Ceres Gardening revision PDF

Preview

Summary

Assignment ...

Description

Ceres Gardening: Channel Stuffing

FIN 4596-002 Professor Tilan Tang March 2, 2018 Dillon Patel

Ceres Gardening cannot sustain its rapid growth without adequate capital expenditures. It’s accounts receivables and inventory are increasing which is putting Ceres in a financial crisis. Ceres’ sales are inflated by selling more products to its dealers that they can sell to the public. As a result, Ceres’ sales look good on the books, but the sales of its dealers are not. The main issue is that the unsold dealer inventory leads to a fall in actual sales putting Ceres at risk of violating its debt covenant leading to negative cash flows. As a result, Ceres to be short on cash to pay expenses and liabilities because its days in accounts receivable is greater than days in accounts payable. Ceres cannot borrow more debt or its current debt covenant will be violated. Ceres will have a tough time getting additional financing as the company’s interest coverage ratio has declined. This is mainly attributed to the unbalance of days in accounts receivables and days in accounts payable. Because of channel stuffing, Ceres is not receiving money from its dealers quick enough to be able to pay for its expenses and liabilities. Dealers are left with excess inventory from previous seasons and are not able to pay Ceres on time. This all contributes to the decline in ROE. Margins have shrunk with unsustainable expansion which has caused ROE to decrease. In addition, Ceres slowly became less efficient from 2002 to 2006 in generating sales with its assets and is not using its assets efficiently enough. Ceres needs to change its marketing plan to be able to obtain adequate capital to sustain its growth. The first step Ceres can take is to stop channel stuffing to allow its dealers to sell inventory and to help its dealers forecast how much inventory they can take. The forecast in Exhibit 1 shows a more manageable amount of inventory that should be produced at the given conservative 8% growth rate in the industry. The GetCeres program must be changed to incentivize dealers to pay early by giving a 15% discount if payment is received in 75 days, 10% in 80 days and all other payments cannot exceed the deadline of 90 days. Ceres must go to the bank to renegotiate its debt covenant to at least 4x EBITDA and a longer payment schedule than 90 days. Exhibit 2 should be shown to the bank as well as attached forecasts to aid in negotiation. These compare the new plan vs continued operations of A/R, A/P and ROE. Growth in the gardening industry is expected to grow and Ceres can see a positive future.

Assumptions: •

I assumed an 8% estimated organic gardening growth rate for direct sales, dealer sales growth, ending inventory growth. The growth rate given in the case was 8%-10% and I used 8% to stay on the conservative side.

Confidence (the good): ●

Strong ability to meet its current liabilities. Ceres has a current ratio of 2.01 in 2006.

●

Constant increase in sales. Between 2005 and 2006, sales increased 21%.

●

The stock price has been increasing by 25% in 2004-2005 and 18.5% in 2005-2006, which shows that investors are confident in Ceres’ future.

●

The equity multiplier increased to 2.94 in 2006 from 2.74 in 2005, which means that Ceres is leveraging their assets more with debt and pursuing an aggressive strategy.

●

EPS has been increasing each year. Ceres is becoming more profitable every year and EPS is important to its stockholders; 0.40 EPS in 2002, 0.43 EPS in 2003 and 2004, 0.50 EPS in 2005, and 0.51 EPS in 2006.

●

The P/E ratio has been rising every year, which means that investors are willing to pay more for every dollar of equity. This ratio shows that the company is expected to perform well in the future.

Concerns: ●

ROE decreased each year from 2002-2006. It was 23.7% in 2002 and 16.04% in 2006. The ROE is expected to become decrease in 2007 and then increase starting in 2008. However, it is not expected to reach levels pre-2006. This is a concern going forward.

●

Days receivables and days payables have significantly increased. Many retailers are waiting until they sell the product to pay us, which could result in us collecting a lower percentage of receivables than we estimated for. Ceres will not have enough money to pay expenses and its own liabilities.

●

High debt to equity ratio: 0.94(2006). The company has almost doubled their total debt relative to the company’s equity. In the case of an economic downturn, this could lead to the company not being able to meet their interest expense.

●

Net margin has been decreasing every year. Net margin was 4.83% in 2002 and 2003, but every year after that it has decreased; it decreased to 3.6% in 2006.

●

Total asset turnover decreasing from 2002 to 2006 could be a sign that Ceres is becoming less efficient in generating sales with their assets. However, the decrease is more likely an indicator of how Ceres is channel stuffing. The decrease indicates the truer value for TAT because the higher values are artificial due to dealers being overloaded with inventory.

●

Dealers’ inventory spiked from $10mm in 2005 to $23mm in 2006. This is a sign of channel stuffing because the dealers’ inventory increased by 130%, which means that customers were not buying all the products Ceres sold to its dealers.

●

The interest coverage ratio has been decreasing every year. It was 8.78 in 2002, and it decreased to 4.59 in 2006. This is an issue for Ceres because their ability to meet their interest payments is not as strong as it was.

●

Potential sales might decrease due to major gardening supply companies, like Burpee Seeds, that have entered the organic seedlings sector.

●

Ceres has maxed out its revolving credit line every year since 2001, which might lead to an issue because days receivables is increasing without increasing the credit line.

●

Ceres’ debt to prior year EBITDA had decreased by 5.88% from 2003 to 2004, but within one year, it had increased 19.7% from 2004 to 2005. Currently in 2006, Ceres is at 2.50x debt to prior year EBITDA, which is near the high end of the 3.25x EBITDA limit Ceres can borrow.

Key Ratios: ●

3.25 times the EBITDA - This ratio has been growing, which gives room to take on more debt. However, it will sharply decline in 2008. Therefore, convincing the bank to allow us to take on more debt is vital to the financial health of Ceres.

●

Interest Coverage Ratio - The interest coverage ratio has been decreasing each year from 8.78 in 2002 to 4.59 in 2006 to 2.43 in 2007. The lower the ratio gets, the harder it will be to pay its interest on debt. This may lead to a debt covenant violation and a calling of loans.

●

Current Ratio - The current ratio has been decreasing from 3.10 in 2002 to 2.01 in 2006. After 2006, it is projected to decrease each year. This ratio is high, which means that Ceres might not be using their assets efficiently. However, because Ceres is currently financially unstable, having a stronger ability to meet their current liabilities would be positive for Ceres.

●

ROE - The ROE has been decreasing over the past few years, and it is forecasted to be 6.2% for 2007. This decrease is a result of the channel stuffing from the past years. After the correction of channel stuffing, ROE will increase in 2008 to 12.4%.

●

Days Receivables - Days receivables increased to 124 in 2007. Under the GetCeres program customers are to pay within 120 days. Needs to match days payable of 75-90 days.

●

Days Payable - negotiated with supplier to extend payment to 75-90 days to better position cash flows in relation to days payable. Cannot increase it anymore or costs will increase.

●

TAT – has been decreasing YoY; it has decreased by 34.9% from 2002 to 2006. It will continue to decrease to 0.90 in 2007 but then increase to 1.35 by 2009. This is important to Ceres because it tells us if Ceres is utilizing assets efficiently, which it is not.

Appendix Exhibit 1 – New Inventory Proposal Forecast

Exhibit 2 – New Proposal of A/R, A/P and ROE Vs. Old...