Brief description of the industry
The industry supports the growth of value-priced beer products and premium craft beers. Products in between the luxurious varieties reported a decline in sales volume. The industry sales declined by 0.2 % in 2012 from 2011 (Big Rock Brewery Inc. 8). Big Rock’s 2012 annual report explains that brewing companies focus on managing cash flows, and increasing operating efficiency. Brick Brewing highlights that one of its strategies is to reduce operating costs. The company targets to save half a million dollars in operating costs, and another half in procurement costs (Brick Brewing Co. Ltd. 2). Companies in the industry have a tendency to launch new products. Both firms launched several products between 2010 and 2012.
The strategy of each corporation
Brick Brewing Co. pursues a strong marketing strategy. It can be noticed from the financial statements that selling, marketing, and administration costs increased by a large margin. The company reports that the increase is attributed to marketing costs, which increased by $1.2 million from the 2011 financial year (Brick Brewing Co. Ltd. 9). The company relies on multiple products and brands to keep its revenues growing. The company strategy includes focusing on the Laker family brand, which had a sales growth of 22.2% brands in 2012 (Brick Brewing Co. Ltd. 8). The company sees the Laker brand as an opportunity to pursue further growth.
Big Rock’s strategy is to increase profitability by increasing efficiency. The managers discuss that its net income increased from $2,533 thousand to $4,135 thousand, despite a decline in sales by 1.5% for the 2012 financial year (Big Rock Brewery Inc. 10). The company also attributes the rise in operating profit to higher prices of products. The company recognizes its strategy to focus on higher-margin brands in higher-margin regions as an opportunity that may provide higher profits (Big Rock Brewery Inc. 10). The company has plans of withdrawing brands with lower margins, or from regions with higher costs.
Profitability Ratios
Return on assets
Return on assets = net earnings/ total assets
Brick Brewing
Big Rock Brewery
Return on assets shows that Big Rock Brewery is more efficient than Brick Brewing in utilizing assets to generate profits.
Return on common equity
Return on equity = net earnings/ stockholders’ equity
Brick Brewing
Big Rock Brewery
Return on equity indicates that Big Rock Brewery shareholders’ value is likely to increase at a higher rate than Brick Brewing’s shareholders. Shareholders have more value-added at Big Rock than at Brick Brewing.
Net profit margin
Net profit margin = net income / revenues
Brick Brewing
Big Rock Brewery
Net profit margin shows that Brick Brewing is more profitable than Big Rock on average. However, Big Rock’s profitability is increasing at a higher rate than Brick Brewing’s. In the last two years, Big Rock has been more profitable.
Liquidity Ratios
Current ratio
Current ratio = current assets/ current liabilities
Brick Brewing
Big Rock Brewery
The current ratio measures a firm’s ability to cover short-term debt requirements. Both firms have the ability to meet short-term debt requirements. Big Rock has more liquid assets to cover short-term debts than Brick Brewing.
Quick ratio
Quick ratio = (current assets – inventory) / current liabilities
Brick Brewing
Big Rock Brewery
Quick ratio checks whether a firm can still meet its short-term debt requirements when inventories are not considered. Inventories are less liquid because they have to be converted into sales. Big Rock’s quick ratio has improved when Brick Brewing has remained less than the required amount. A firm needs a quick and current ratio that is closer to 1.0. The value may change depending on the industry. The beer industry products are fast-moving goods. The companies may have a lower quick ratio.
Operating cash flow to current liabilities
Cash flow liquidity = operating cash flow/ current liabilities
Brick Brewing
Big Rock Brewery
Operating cash flow to current liabilities shows the ability of cash from operating activities to cover its operational needs. Big Rock has enough cash to cover its operations when Brick Brewing generates less cash to cover its operations.
Solvency Ratios
Total liabilities/ total assets
Debt ratio = total liabilities/ total assets
Brick Brewing
Big Rock Brewery
The firms use almost the same ratio of debt to finance their capital. However, Brick Brewing provides a slightly higher level of risk to an investor because of its higher reliance on debt.
Long-term debt to long-term capital
Long-term debt to total capitalization = long-term debt/ long-term debt + stockholders’ equity
Brick Brewing
Big Rock Brewery
The long-term debt to total capitalization ratio shows that both firms use a small proportion of debt to finance their capital. Brick Brewing uses less long-term debt than Big Rock. It provides less risk to shareholders than Big Rock.
Interest coverage ratio
Interest coverage ratio = operating profit/ interest expense
Brick Brewing
Big Rock Brewery
The interest coverage ratio shows that Big Rock has more ability to service its debts than Brick Brewing.
