The problem of capital structure that affecting profit margin the case of hung vuong corporation

UNIVERSITY OF ECONOMICS HOCHIMINH CITY INTERNATIONAL SHOOL OF BUSINESS THE PROBLEM OF CAPITAL STRUCTURE THAT AFFECTING PROFIT MARGIN: THE CASE OF HUNG VUONG CORPORATION Instructor: Dr Pham Phu Quoc Student: Nguyen Thanh Quyen MBA Class 5.2 Ho Chi Minh City – Year 2017 List of Tables Table 1: Income Statement of HVG 2014 – 2015 11 Table 2: Capital structure of HVG over the period 2014 – 2015 12 Table 3: Performance of biggest corporate in the fishery industry in 2015 15 Table 4: ROA and ROE of the biggest companies in the fishery industry 16 Table 5: HVG Dupont Analysis 2012 – 2015 17 Table 6: HVG’s debt and BEP ratio 2013 - 2015 20 Table 7: Capital structure of biggest corporates in the fishery industry in 2015 21 List of Figures Pig 1: HVG’s stock price performance over the period 2013 - 2016 13 Pig Revenue of the biggest companies in the fishery industry 15 Pig Profit margin of the biggest companies in the fishery industry 15 Pig 4: Potential causes and effect tree of the problem 23 Pig Methods of raising capital 32 Table of Contents Executive Summary Chapter 1: The Problem Context The Framework of Thesis Chapter 2: Problem Identification 10 2.1 Company’s Symptoms 10 2.1.1 The higher increasing in the revenue, the greater rising in cost and expenses 10 2.1.2 The decline of HVG’s profitability and profit margin over the time 11 2.1.3 The fluctuation and reduction of HVG’s stock price 12 2.2 Problem identification 13 2.4 Possible reasons of problem 16 2.4.1 Recognition of Possible reasons 16 2.4.2 In-deep on-the-field interview for more understanding the causes 22 Chapter 3: Design Solutions and Suggestions 25 Chapter 4: Action Plan 33 References 35 Appendix 38 Executive Summary HVG is one of the leading processors and exporters of Pangasius in Vietnam, its business performance showed the development in the last three years However, HVG’s business efficiency showed the opposite trend, most of the profitable ratios such as ROE, ROA or EPS went down steeply and was much lower in comparison with other corporates in the industry Additionally, its stock price has fluctuated in a wide range and decreased in recent years The main causes lead to the problem of low profitability could be poor management of expenses, specialized in financial expenses According to the data collecting from HVG’s annual financial report and its competitors, HVG uses a very high financial leverage The percentage of debt in HVG’s capital structure was at the high rate and much higher than the rivals’ and the average of the industry An analysis Dupont model had been conducted based on financial data and also a survey of deep interview HVG’s staffs had been conducted to confirm the main causes which consistent with the findings of Hamid MA et al (1) that debt ratio is negatively and significantly related to profitability and profitable firms depend more on equity as their main financing option The results also confirmed that an increase in leverage position is associated with a decrease in profitability The study also prefers to the possible solutions for building an effective capital structure, improving operational efficiency by maintaining the debt percentage in the capital structure as the level of average of the industry and restructuring the HVG’s capital structure by raising capital instead of raising borrowing capital HVG should prioritize using endogenous sources (such as retained earnings) to response the demand of capital for operation, then debts and finally equities issued which used to be mentioned the research of Quang and Wu (2) Among numbers of methods of raising equity, undistributed earnings may be best alternative internal capital for borrowing capital from outside Finally, the action plan is also suggested in the study Chapter 1: The Problem Context Hung Vuong Corporation was initially established under the name of Hung Vuong Limited Company in September, 2003 with its major function as a processing plant of Pangasius for export Later the company enlarged its scope and officially changed its name into Hung Vuong Corporation in 2007 At the moment, Hung Vuong Corporation runs a closed system of producing breed, aquaculture, processing, cold storage, and exporting Thus, the company is able to self - supply raw materials, helping the company to strictly control the quality and cost of operation In 2015, Hung Vuong’s charter capital is VND 1,892 billion with the total of employee is over 17,000 The head office of the company is placed in Block 44, My Tho Industrial Zone, Tien Giang Province, Vietnam and two Representative offices in Ho Chi Minh City One is in 144 Chau Van Liem St, Ward 11, District 5, Ho Chi Minh City, Vietnam and the other one is in Level 7, Resco building, 94-96 Nguyen Du St, Ben Nghe Ward, District 1, Ho Chi Minh City, Vietnam Hung Vuong Corporation is proud of itself after over 10 years in business Hung