Page 47 of 131 Operational leasing obligations are not included in the balance sheet making comparison be-tween firms with different financial and/or operational leasing activities difficult. Given insuf-ficient details on the notes of the companies leasing obligations, that are considered minor expenses, the authors conclude that no correction for these assets has been necessary (Søren-sen, 2012, p. 146). The analytical balance sheets are found in appendix 13 for Tican and 20 for Danish Crown.
Page 48 of 131 7.3.1 Level 1: Decomposition of return on equity, ROE
The ROE is the general profitability measure of the company and measures the required re-turn on equity for the equity holders. The ratio is best understood as how much value the firm is required to generate for each DKK invested by owners invest in the firm (Petersen & Plen-borg, 2012, p. 116):
𝑅𝑂𝐸 = 𝑅𝑂𝐼𝐶 + (𝑅𝑂𝐼𝐶 − 𝑁𝐵𝐶𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥) ∗ 𝐹𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙 𝑙𝑒𝑣𝑒𝑟𝑎𝑔𝑒
Table 7-2: Decomposition of the return on equity for Tican, based on (Petersen & Plenborg, 2012)
Level 1: Decomposition of ROE 2011 2012 2013 2014
Return on Equity [ROE] 37.7% 22.0% 15.2% 8.6%
Return on Invested Capital [ROIC] 24.9% 14.9% 11.1% 5.6%
Financial leverage 0.68 0.77 0.76 1.14
The data applied is based on end-of—financial-year balance figures and book value of equity is used when estimating ratios relying on equity although the market value may provide a more precise estimate (Petersen & Plenborg, 2012, p. 155).
Table 7-2 portrays that ROE for Tican has declined by roughly 75% over the course of 4 years. In other words, the company is generating less consolidated profits for each invested DKK in equity. The decomposition of the ROE finds that the main driver is a decline in the ROIC, whereas the financial leverage has actually been increasing over the review period.
The same declining pattern has not been observed for Danish Crown, leading the authors to conclude the declining ROIC to be specific to Tican. Further decomposition of the ROIC may exhibit the factors that driver the declining profitability.
7.3.2 Level 2: Decomposition of return on invested capital, ROIC
Declining profitability is a critical factor when assessing the attractiveness of Tican as a target for Danish Crown and could, potentially, be a deal-breaker under the circumstances that the profitability loss is not deemed transitory.
Further analysis on the ROIC, which is a product of the turnover rate on invested capital (henceforth ATO) and the profit margin (henceforth PM), may reveal the cause of the decline:
𝑅𝑂𝐼𝐶 = 𝑁𝑂𝑃𝐴𝑇
𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙= 𝑃𝑀 ∗ 𝐴𝑇𝑂 = 𝑁𝑂𝑃𝐴𝑇
𝑅𝑒𝑣𝑒𝑛𝑢𝑒∗ 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙
Page 49 of 131 Table 7-3: Decomposition of return on equity for Tican based on (Petersen & Plenborg, 2012) and (Sørensen, 2012)
Level 2: Decomposition of ROIC 2011 2012 2013 2014 Return on Invested Capital [ROIC] 24.9% 14.9% 11.1% 5.6%
Profit margin [PM] 6.0% 3.7% 2.6% 1.4%
Asset turnover rate [ATO] 4.1 4.0 4.3 4.1
Table 7-3 shows that the declining ROIC is primarily attributed to a decline in the PM, whereas the turnover rate on assets, measuring the revenue generated for each DKK in invest-ed capital, appears relatively stable in the period of interest. Furthermore, the measure is much higher than the industry average of 2.5 and the average ATO of Danish Crown of 3 (Sørensen, 2012, p. 218). Thus, Tican is able to generate large sales with relatively few investments, but are experiencing a declining margin on the realized sales.
The PM declines from a level of 6%, which is much higher than the industry average of 3%
and the average of Danish Crown of 3.4%. The measure, while being historically profitable, declines to a level of 1.4% before net financial expenses are deducted.
7.3.3 Level 3: Decomposition of the profit margin
Before the authors conclude on the declining profit margin, the final layer of the DuPont pyr-amid is analysed to allocate the origin of the declining profit margin. This analysis is best conducted using a common-size analysis, which is included in appendix 15 for Tican and 22 for Danish Crown. Table 7-4 highlights the key findings from the common-size analysis.
Table 7-4: Common-size summary of Tican based on (Petersen & Plenborg, 2012)
Tican: Common-size summary 2011 2012 2013 2014 Total ∆
Production expenses -86.0% -87.4% -87.4% -88.0% -2.0%
Distribution expenses -5.5% -5.7% -6.4% -6.4% -0.9%
Administration expenses -2.6% -2.5% -2.4% -2.6% 0.0%
Net other operating expenses 0.1% 0.1% 0.0% 0.0% -0.1%
Depreciations -1.3% -1.4% -1.5% -1.6% -0.3%
EBITDA 7.8% 5.3% 4.3% 3.4% -4.5%
The common-size analysis found that the EBIDTA margin more than halved in the period of interest, decreasing from 7.8% to 3.4%. The largest contributors are found to be increased production and distribution costs that increased by 2% and 0.9%, respectively.
