First Farms Corporation started as a small animal feeds manufacturing in 1950s. The company has expanded to other agribusiness products and set up nationwide facilities. Though the company has performed well, it has a dilemma – a huge deficit in the operating cash flows of Php 719 million despite increasing revenues.

BA 219

Executive Summary

This paper explained the reason behind First Farms

Corporation’s deficit in their operating cash flow and decrease

in ROE even with the significant increase in sales and company’s

net income. The aim of the study is to decide whether the company

will proceed with the construction of new plants and feed mills

using Ricardo Sarmiento’s, Vice President for Finance, point of

view.

FFC’s decision to invest their operating cash on acquiring

inventory accompanied by low inventory ratio resulted to negative

operating cash flow. Using the data of the company’s financial

statements, it could be seen that the percentage increase in

inventory is not in proportion to the percentage increase in

sales. The decrease in the ROE given the increase in sales and

net income can be traced to the IPO. The increase in equity

decreased the ratio of net income to stockholder’s equity.

The result of the financial ratio and SWOT analysis

conducted in the study suggests that FCC should not proceed with

the expansion through the construction of new dressing plants and

mills. As the VP for Finance, it is recommended that the company

venture into activities and policies that would improve its ROE

by improving their profitability, efficiency and leverage.

Implementing a rigorous collection policy will improve company’s

liquidity. Internally, the company must (1) review the current

system of operation, and (2) look for alternative sources of

inputs. These would allow them to lessen the cost of production.

Equally important is to evaluate macroeconomic factors to

determine possible price and profit increase.

Point of View

This paper used the point of view of Mr. Ricardo Sarmiento,

Vice President for Finance of First Farms Corporation (FFC), who

will present to the Board of Directors the FFC’s Financial

Statements and provide necessary recommendations.

Case Context

First Farms Corporation started as a small animal feeds

manufacturing in 1950s.   The company has expanded to other

agribusiness products and set up nationwide facilities. In 1995,

FFC raised P1.1 billion from its initial public offering. P500

million of the proceeds was used as working capital (livestock

inventories and raw materials), P476 million went to expansion of

operations and acquisition of properties while P69 million was

used to pay part of the corporation’s long term debt. In the same

year, the Company acquired exclusive rights to develop and

operate California Chicken and Gulliver’s Chicken restaurants in

the Philippines.

In a stiff competition, consolidated sales for the year

still amounted to P5.7 billion which is 44% higher than the

previous year. P3.508 billion or 62% of revenue was from chicken

sales hence, taking over leadership in the business from Marigold

Foods Inc. Moreover, FFC has outpaced the industry growth on

chicken sales volume which is largely attributed to the company’s

increased contract growing base. Net income was also up 89%

amounting to P280 million despite the increasing costs of

production.1

During the year, FFC launched a new line of extruded

aquaculture feeds. It also entered the fast food business thru

California Chicken and Gulliver’s Chicken restaurants. Management

is proposing for construction of three dressing plants and four

new feed mills for the following year (1996) as they believed

that sales and profits were held back in 1995 partly by

constraints in production capacity. It is expected to be financed

by short term notes if approved.

It must be noted, that the Industry is bracing for the entry

of imported frozen chicken in 1998, when trade barriers in the

Philippines are lowered.

1 See Exhibit 6

Problem Definition

1. Why did the First Farms Corporation incur a deficit in the

operating cash flow and decline in the ROE in 1995 despite

the 44% increase in sales and 89% increase in net income?

2. Is it recommended for the FFC to proceed with the expansion

through the construction of new chicken dressing plants and

new feed mills?

Analytical Framework

Financial Ratio Analysis, Common-size and Trend Analysis (We

used 1993 as the base year) were used in order to assess the

financial position and performance of First Farms Corporation for

the period 1993-1995. Specifically, the paper looked into the

profitability ratios, operating efficiency measures and financial

leverage and Liquidity ratios and compared it across the period

1993-1995. Percentage change in Account Receivables and inventory

vis-à-vis percentage change in Sales are likewise analyzed.

To further analyze the qualitative position of FFC and to

determine the possible risks and benefits of business expansion,

SWOT Analysis was used. The company’s Strengths and Weakness and

the Opportunities and Threats in relation to the business

expansion were taken into consideration.