Vuong is the biggest processor and exporter of Pangasius in Vietnam At present, Hung Vuong’s products are available in 60 countries in the world (Appendix 1) EU and USA are the two main exported markets, these markets account for 60% in total Hung Vuong's Export Market Share by Country (Appendix 2) The export value of Hung Vuong Corporate has been increasing since 2004 until now In 2015, its total export value achieved USD 400 million in average (Appendix 3) According to the result of operating during the period of 2012 - 2015, profit decreased significantly and did not achieved the annual plan while the revenue showed the up-ward trend HVG’s gross profit margin (GOS) and other financial ratios of efficiency such as return on asset (ROA), return on equity (ROE), return on revenue (ROS)… also showed the down-ward trend In 2015, HVG’s profit after tax was VND 120 billion, down 58.86% in comparison with 2014’s and equal 22% profit plan in 2015 The gross profit margin was 7.51%, down 0.29%, ROA and ROE decreased significantly from 3.22 and 12.3 to 0.383 and 3.61 in respectively Additionally, EPS was VND 750 per share which was much lower the EPS in 2014 (VND 2,200 per share) This study will make a deeply analysis in the operation of the company over the period 20132015 in order to find the real problem causing the fallen in Hung Vuong Corporates operation in recent years The Framework of Thesis Company's The higher increasing in the revenue, the greater rising in cost and expenses symptoms The decline of HVG’s performance efficiency over the time The fluctuation and reduction of HVG’s stock price Problem identification Potential problems: factors affecting on the profitability such as controlownership disparity; macro-economic; industry attribute and firm attributes such as financial structure, size, market share, and business strategy Real problem: Low business efficiency related to high cost and expenses in operation Main causes Recognizing possible reasons through theory information, Dupont model analysis and In-deep interview, including: - The asset was not utilized effectively; and; - Poor management of cost and expenses lead to profit margin down;  The asset was not utilized effectively;  Poor management of cost and expenses lead to profit margin down: (i) COGS and especially (ii) Financial expense (Financial structure) Design Theory information: Solutions And - Firms prioritize using endogenous sources (such as retained earnings), then debts and finally equities issued; Suggestions - Most of the firm prefers internal to external financing; ect… Solution: reconstructing the capital structure - Maintaining the debt percentage in the capital structure as the level of average of the industry; - Action plan Raising equity instead of raising borrowing capital:  Internal capital: Paid-in capital, Undistributed earnings; and  External capital: Debt; Issuing new share - Identifying capital needs for operating activities; - Capital mobilization options to choose reasonable source of capital; - Making a capital distribution and utilization plan effectively and efficiently Chapter 2: Problem Identification 2.1 Company’s Symptoms After investigating some of the financial ratios and interviewing all the responsible members of the company, the symptoms of the problem had revealed as following: - The growth rate of the HVG’s cost of goods sold and expenses is greater than this of its revenue; - HVG’s profit margin and profitability have decreased steadily over the time; - HVG’s stock price has fluctuated in a wide range and illustrated the down-ward trend in the last few year In detail, the symptoms have been proved as below: 2.1.1 The higher increasing in the revenue, the greater rising in cost and expenses For the whole company, export value and operating revenue increase gradually over the period 2013-2015 In detail, the Company’s export value increased sharply in 2014 and got the highest value at USD 400 million in 2015 (Appendix 3) Operating revenue increased from VND 7,749 billion in 2012 to VND 11,179 billion and VND 15,042 billion in 2013 and 2014 respectively Although in 2015, its operating revenue could not maintain this amazing rate and decreased slightly 17%, in general, the company has a high growth rate over the period The average growth rate during the period 2012-2015 was 20.5% - quite high when comparing to the average rate at 10.6% of the fishing industry as published by the General Statistics Office of Vietnam In the mean of time, the cost of goods sold increased dramatically from VND 10,058 billion in 2013 to VND 13,782 billion in 2014 This trend continued in 2015 with the cost of goods sold raised to VND 11,446 billion, accounted for 91.98% in the structure of the revenue 10 and Frank and Goyal (22) stated that there is a positive relationship between payout ratio and debt Therefore, shares issued may not the suitable option for raising equity while HVG’s stock price fluctuated and decreased steadily