Summing up the second area of research the thesis determines the factors that have been driv-ing the historical profitability of Tican. This was analysed through a decomposition of ROE
Page 50 of 131 which provided a series of interesting results. First of all, the findings seem to support the recent movements towards horizontal integration in the slaughterhouse industry. The econo-mies of scale from production allow the slaughterhouses to deliver competitive prices without sacrificing profitability, as was the case with Tican. Secondly, the increased cost production was found to be a major factor in the declining profitability of Tican. The effect of the Rus-sian embargo and increased activity in the affiliates of Tican is found to be the main driver in the increased relative cost. The proposed merger with Danish Crown could potentially offset the decreasing profitability through economies of scale, synergies and a general lower cost of production per kg pork produced, reflected in a production cost as % of revenue roughly 2%
lower than Tican’s. Further analysis is required to determine whether the synergies from the merger are sufficient to reverse the declining profitability.
7.3.4 ROIC vs. WACC and the implications on invested capital
The ROIC has been decomposed and the prime factor in the declining profitability of Tican has been detected. The following analysis will determine the impact of the declining profita-bility on the value creation within Tican using the Economic Value Added theory:
𝐸𝑉𝐴𝑡= (𝑅𝑂𝐼𝐶𝑡− 𝑊𝐴𝐶𝐶𝑡) ∗ 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙𝑡
The EVA exhibits abnormal returns generated on invested capital. When return on invested capital supersedes the weighted average cost of capital (henceforth WACC) it is said to gen-erate value (Petersen & Plenborg, 2012, p. 96).
For the purpose of this thesis, the ROIC of Tican will be benchmarked against Danish Crown’s WACC. While counterintuitive at first glance, the assumption allow the authors to better determine the attractiveness of the business case of Tican, as the value creation has to be seen from the perspective of Danish Crown. The comparison thus looks at whether the level of profitability in Tican satisfies the equity and debt holders in Danish Crown. Hence we apply the WACC of 6.40% as reported in the annual report of Danish Crown. See appendix 46 for an extensive analysis on the WACC.
Figure 7-3: Abnormal return illustrated through ROIC and WACC (Own creation)
0.00%
10.00%
20.00%
30.00%
2011 2012 2013 2014
WACC [DC]
ROIC [Tican]
Page 51 of 131 Figure 7-3 illustrates that Tican would not be generating value under the control of Danish Crown in 2014, disregarding any potential synergies that would arise during the merger. In fact, the company would destroy value for each DKK in invested capital. Prolonged operation with negative EVA would cause the market value of equity to drop below the book value of equity, which is already very close reflected in a market to book ratio on equity of 1.04 (Pe-tersen & Plenborg, 2012, p. 98).
The figure portrays that Tican, prior to 2014, was generating value above what was required by the investors in Danish Crown and, all else equal, would impose a great economic partner.
Further assessment on the attractiveness of Tican relies on whether the company is able to improve their PM through reductions in operational costs.
7.3.5 Benchmarking of the financial ratios
The following section intends to benchmark the key financial ratios with the peer group as argued in the second research area of the thesis. This allows the authors to determine the size of the relative ratios, rather than the historical direction.
Figure 7-4: Benchmarking ROIC of Danish Crown and Tican with appropriate peers, own creation based on (Bloomberg Terminal, 2016).
Figure 7-4 indicates that Tican has been underperforming relative to Danish Crown and its peers, as of 2014. Controversially, Tican has been generating an incredibly large return on their invested capital prior to the Russian embargo. The figure concludes that Tican used to be several times more productive in terms of value creation than the peer group existing of large well established slaughterhouses. The decomposition found that a declining PM was the main driver to the declining ROIC; hence the following Figure 7-5 is intended to benchmark the level of PM in Tican with its peers.
00%
05%
10%
15%
20%
25%
30%
2011 2012 2013 2014
Tican Danish crown Average
Page 52 of 131 Figure 7-5: Benchmarking Profit Margins of Danish Crown and Tican with appropriate peers, own creation based on (Bloomberg Terminal, 2016).
Figure 7-5 illustrates the turbulent years that Tican has experienced in recent years. While maintaining a stable turnover rate on assets and generating returns well above the required returns from the owners in Danish Crown, Tican has been experiencing rapidly decaying prof-it margins. A slight decrease is observed in the PM of the average peer group, although not significant enough to argue the decline in PM to be a general market condition. The section on forecasting will determine whether Tican is likely to return to their production level prior to the Russian embargo and whether potential synergies can outweigh the current situation of decreased profitability.
7.4 Risk analysis