Financial performance HPL‘s historical financial performance has been steadily increasing for past five years. It has generated $681 million revenue in 2007. However due to high cost of goods sold company net income decreases this year. Companies total cash generated is in negative this is due to fact company had invested some of its cash into non-current assets as compare to previous years. Major Issues:
One of the retail customer wanted to increase their share of private label manufacturing, due to this reason HPL have to invest 50$ million in order to accommodate their request, as most of the operating plant of HPL are already running at 90% of its capacity . However sooner or later HPL have to expand its bus business because company’ ny’s fut future ure is in question by employees, they wanted to see change. Customer will only commit three year contracts, which is the main dilemmafor Hansson, because at the end of contra contract ct fixed fixed cos costt wil willl inc increa rease se if com compan pany y unable unab le to cater cat er other oth er retai re taill custo cu stomer mers. s. Need to determine return on investment investment to justify efforts efforts and risk
The owner of Hansson Private Label (HPL) must determine whether or not to accept an aggressive expansion project that would preclude the company from pursuing any alternative investment opportunities for several years. The investment, if successful, would offer numerous benefits to the company, capturing greater market share, strengthening relationships with major customers, crowding out competition and increasing firm value. Nonetheless, the decision carries significant risks and could lead to a substantial decline in firm value, if not bankruptcy, should any number of variables prove unfavorable to HPL. Moreover, the project relies heavily on a contract with a single large customer. Given the high level of risk and relatively low return associated with the project, despite a positive NPV based on pro forma cash flows, I would strongly recommend the firm consider alternative investment opportunities. Problem Being Examined The expansion project, however, is not without significant risk. For one, this single investment would close off all other investment opportunities for the foreseeable future. Furthermore, pursuing the project would raise HPL’s debt to the highest levels Hansson is willing to assume in addition to maxing out the firm’s management capacity. Lastly, the investment would add substantially to the A brief evaluation of Hanson Private Label (HPL) will reveal signs of an excellent, growing, and well run company. There are no danger signs within the financials of HPL. The following have seen growth with every passing year: revenue, revenue, current assets, owner’s equity, net working capital, and sales (even groceries). The following categories have grown every year with the exception of 2005, where a higher than usual COGS – 15% 15% versus a historically high teen’s percentage: Gross Profit, EBI TDA, EBIT, caused a dip in gross margin – and Net Income. Utilization rates are high. During this same period, long term debt trended downward with decreases every year. Sales across HPL retail channels increased every year over year in the following categories: mass merchant, club, drug, dollar stores, convenience stores, and miscella miscellaneous neous distributors. Groceries increased or held steady during this time, and never decreased. Market share increased in slight increments during 2005-2007. During the five year period 2003-2007, total assets rose over $40M, profits climbed steadily from $98M (2003) to 122.5M (2007), net income has increased four of five years, and s ales have outgrown the market. Additionally, Additionally, long term debt has been cut nearly 50% over the last 5 years. The cumulative cash flows over the same period have been positive while the company has been able to pay
dividends every year. It is a safe assumption to say that HPL is an excellent business and has shown maintainable, measured, and sustainable growth. The only potential downside is that the company, with high utilization rates, is reaching production capacity, and addition of more accounts will necessitate investment in expansion.
**Hansson Private Label should proceed with the proposed project expansion. This decision is based on the fact the net present value is positive across a wide range of economic and operational assumptions. These assumptions were conservatively set at baseline and aggressively modified to project several worst case scenarios. HPL needs to expand its facilities to continue maintain its current growth rate and this project is an ideal candidate. Furthermore if HPL does not undertake an aggressive expansion it will suffer in the near future from infringing competition, a plateau in current capacity, and an inefficient capital structure.