as mentioned in the company’s systems All the ways of raising capital could be summarized as below: Retained earnings: best altanative capital for debt INTERNAL FINANCE Paid-in capital: there are limits to utilize CAPITAL Issuing debt/Borrowing debt EXTERNAL FINANCE Pig Methods of raising capital 32 Issuing new equity: this can decrease the stock price and dividend payments may increase debt Chapter 4: Action Plan Building capital mobilization, utilization plan trading capital always plays a decisive role to the survival and development of the company To utilize trading capital, expand market or increase competitive capabilities, sufficient capital is crucial Consequently, building a reasonable capital mobilization and utilization is necessary for contributing to motivate efficient use of trading capital as well as productivity of the company Therefore, to utilize capital reasonably and safely; to minimize expenses and maximize the company’s value, it needs to implement the followings: Firstly, Identify capital needs for operating activities of the company to avoid capital shortage which makes operating activities stagnate At the same time, forecast minimum capital needs to avoid capital redundancy which is wasteful Besides, the company has to identify the working capital needs, which plays an important part in production process To this, the company needs to monitor capital needs, frequently adjust the needs quarterly to ensure that mobilized capital is used efficiently and consider the relationship between capital or assets and revenue Capital in cash, buffer inventory level, work-in- progress or finished goods and payables will increase in proportion with sales of goods and receivables Then, estimating next year’s trading capital based on proportion of items which directly affect revenue Secondly, based on the building of capital needs, the company offers capital mobilization options to choose reasonable source of capital which is accessible, and identifies current capital surplus, decides capital structure to minimize capital mobilization expenses In reality, interest expenses of the company increased over the period 2012-2015, HVG should look for medium or long term sources of capital which have high stability to meet future development strategy as 33 well as the increase in equity capital This gives the company the high discretion level in finance, and reduces considerably the exposure to changes in interest rate The company needs to consider, utilize positive effects of equity capital such as timely meet capital needs, saving times, low cost of mobilizing capital, avoiding liquidity pressures, take business opportunities in time Thirdly, after mobilizing capital, the company needs to actively make a capital distribution and utilization plan effectively and efficiently In respect of short-term assets, the company should analyze market, market needs research, update adjusted data quarterly to estimate inventory quantity level, the time inventory in stock, to accelerate inventory turnover to avoid capital stagnation, reduce interest rate fluctuations In respect of fixed assets, the company also needs to have an effective investment plan, use modern production process with high productivity to save operating costs, then reduce cost of goods to increase market competitive capabilities 34 References Hamid MA, Abdullah A, Kamaruzzaman NA Capital structure and profitability in family and non-family firms: Malaysian evidence Procedia Economics and Finance 2015(2);31:44-55 Xin WZ The impact of ownership structure and capital structure on financial performance of Vietnamese firms International Business Research 2014;7(2):64 Myers SC Determinants of corporate borrowing Journal of Financial Economics 1977;5(2):147-75 Cai J, Zhang Z Leverage change, debt overhang, and stock prices Journal of Corporate Finance 2011;17(3):391-402 Joh SW Corporate governance and firm profitability: Evidence from Korea before the economic crisis Journal of financial Economics 2003;68(2):287-322 Li Q, Wang T Financial 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Evidence from SMEs in France and Greece Applied Financial Economics 2008;18(2):87-97 20 Modigliani F, Miller MH The cost of capital, corporation finance and the theory of investment The American economic review 1958;48(3):261-97 21 Bhaduri SN Determinants of corporate borrowing: Some evidence from the Indian corporate structure Journal of Economics and Finance 2002;26(2):200-15 36 22 Frank MZ, Goyal VK The effect of market conditions on capital structure adjustment Finance Research Letters 2004;1(1):47-55 37 Appendix Appendix HVG’s export market Appendix 38 Appendix Appendix 4: Deep interview HVG’s Staff  Person 1: Mr Tuan Vu, an experience accountant of HVG Question: Why does the HVG’s profit decrease steadily while its revenue increase at a high growth rate in the last five years? Mr Tuan Vu: The reason is that the cost of expanding the area farmed too fast and