See attached assignment and article that is supposed to be used to answer the questions.
Case Study Hill Country Snack Foods Co. Question 1: Describe Hill Country’s operating strategy. How does this operating strategy impact the company’s business risk. Question 2: Why shareholders do not like the firm having large cash balances? Question 3: What are the advantages of adding debt to the firm’s capital structure? Question 4: What are the disadvantages of adding debt to the firm’s capital structure? Question 5: What capital structure (debt to capital ratio) would you recommend for Hill Country Snack Foods, and why? Question 6: If the firm decides to implement debt financing, what methods would you recommend the firm use to increase debt and decrease equity? Question 7: How would the financial markets (stock and bond markets) react if the company increases its financial leverage? Question 8: Considering Hill Country’s corporate culture, what arguments could you use to persuade CEO Keener or his successor to change its capital structure? Hill Country Snack Foods Co. ________________________________________________________________________________________________________________ HBS Professor W. Carl Kester and Babson College Professor Craig Stephenson prepared this case solely as a basis for class discussion and not as an endorsement, a source of primary data, or an illustration of effective or ineffective management. Although based on real events and despite occasional references to actual companies, this case is fictitious and any resemblance to actual persons or entities is coincidental. Copyright © 2012 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School. W . C A R L K E S T E R C R A I G S T E P H E N S O N Hill Country Snack Foods Co. The Chief Executive Officer of Hill Country Snack Foods had never enjoyed analyst conference calls, but in late January of 2012, Howard Keener was yet again asked about the company’s cash balances, capital structure, and performance measures. One analyst complained that Hill Country’s growing cash position, absence of debt finance, and large equity balance made it difficult for a company in a mature industry to earn a high rate of return on equity, and recommended a more aggressive capital structure. “Maybe I don’t fully understand capital structure theory and practice,” replied Keener, “but I have observed that companies don’t get into trouble because they have too much cash; they get into trouble because they have too much debt.” Hill Country had seen its sales and profits grow at a steady rate during Keener’s tenure as CEO, and at the end of 2011 the company had zero debt and cash balances equal to 18% of total assets and 13% of market capitalization. Having just celebrated his 62nd birthday, Keener was approaching retirement, creating speculation by investors and analysts that the company might change to a more aggressive capital structure in the near future. Company Background Hill Country Snack Foods, located in Austin, Texas, manufactured, marketed, and distributed a variety of snacks, including churros, tortilla chips, salsa, pretzels, popcorn, crackers, pita chips, and frozen treats. Although many of its products had a Southwestern flair, it also offered more traditional snack foods, which were purchased by end consumers thousands of times every day in supermarkets, wholesale clubs, convenience stores, and other distribution outlets. The company’s growth and success was driven by its efficient operations; quality products; strong position in a region that was experiencing both population and economic growth; and its ability to expand its presence beyond the aisle into sporting events, movie theaters, and other leisure venues where consumers were more likely to purchase snack foods. Many of Hill Country’s products were also sold through school systems, which required the company to reduce the fat and sugar content of its products. This was just one example of the company’s continual work to solicit, collect, analyze, and internally distribute customer feedback so the company could quickly react to customer requirements or preferences, and reinvent and expand its products as required to succeed in the rapidly changing marketplace. 9-913-517 O C T O B E R 2 2 , 2 0 1 2 This document is authorized for use only by Karen JONES (
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[email protected] or 800-988-0886 for additional copies. 