Background: About Hansson Private Label (HPL)
Started in 1992 (Purchase of manufacturing assets from Simon Health and Beauty Products)
Purchased by Hansson for $42 million ($25 million equity & $17 million debt) – Hansson’s largest single investment
Hansson believed he was paying significantly less than replacement costs for the assets
Hansson was confident private-label growth will continue
HPL’s development and success:
Hansson’s focus on manufacturing efficiency, expense management and customer service turned
HPL into a success
Secured most major national and regional retailers as customers
Conservative expansion of HPL – opening of any new facility only if (>60% capacity utilization)
Currently, all operating at (>90%) capacity
HPL’s Business Operations & Performance:
Manufacturer of personal care products (soap, shampoo, mouthwash, shaving cream, sun screen and others) under brand label of HPL’s retail partners (supermarkets, drug stores, mass merchants)
Generated $681 million (revenue) in 2007 [28% of total wholesale sales of $2.4 billion]
Situation:
$170 million investment proposal (expand manufacturing capacity of Hansson Priv ate Label [HPL]) to accomodate request by HPL’s largest retail customer to increase their share of private label
manufacturing
Land acquisition ($16 million)
Plant construction ($56 million)
Manufacturing equipment ($52 million)
Packaging equipment ($24 million)
Working capital for yr 1 ( $22 million)
Customer will only commit to a 3-yr contract
Expect from Hansson a go/no-go commitment within 30 days
Dilemma:
Needs to determine return on the investment to justify effort and risk
May risk future opportunities of rapid growth an d significant value creation by locking in strong relationship with huge, powerful retailer
Need to maintain debt at modest level to contain risk of financial distress in the event the company loses a big customer
Perspectives: (Pro-Investment)
Additional capacity will allow HPL to expand relationship with its largest customer (g rowing sales in US)
Generate attractive payback
Expansion will enable HPL’s growth from additio n of new customers
Deter HPL competitors from expanding production capacity in HPL’s personal care sub-segments
Perspectives: (Con-Investment)
Making investment and incurring associated debt -> significantly increasing HPL’s annual fixed costs and increase risk of financial distress should sales fall or cost rises (or both)
Sales (from HPL’s largest customer) may initially increase. However, demand may disappear at end
of 3-yr contract
Industry Trends: (Personal Care Product Market)
Personal care market (hand&body care, personal hygiene, oral hygiene, and skin care products)
US sales ~ $21.6 billion in 2007
Volumes increased (<1%) in each of past 4 years
Dollar sales growth (driven by price increases ) averaged growth of 1.7% annually the past 4 years
Featured numerous national names (high-end to low-end) with considerable brand loyalty
Private label penetration range (3% in hair care to 20% in hand sanitizers)
Personal care products are sold mainly through (1) mas s merchants, (2) club stores, (3) supermarkets, (4) drug stores and (5) dollar stores
Over past 15 years, manufactures heavily depended on small number of retailers who had large national presence
Intense competition for shelf space (~80,000 new products launched each year)
Industry Trends: (Private Label Industry)
With private label brands, retailers rather than manufacturers controlled production, packaging and production of goods
Retailers carry private label goods to provide consumers with lower-priced alternatives to national branded goods
Quality improvements in private label goods led to increased acceptance by customers
Private label sales exceeded $70 billion in 2007
Private label products accounted for $4 billion of sales at r etail (19% of $21.6 billion), translating to $2.4 billion in wholesale sales from manufacturers
Benefits of Private Label:
Potential to increase profits by capturing a greater share of value chain
Manufacturer profits per unit could double those of retailer (esp. if brand was famous)
Retailers’ cost of goods was 50% lower than branded goods -> can double profit-per-unit sold despite
lower selling prices
Opportunity for growth (sales of private label goods <5% in many product categories)
Hansson Private Label
Case – Hansson Private Label, Inc.
Question 1: How would you describe HPL and its position within the private label personal care industry?
HPL started in 1992, manufacturing personal care products – soap, shampoo, mouthwash, shaving, cream, sunscreen and etc., and selling them under the brand label of HPL’s ret ail partners, which includes supermarkets, drag stores, and mass merchants.
It is a conservative company similar to other private label manufacturers since the have never had major expansion plan in the past and the only investment opportunities they had evaluated are incremental new product types. They also tend keep the debt at the modest level with facility over 60% of capacity utilization.
HPL is a major supplier for retailers’ private label of personal care products for the company’s $680.7K sales accounts for 28% of $2.4 billion whole sales from retailer’s personal care market. However, if compare to the whole $21.6 billion personal care market, HPL’s share within the retailer’s total $4 billion sales market size accounts for 3% of the industry.
Question 2: Using assumptions made by Executive VP of Manufacturing, Robert Gates, estimate the project’s FCFs. Are Gates’ projections realistic? If not what changes might you incorporate?
Please see Table 1 for the calculation based on Gate’s estimation.
FCF = Free Cash Flow = Operation CF - Capital expenditure
= EBIT (1-Tax Rate) + Depreciation & Amortization - Change in Net Working Capital – Capital Expenditure
It is not realistic. Main reason is that the contract states a 3-year deal whereas Robert Gate's estimation is based on a 10-year deal. An obvious assumption can be made is that after year three the capacity of the new machine will be no longer as high as estimated. In other words, the revenue generated will be greatly reduced and so be the FCF.
For example, it could be that the relationship with major partners ended or erosion effects on other products or partners that the capacity drops of these additional machines to 40% after year three. We estimated then from the new FCF will be negative start in year 5.
Another factor that this 10-year-estimation seems not to take into account is the level of risk. For example:
1) The dramatic increase in debt will increase the financial risk.
2) The increase in total capacity, staff, inventory, and ship out units will increase the operational risk.
3) The increase in sales will make competitors nervous, and might initiate a price war. This will create risks.
Moreover, the price increase of the personal care industry is estimated at 1.7% instead of the 2% Gates is making, which is another factor that will greatly affect the total revenue of estimation.
We also add another factor where the opportunity cost is that during this period, the company’s finance situation is tied to this project while it can actually be allocated to other investment.
As a result, taking into account the total induced risks is required during this 10-year investment analysis estimation. Detail calculation is displayed in Table 2