pangasius products under competitive pressure as well as the anti-dumping duty in the US market In addition, the most worrying point is the expansion of HVG too fast accompany the total short and long -term debt increased from 2,958 billion in 2012 to 8.355 billion in 2015 39 (accounting for 58 % of total assets) has created considerable pressure on interest rates Interest expense is always at the high level, 2015 recorded 239 billion Additionally, another problem which HVG facing is quite large accounts receivable increased from 1.854 billion in 2012 to 5,641 billion in 2015 makes provision for bad debts of up to 347 billion in 2015 This also effects on the profit  Person 2: Mrs Ngoc Thuy, a financial staff of HVG Question 1: What is your evaluation about the position of HVG in the industry? Mrs Ngoc Thuy: HVG has over 13 years operation in this industry Therefore, it branding has been built based on its product’s quality and quantity exported HVG has invested completely production chain stages from seed, animal feed and product exports, this help the enterprise can supply raw material actively and control the quality of product In comparison with the rivals in the industry, HVG’s size are bigger and also HVG’s market share are much higher It can be said that HVG is one of the leading enterprises in the fisheries industry Question 2: Why does the HVG’s profit decrease steadily while its revenue increase at a high growth rate in the last five years? Mrs Ngoc Thuy: The reasons why HVG’s profit decreased over the period while it revenue showed the opposite trend, includes internal and external causes The external causes come from the unstable market over the a few last years, the pangasius market become very competitive, the price decreased steadily and the demand of main foreign market become narrow, such as USA, Asean, Mexico… and especial European market, the value exported to this market decreased deeply because of the dumping rule published by these countries The 40 internal causes come from investing with a high growth rate and using high leverage The total of short-term and long-term debt increased sharply over the period This lead to the financial expense always being at the high percentage in the revenue and increased steadily For example, financial of financial expense in 2015 is VND 235 million, account for 2.61% in the revenue and this continue increased to 2.86% in the first three quarters of year 2016  Mr Minh Quan, a financial analysts of SSI Question 1: Can you identified the character of the HVG stock price over the last five years? Mr Minh Quan: The price of HVG has decreased steadily since 2014 In the July of the year 2014, the price of HVG has get the highest point at VND 22.000 per share and this decreased steeply to under VND 14.000 in the May of year 2015 Then It increased back and fluctuated around VND 17.000 in the last month of year 2015 After that, HVG’ price showed a steadily decreased to the lowest point at VND 8.500 in the February of year 2016 Since then, It has recovered and fluctuated around VND 10.000 until now In general, the price of HVG shows a down-ward trend over the period of 2014 – 2016 Question 2: Why did the price stock of HVG decrease steadily over the last years? Mr Minh Quan: Stock prices reflect the most negative HVG's business results First of all, HVG has met risks from trade barriers from main market like US and Europe, it has been beaten highly dumping duty Then the causes from inside of the company, the growth rate of receivables is so high and followed the growth rate of revenue This lead to increase highly expenses when HVG must reserve for bad debt Additionally, highly expanding investment have make the pressure on the interest expenses for borrowing debt, both short-term and long–term 41 debt In sum, the quality of accounts receivable, inventory, and financial pressures are the problems that investors pay attention when investing in this stock 42 Appendix 5: HVG’s income statement Appendix 5a: HVG’s income statement in year 2015 43 Appendix 5b HVG’s income statement in year 2014 44 Appendix 5c: HVG’s income statement in year 2013 45 Appendix Closed Production Process High Quality Feed Artificial Reproduction Feed Factory (fish cattle and poultry) By Product Baby Feed Aquaculture Haccp Standards Processing Plant Standard Fish Cold Storage Customers 46 Standard Fish ... 2012-2014 and its profit margin got the lowest value among the four corporations in 2015 As gross profit margin is the quick indicator of the ability of generate profit from the company main activity... HVG’s profitability is reconstructing the capital structure by reducing the percentage of debt in the capital structure Cause most of the studies found a negative relationship between profitability... to the financial expense increasing rapidly during the time and then affecting on the profit Shubita et al (9) argued that the higher the debt ratio, the greater the risk, and thus higher the