5.4 Risk Analysis
5.4.1 Liquidity risk analysis
Liquidity is an essential part of any business. A lack of liquidity leaves firm’s less prone to respond to unexpected changes in their operation, for example acting on investment opportunities but also more severe factors such as lack of capital to just operate core business activities. Such occurrences may force a firm to divest business units it may not otherwise want to divest and even at unfavorable valuations. Lack of liquidity may also cause payment suspension and put valuable supplier relations at risk, it can tilt a company towards bankruptcy and ironically enough, poor liquidity management may also increase the cost of debt. Liquidity risk is hence directly linked to the firm’s ability to generate positive cash flow in both the short- and long-term (Petersen & Plenborg, 2012, p. 150).
In the following section an array of key liquidity metrics has been used to analyze the situation at Campbell and its peers, the metrics are based on each company’s annual reports, but just like the previous section, there is a bias related to different accounting periods. Nonetheless, these figures are used as they yield the most updated picture of each company (Petersen & Plenborg, 2012, p. 155).
5.4.1.1 Short-term liquidity risk
The short-term liquidity risk can be valued by assessing a range of metrics with basis in a firm’s financial information. The authors have decided to utilize three metrics: “the liquidity cycle”, “the current ratio” and “the quick ratio”. The liquidity cycle shows how long it takes to convert working capital to cash, hence, the shorter time span needed in order to convert working capital to cash the better the short-term liquidity situation for a firm is
General Mills
The J.M. Smucker Company Kellogg Company
ConAgra Foods
Campbell Soup Company
Source: Authors own compilation based on (Campbell Soup Company, 2010 - 2015) Figure 27. Return on Equity (ROE)
-10%
20%
50%
80%
110%
140%
170%
200%
2010 2011 2012 2013 2014 2015
Financial Analysis
68 (Petersen & Plenborg, 2012, p. 153). The current ratio shows the relationship between current assets and current liabilities, the higher the ratio the higher the presumed likelihood of current assets being able to cover current liabilities should the liquidity need arise (Petersen & Plenborg, 2012, p. 155). The third metric, the quick ratio, tries to yield insight into the same issue as the current ratio but is more conservative as it only looks at the most liquid current assets (Petersen & Plenborg, 2012, p. 155).
Eq. 8. 𝑳𝒊𝒒𝒖𝒊𝒅𝒊𝒕𝒚 𝑪𝒚𝒄𝒍𝒆 = 𝟑𝟔𝟓 ∗ 𝑪𝑶𝑮𝑺𝟏
𝑨𝒗𝒈.𝑰𝒏𝒗𝒆𝒏𝒕𝒐𝒓𝒚𝒕,𝒕−𝟏
+ 𝟑𝟔𝟓 ∗ 𝑵𝒆𝒕 𝑺𝒂𝒍𝒆𝒔𝟏
𝑨𝒄𝒄𝒐𝒖𝒏𝒕𝒔 𝑹𝒆𝒄𝒆𝒊𝒗𝒂𝒃𝒍𝒆𝒔
− 𝟑𝟔𝟓 ∗ 𝑪𝑶𝑮𝑺𝟏
𝑨𝒗𝒈.𝑷𝒂𝒚𝒂𝒃𝒍𝒆𝒔𝒕,𝒕−𝟏
Eq. 9. 𝑻𝒉𝒆 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑹𝒂𝒕𝒊𝒐 = 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑨𝒔𝒔𝒆𝒕𝒔 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔
Eq. 10. 𝑻𝒉𝒆 𝑸𝒖𝒊𝒄𝒌 𝑹𝒂𝒕𝒊𝒐 =𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑨𝒔𝒔𝒆𝒕𝒔−𝑰𝒏𝒗𝒆𝒏𝒕𝒐𝒓𝒚 𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐞𝐬
From figure 28 it is clear that the liquidity cycle has been increasing steadily since 2001, from when it was 30 days, to more than double in the second quarter of 2016. Hence, it takes Campbell twice as long to convert working capital into cash, something that is in large due to an increasing payables turnover rate. The current ratio has since its peak in 2010 declined but is still above its average of 0.63, the reduction can be seen in conjunction with Campbell’s acquisitions as most of these were financed through commercial paper. The quick ratio, has like the current ratio, seen a decline since the financial crisis, but appears to have stabilized around its average of 0.3 the last few years. Although the metric is also affected by the same changes to liabilities as the current ratio, it is not affected by changes to inventory which represent more than half of current assets and which on average has seen an increase over the last decade. Campbell holds a higher liquidity risk compared to peers, but is actively seeking such a profile in order to utilize other capital as working capital (hence the negative working capital)
0,0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 0,9 1,0
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2001 2003 2005 2007 2009 2011 2013 2015
The Current Ratio The Quick Ratio The Liquidity Cycle
Source: Authors own compilation based on (Campbell Soup Company, 2001-2015; Campbell Soup Company, 2016)
Figure 28. Short-term liquidity indicators
The Current Ratio [avg.] The Quick Ratio [avg.] The Liquidity Cycle [avg.]
69 5.4.1.1.1 Liquidity Cycle
The liquidity cycle of Campbell’s has been declining (see figure 29) mostly due to a decline in turnover days for payables.
