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Case analysis - Ust Inc. Debt Policy

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documents in English
case study
10 pages
General public
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  1. Case summary
  2. The company
  3. Issues and risks
  4. Recapitalization
  5. Dividends
  6. Recommendations

UST Inc. is the dominating smokeless tobacco company in the market with over 75% of market share and 90% of sales coming from their tobacco products. Their declining market share poses a problem for the company. As a premium and leading brand, the company ignored lower priced competitors.

After losing 9% of their market share to price-value brands/competitors, they launched their own price-value brand named "Red Seal". This move was too late as they addressed the problem as insignificant early on. With declining market share, and pending litigations, health movements/reforms against tobacco, these aspects may negatively impact future cash flows and estimates. Even though smokeless tobacco is a much healthier alternative to cigarettes and has fewer litigation cases, UST Inc. has put most of its eggs in one basket by having over 90% of their sales come from their smokeless tobacco line.

[...] Some recommendations for the company are to; Use the debt for the repurchase of shares, focus on their price-value brand and try to take back market share from the price-value market share, or acquire their largest price-value competitor using shares and equity. The Company The U.S smokeless tobacco industry generated billion in revenue in 1998. Smokeless tobacco is the fastest growing segment of the tobacco industry with a annual growth rate year over year compared to the decline year over year in cigarettes. Tobacco has an inelastic pricing market, there is always a high demand for tobacco and tobacco products. In this industry, UST Inc. (the company) is the leading producer of moist smokeless tobacco, with over 75% of market share. [...]

[...] while all other competitors gaining market share in figure 5 below. Figure 5 The company is not in good position to expand internationally due to smokeless tobacco and tobacco (in general) not being of popular use overseas. Recapitalization UST Inc. considering leveraged recapitalization after a long history of conservative debt policy can be attributed to using debt to increase interest tax shield, fund discounts and rebates to retain or gain market share, reduce capital costs, buy back shares, increase share value, and fight or defend against hostile takeovers. [...]

[...] in 1998 by and slowdown the percentage decrease in total market share by as down in figure 10 below. Figure 10 This slowdown in market share loss is the company's attempt at regaining market share by their price-value marketing strategy. The downfall to this was the lower profit margins as the COGS is higher due to the marketing expenses shown in figure 11 below. Figure 11 Another recommendation is to acquire their largest price-value competitor which would be the Swisher Company. Swisher has the highest 7 Yr. [...]

[...] The calculated WACC is which means for every the company raises cents must be paid out to investors. The company will be able to afford the dividend and keep shareholders happy through taking on leverage. Strong stock price growth (in relation to increasing or keeping the dividend) acts as free marketing for the brand. The strong position and growing sales show the company is able to operate without taking on debt. By taking on this leverage the company will be able to increase its market value with a low chance of bankruptcy. [...]

[...] We ran a proforma for 1999 with EBIT being 53% of sales, different cost of debt, and ratings. Our results are in figure 6 below. Figure 6 With interest coverage averaging 9.275 for the different scenarios of debt costs, this means for every dollar of interest, the company will have $ 9.275 to pay interest when interest is due. After analyzing results, the idea to use debt financing to repurchase shares is positive choice for the company. To raise debt to buy back equity is overall a positive strategy to increase value and overall wealth of the company. [...]

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