Activity Ratios
Accounts receivable turnover
Accounts receivable turnover = net sales/ accounts receivable
Brick Brewing
Big Rock Brewery
Accounts receivable turnover indicates that Big Rock receives cash from receivables more frequently than Brick Brewing. As a result, Big Rock is a more efficient manager of receivables than Brick Brewing.
Days in receivables
Days in receivables = net accounts receivables/ (net sales/ 365)
Brick Brewing
Big Rock Brewery
Days in receivables show that Big Rock uses fewer days to collect receivables than Brick Brewing.
Inventory turnover
Inventory turnover = cost of goods sold/ inventory
Brick Brewing
Big Rock Brewery
Inventory turnover shows the number of times that the stocks of goods are cleared. Brick brewing has a higher frequency. It indicates it manages inventory more efficiently than Big Rock.
Accounts payable turnover
Accounts payable = cost of goods sold/ accounts payable
Brick Brewing
Big Rock Brewery
A firm that prolongs paying accounts receivable may need less cash for its operations. Brick Brewing has a lower frequency. It indicates Brick Brewing prolongs payables’ days longer than Big Rock. Brick Brewing is a better manager of accounts payables than Big Rock.
Income statements and balance sheets’ forecast
Basis for forecast
The forecast is based on horizontal common-size analysis averages (see Appendix A). It could have been more accurate if the years were more than three years. The income statements apply the average change in the horizontal common-size analysis of sales, costs of sales, and expenses. It is difficult to apply the same technique on the balance sheet (see Appendix B). The balance sheet applies a single unit of improvement for all items based on the average increase in the 3 years. Big Rock total assets increased by an average of 12.95% in two years when Brick Brewing increased by 0.56%. Brick Brewing balance sheet items apply an increase of 0.56%. Big Rock balance sheet items apply an increase of 3.5%. It considers that the 12.95% is distributed in several items as well as the difficulty of maintaining a 12.95% growth rate. Big Rock shows a great improvement mainly because it invested largely in 2010. Its profitability increased by a large margin in 2011 and 2012, despite reporting losses in 2010. The growth is valid because it follows a trend. When a business sets a trend, it is unlikely to change by a large margin in the short run. The common-size analysis also covers the impact of past retained earnings on business growth.
Calculating WACC
WACC shows the rate of returns that a company needs to generate to satisfy both shareholders and long-term creditors. I would use WACC because it moderates the rate of return required to satisfy those who contributed capital. Using equity’s rate would give a rate lower than the actual rate, and using the debt’s rate would give a rate higher than the actual rate.
WACC = E/V * Re + D/V * Rd * (I – Tc), where E is the value of equity, V is equity + debt, D is the value of debt, and Tc is corporate tax.
Assuming the cost of equity is the risk-free rate and inflation, it gives a combined rate of 4%. Brick Brewing’s cost of debt is about 6.5%. It uses a few loans with different rates. Big Rock’s average cost of debt is about 5.5%. The income tax indicates that the companies’ income tax rate is about 27%.
Brick Brewing (Jan 31, 2013) WACC = (29,592,544/ 35,997,909) *0.04 + (6,405,365/ 35,997,909) * 6.5% * (1 – 0.27) = 0.03288 + 0.00844 = 0.04132 =4.1%
Big Rock (Dec 30, 2012) WACC = (32,071/ 39,982) * 0.04 + (7,911/ 39,982) * 0.055 * (1 – 0.27) = 0.03209 + 0.00794 = 0.04003 = 4.0%
Discounted cash flows
The net present value of incomes shows that Big Rock has a higher value than Brick Brewing. Big Rock is about five times Brick Brewing’s value.
Altman Z-score
The score measures the likelihood of a firm filing for bankruptcy. A score below 1.8 indicates the likelihood of bankruptcy. A score above 3.0 represents the unlikelihood of bankruptcy.
Both firms indicate a strong financial position. Big Rock is closer to the unlikelihood of falling into bankruptcy when Brick Brewing is closer to the bankruptcy zone.
Investment choice
Big Rock is a better investment choice because it has better scores in most of the indicators. Big Rock has a higher profit growth rate than the competitor. Higher profits may be transformed into a higher firm’s growth rate. Big Rock promises a higher return on equity and assets than the competitor. It is more liquid than the competitor as shown by the current ratio, quick ratio, and operating cash flow liquidity ratio. Big Rock has a higher ability to pay interest expenses than the competitor. Both firms use the same level of debts, but the Big Rock balance sheet grows at a higher rate than Brick Brewings. Big Rock has a higher Altman Z-score than the competitor, which indicates it is more unlikely to go into bankruptcy than the competitor.
Works Cited
Big Rock Brewery Inc. 2012. 2012 Annual Report. PDF file. Web.
Brick Brewing Co. Ltd. 2012. 2012 Annual Report. PDF file. Web.
Appendices
Appendix A
Big Rock Income statement.