913-517 | Hill Country Snack Foods Co. 2 BRIEFCASES | HARVARD BUSINESS SCHOOL Hill Country’s Corporate Culture Hill Country was a well-managed company, where all decisions were made according to one criterion: will this action build shareholder value? This singular management focus came directly from Howard Keener, the company’s CEO for over fifteen years, who strongly believed that management’s job was to maximize shareholder value. This philosophy was applied at every level of the organization and in all operating decisions. Many managers talk about shareholder value, but Keener was proud of the fact that, at Hill Country, shareholder value was a way of life, not just a talking point. Keener and other management insiders also held a significant proportion of the company’s common stock, approximately one-sixth of the 33.9 million shares outstanding, so this focus on building shareholder value was also personally beneficial to the members of the management team. Another important component of company culture was a strong commitment to efficiency and controlling costs. The snack foods industry was very competitive, with Hill Country facing off against industry giant PepsiCo and smaller companies like Snyder’s-Lance every day. Efficient operations and tight cost controls were necessary conditions for success; the company could not rely on price increases in this high rivalry industry. Operating and capital budgets were lean and aggressive, and Keener himself was actively involved in both the budget approval process and in ensuring the business was managed to the numbers in the budget. Unfavorable cost variances resulted in management action to bring costs back into line with plans, even when the cost increases were due to external factors. Management didn’t always have a solution to unfavorable variances, but they did all they could to keep costs under control. The final component of Hill Country’s culture and managerial philosophy was caution and risk- aversion. The company invested in new capacity and new products when attractive opportunities were identified, but it did not make high-risk bets in its product markets. Growth was low-risk and incremental, driven by extensions of existing products and the acquisition of smaller specialty companies. This strategy produced sales growth rates that were steady, if unspectacular, but also increased the likelihood that customers would respond favorably to the company’s new products. Management avoided great leaps in its product markets, instead believing a series of small but successful product launches, combined with the company’s operating and cost efficiencies, would quickly contribute positive operating profits. Hill Country’s culture of risk-avoidance was also manifested in its financing decisions. The CEO had strong preferences for equity finance and against debt finance, and the company was managed consistent with these beliefs. Debt was avoided, investments were funded internally, and the balance sheet was strong. The company also held large cash balances to increase both safety and flexibility. Some members of the analyst and investment communities questioned these policies, but CEO Keener believed they were appropriate for the company. Financial Performance The combination of good products, efficient and low-cost operations, and all-equity funding had produced consistently strong financial results, as presented in Exhibit 1. Sales had increased at a steady rate, and except for the difficult economic years of 2007 and 2008, net income had followed a similar growth pattern. The company had experienced a decrease in earnings in 2007, and struggled to increase profitability in 2008, but growing sales and continued attention to costs drove large increases in net income since the recession ended in 2009. Return on asset and return on equity numbers had similarly increased in the past few years, with return on assets reaching 10%, and return on equity exceeding 12% in 2011. Hill Country’s cautious growth strategy also allowed the This document is authorized for use only by Karen JONES (
[email protected]). Copying or posting is an infringement of copyright. Please contact
[email protected] or 800-988-0886 for additional copies. Hill Country Snack Foods Co. | 913-517 HARVARD BUSINESS SCHOOL | BRIEFCASES 3 company to pay continuous and growing dividends; carefully considered and controlled growth meant the company’s cash flow was sufficient to fund both capital investments and dividend payments to shareholders. The dividend payout ratio had been just below 30% of net income in each of the past five years, and management planned to maintain this distribution ratio. The company’s cash position and conservative capital structure, however, had a negative impact on its financial performance measures. Return on assets was reduced by Hill Country’s large cash balances in two ways. The interest rate earned on invested cash was barely over 0%, contributing almost nothing to net income, and more cash meant more total assets. Return on equity was similarly reduced by the avoidance of debt and complete reliance on equity capital. Hill Country’s common stock was widely held by investors and covered by analysts, reflecting the stock market’s favorable opinion of the company’s products, prospects, and management. Many members of the investment community were also frustrated by the company’s excess liquidity and lack of debt finance. Even modest reductions to cash, increases to debt, and reductions to owners’ equity would significantly increase return on equity. There was no clear consensus about this issue, however, as others worried about the wisdom of demanding changes from a successful company. Capital Structure Cash holdings of U.S. non-financial corporations had increased to record levels by the end of 2011;1 thus Hill Country’s large and growing cash balances were not unusual. The company’s capital structure with zero debt finance, in contrast