Compared to its peer group Campbell holds a relative average liquidity cycle, but the trend of increasing liquidity cycle does not appear to apply for the rest of the peer group (see appendix 16). For most peers the payable turnover has actually been increasing, indicating that other firms may have an increased bargaining power with its supplier group. In general, payable turnover lies between 30 and 60 days for the peer group, however, the differences may also just be a reflection of different strategies with suppliers. For example, a longer credit line with suppliers might be important for some, but would likely also mean a higher purchase price, if a firm does not need the extended credit then they may be able to negotiate more favorable price terms. In section 5.3.1.1.1 it was shown that Campbell hold higher margins than most of its peers, something that in part may be due to term agreements with its supplier group.
5.4.1.1.2 Current Ratio
The current ratio of Campbell is 0.71 which is low compared to its peers, several of which hold ratios between 0.8 and 1.8, except for Kellogg who holds a ratio of 0.56 (see appendix 12 for full historical overview). This indicates that Campbell, compared to peers holds a higher liquidity risk, question is, is it alarming? Based on the strategic findings on Campbell, the low ratio could easily be a symptom of Campbell’s intentionally tightly managed current liabilities. A ratio below 1.0 depicts a company with negative working capital, something Campbell has been consistently operating on. The authors believe this is an indicative of the firms bargaining power with suppliers, which based solely on current ratio, may be higher.
5.4.1.1.3 Quick Ratio
The quick ratio was 0.38 in Campbell’s second quarter report for 2016 and has been steadily increasing over the last several years. The ratio tells a similar story to that of the current ratio, which is that Campbell, is consistently utilizing the capital of its suppliers as working capital. The quick ratio’s 15-year average is 0.3 and the volatility is rather low something that indicates that this is a company strategy. There should however be no question about this increasing liquidity risk, which it does, it does however appear to be a common practice among industry peers to operate with negative working capital. The seemingly high liquidity risk is hence a direct effect of the apparently low operational risk. The full overview of peer group quick ratio can be seen in appendix 12.
10 20 30 40 50 60 70 80
2001 2003 2005 2007 2009 2011 2013 2015 Receivables Cycle Payables Cycle
Inventory Cycle
Source: Authors own compilation based on (Campbell Soup Company, 2001-2015)
Figure 29. Liquidity Cycle
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Financial Analysis
70 5.4.1.2 Long-term liquidity risk
The long-term liquidity risk can be assessed through analyzing the financial leverage and the solvency ratio of Campbell and its peer group (Petersen & Plenborg, 2012, p. 158). The full overview and calculation of long-term liquidity risk metrics can be seen in appendix 12. The long-term liquidity risk is directly linked with the degree of leverage, as a firm is required to allocate more cash flow to its long-term obligations. A high degree of financial leverage results in a low solvency ratio, which leads to increased liquidity risk (Petersen & Plenborg, 2012, p. 158).
The solvency ratio based on book- and market values tell different stories about Campbell. The full historical development can be seen in appendix 12, there, one can see that the solvency ratio based on book value has moved from negative to approximately 0.19. The last five-year development can be seen in figure 30 below and shows that Campbell’s solvency ratio (BV13) is low compared to its peer group, indicating a higher liquidity risk associated with Campbell. However, the solvency ratio (MV14), also seen in figure 30, shows that Campbell holds the highest solvency ratio among its peers supported by decreasing financial leverage, which has mostly been driven by increasing equity valuation as total liabilities has stayed relatively stable around $6 billion.
In summary, the liquidity risk analysis yields contradicting results. The short-term liquidity analysis indicates a high risk compared to the peer group, however, that is most likely a result of supplier and buyer negotiations when it comes to payment period. The liquidity cycle is approximately 60 days, and has been so for several years, it therefore
13 (BV) = book value
14 (MV) = market value
The J.M. Smucker Company General Mills
Kellogg Company ConAgra Foods
Campbell Soup Company
Source: Authors own compilation based on (Yahoo!, 2016; Campbell Soup Company, 2010 - 2015; Kellogg's, 2010 - 2015; General Mills, 2010 - 2015; ConAgra Foods, 2010 - 2015; The J.M. Smucker Company, 2010 - 2015) Figure 30. Solvency Ratio, Campbell Soup Company & Peer Group
0,0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8
2010 2011 2012 2013 2014 2015
0,0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8
2010 2011 2012 2013 2014 2015
Based on Book Values Based on Market Values
71 appears to be an intentional strategy. The long-term liquidity analysis is based on book- and market values and has yielded opposite results. Where book values indicate a high long-term liquidity risk compared to peers, market values show Campbell holding the least risk associated with its long-term obligations. With Campbell being a publicly traded company, and has been so for many years, it is the authors view that market values are closer to the realizable value and hence depict a more accurate picture (Petersen & Plenborg, 2012, p. 158). The liquidity position is therefore viewed as strong in the short term and moderate in the short term. One should also note that Campbell does hold a revolver facility of $2 billion, which enables them to operate with a higher risk in the short-term as they can utilize the revolver facility in the event of unforeseen economic changes to the short-short-term environment.