average shareholders equity

2015

)

66055 x 100 261952 + 314388 2

(

(

(

)

12408 x 100 % 314388 + 31266 2 12408 ¿ x 100 % 627054 /2

(

66055 ¿ x 100 % 576340 /2

2016

)

28779 x 100 31266 + 327838 2 28779 ¿ x 100 % 640504 /2

(

28799

12408

net profit before interest∧tax x 100 % averagetotal assets

Return on total assets =

2015

2014

2016

16434+3644 ( )x 1 (548637+552419)/ 2

93580+ 6392 ) ( (549221+548637)/ 2 %

39900+ 3835 ) ( (552419+586674)/ 2 %

(

(

20078 ¿ x 100 % 1101056 /2

99972 ¿ x 100 1097858 /2 %

(

(

43825 ¿ x 100 % 1139093 /2

20078 ¿ x 100 % 550528 (

99972 Net profit margin (ratio) =

2014 (93580+6392) x 100 % 1069392

Net profit before interest ∧tax x 100 % sales 2015

2016

(16434+3644 ) x 100 % 112630

(39900+3835) x 100 % 1195967

(

99972 ¿ x 100 % 1069392

43825 ¿ x 100 569546 5

(

920078 ¿ x 100 % 112630

0.0180 x 100 %

(

43735 ¿ x 100 % 1195967

0.0366 x 100 %

Gross profit margin (ratio) =

2014 118275 ¿ x 100 ( 1069392

gross profit x 100 % sales

2015

(

2016 (

)

121092 X 100 % 1112630

% = 10...