Case Study: Burn Fails to Deliver the Bread

By Gabrielle Costa

International food giant Burns Philp has failed to translate a steep rise in  revenue into a better bottom line, announcing net profit has fallen 9.3 per cent in the six months to December 31.

The company, which recently bought out Goodman Fielder in a $2 billion-plus deal and had a $2.6 billion debt on its books at the end of 2003, yesterday announced a half-year net profit of $86.3 million.

That was down 9,3 per cent on the previous corresponding period and was off revenue that was up by 164 per cent on the previous corresponding period, to $1.86 billion.

The revenue increase was largely attributable to the purchase of Goodman Fielder – marker of household brands Uncle Tobys, Meadow Lea, Pampas, Buttercup and Helga’s-as well as Fleishmann’s Latin America. Burns Philp has interests in yeast, pieces and packaged good, including branded cereals and bread.

But debt levels drove profit down, as did the rise in the value of the Australian dollar. In the final six months of 2003, interest expenses amount to almost $145 million from $63.3 million in the second half of 2002.

Basic earnings per share were 3.9 cent, well down on the 10.4 cent recorded in the previous corresponding period; yet earnings before interest and tax rose from $54.5 million to $141 million.

The announcement, which was touted by company chief executive Tom Degnan as a sign that Burns Philp’s acquisition of Goodman fielder was delivering, was met with scepticism by investors and analysts.

After hitting a high of 58 cent, Burns Philp share slipped to a low of 51 cent. They have been falling since mid-August, when they reached a high of 89 cent.

Analysts yesterday questioned whether the company’s performance was a positive as Mr Degna suggested.

‘Our initial analysis indicates the underlying performance of Goodman Fielder’s Australian operations declined over the previous,’ said ABN Amro food and beverage analyst David Cooke. ‘Commodity costs account for some of this, although it seems the underlying operations are not performing as well as expected.’

The Age

5 February 2004

Questions

1.      What determines the opportunity cost of capital? Why might Burns Philp has used borrowed funds rather than increasing owners’ equity to finance the purchase of Goodman Fielder?

2.      Use economic of scale and scope as a possible reason to explain why Burns Philp acquired Goodman Fielder.

3.      Use your knowledge of market structures to give another possible reason that would why Burns Philp wanted to acquire Goodman Fielder.

4.      Does it make any difference to the market in terms of price and quantity as to which of these explanations for acquisition is true?

5.      Explain with the aid of an appropriate model why Burns Philp failed to translate a steep rise in revenue into higher profits.

6.      Why might Burn Philp’s chielf executive, Tom Degnan, be ‘comfortable’ with the company’s level of debt even though, according to the article, ‘debt levels drove profit down’? Use the opportunity cost concept, in the case of capital to explain why the debt might have been beneficial for Burn Philp’s shareholders.

7.      The performance of Goodman Fielder’s Australian operations declined over the period partly because of higher commodity prices. With the aid of cost curves, explain how higher commodity prices would reduce the profitability of a firm that made food products.

8.      Explain why the price of Burn Philp shares slipped from a high 89 cents in mid-August 2003 to 54 cents when the article was written.

Case Study: Burn Fails to Deliver the Bread