Case 1 – Debt Policy at UST Inc.
1) UST is the dominant producer of moist smokeless tobacco, or moist snuff, controlling approximately 77% of the market. UST has been one of the most profitable companies in corporate America with low debt compared to other companies in the tobacco industry and the company has been recognized by Forbes in terms of profitability by achieving return of capital of 92.1%. Price elasticity of its products is also important while evaluating. Smokeless tobacco industry has a relatively steep demand curve and should be considered as having an inelastic consumer demand. UST has products outside of its core operations in the wine and premium cigar market also. The company built itself strong brand name recognition over the years by providing premium products. Tobacco industry does not allow new competitors to enter the market due to strict legal regulations and advertisement bans. So, we can think that UST will hold its position in the market in the long run. Although for the past couple of years, UST faced market share erosion due to price-value brands which offer low priced products. UST have been criticized for lacking innovation and new product offering. The company also has lack of international (geographical) diversity. Also, there is a chance of a cultural shift against tobacco, and UST is unlikely to expand to international market We can say that; UST is in a good position in terms of brand name and market position, capability to generate cash flow, cyclicality and asset tangibility. Business risks associated with UST can be litigation and product diversification risks. The smokeless tobacco industry will always face potential lawsuits because of the ongoing health concerns. Also, even though UST has diversified into other markets (wine and cigars), these products are very minimally attributing to UST’s EBIT. However, as it is stated UST products have a steady demand for their products, they produce positive cash flows year-to-year, and the company has a dominant market position and brand name with regard to their core business. If we can make a comparison between UST Inc. and the companies that have bond ratings. The highest grade belongs to Philip Morris which is “A”. As seen in appendix A and B; UST has higher ratios and better position than Philip Morris, so we can rate UST’s bond greater than A, maybe AA or AAA if they ever got issued.
2) Except year 1997, there is increase in UST’s net sales, gross profit and EBIT as seen in appendix C. It may seem that UST is slowing down its financial performance due to increase in competitors, less consumer demand, etc. However, when analyzing the 5-year and 10-year averages, the data indicates that UST financials are still steady and increasing. We may assume that recovery costs paid to Medicaid due to legislations may have an impact on increasing debt to capitalization ratio. At that time, UST had settled to agree to pay $100 to $200 million over 10 years to compensate health related law suits. UST’s growth has been slowing down when looking at the 5 and 10 year CAGRs. Although the company remains its profitability, decreasing market share lowers profits. On the other hand, due to some reasons that there has been increased competition in the premium smokeless tobacco market, UST is losing market share with products in its core operations. Also, the price value products in the industry are showing a dramatic increase in market share, yet UST only shows a 0.6% market share in 1998. UST should focus on its efforts on attracting the growing demand with the price value smokeless tobacco products in order to strengthen long-term financial performance. Because of the increased competition in the smokeless tobacco industry, UST has to constantly look for innovative ways in order for them to be a driving force in the smokeless tobacco industry; like innovations, product diversification. 3) As we can see from appendix D. UST has the lowest...
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