Analysis

Financial Ratio Analysis

Profitability

Net profit margin, which measures how much out of every peso of

sales a company actually keeps in earnings, had increased

from .03 in 1993 to .04 in 1994 then to .05 in 1995. Return on

investment, a performance measure used to evaluate the efficiency

of an investment had also improved from .13 in 1993 to .20 in

1994 then to .26 in 1995. Return on assets, that shows what earnings

were generated from invested assets, also improved. However, return

on equity, which measures the company's profitability by revealing

how much profit is generated with the money shareholders have

invested went down from .21 in 1994 to .16 in 1995. The return

on equity had gone down partly due to the issuance of 25% of

the Company's common stock in 1995. 2

Liquidity

The Company's current ratio has improved to 1.35 in 1995 from 1

in 1994. Despite the increase, it is misleading to state that the

Company is doing well in terms of liquidity without also

evaluating their cash flow. Their cash flow statement for 1995

reflected a negative operating cash flow amounting to about Php

719 million. This clearly indicates that the company might

encounter difficulty in meeting their currently maturing

obligations.3

Leverage

The financial leverage ratio reflects the company's method

of financing. Debt ratio is the company's assets financed by

2 See Exhibit 13 See Exhibit 2

creditors. First Farms Corporation's debt ratio improved

from .62 in 1993 to .54 in 1995. The same can be said to its

equity ratio, from .37 in 1993, it had improved to .46 in 1995.

Interest coverage ratio substantially improved. From 1.37 in 1993 it

jumped to 11.88 in 1995. That means that interest payments made

by First Farms Corporation were earned 11.88 times over during

the period. 4

Efficiency

Asset turnover measures a company's efficiency at using its

assets in generating sales or revenue. First Farms Corporation's

asset turnover had decreased from 2 in 1994 to 1.46 in 1995. The

decrease was caused by the Company's expansion in 1995 which was

financed by the proceeds from its issuance of 25% common stock.

Accounts receivable turnover had steadily decreased from 14.19 in 1993

to 11.35 in 1994, then to 7.65 in 1995. Accounts receivable

turnover measures a firm's effectiveness in extending credit as

well as collecting debts. Average collection period deteriorated from

25.38 in 1993 to 31.73 in 1994 then to 47.03 in 1995. 5

SWOT Analysis

The possible risks and benefits of the expanding available

production facilities through the construction of new dressing

plants and new feed mills for 1996 can be analyzed in the context

4 See Exhibit 35 See Exhibit 4

of the existing strengths and weakness of the company and the

possible opportunities and threats of this expansion.

Strengths

- The company is considered a the leading poultry integrator in

the country and have expanded to different product lines

including agribusiness products , animal feeds manufacturing,

new line of extruded aquaculture feeds and fast-food business.

- There is an available nationwide facilities and large number of

workforce that accommodate the existing demand of the products

and an additional investment of Php476 from IPO proceeds to

expand its operation capacities and to acquire additional

delivery equipment, warehouses and silos.

- Sales are up over 44% and net income by 89% on year-on-year.

- FFC significantly outpaced industry growth of about 6-7% in

chicken sales volume largely attributed to the increased in the

company’s contract growing base.

- FFC acquired exclusive rights to develop and operate California

Chicken and Gulliver’s Chicken Restaurants in the Philippines

Weakness

- The company’s ventures on the product lines with tight

competition that constrained the prices of the products.

- Most of the company’s inputs or raw materials are prone to

price increase which cause the increase in cost of production

- Production is constrained by the production capacity of the

FFC’s available facilities and expansion of such would require

large investment.

Opportunities

- Additional production facilities would increase the production

capacity of the company to accommodate demand of the products.

- New facilities may encourage potential buyers due to

accessibility of plants and greater reliability of supply.

Threats

- There is no assurance that the demand of the product and the

sales will increase given the industry’s supply glut.

- Cost of corn, soybean meal and fishmeal have been rising, thus

increasing the costs of production.

- Tight competition exists in the industry which hinders price

increase of the products.

- Threat of additional competition due to entry of imported

frozen chicken in 1998 as a result of the trade liberalization

agreement that would probably offer products at a lower price.

- Proposal for expansion is to be financed by short-term notes

but costs of borrowing are still high.

Percentage Change in Inventory vis-à-vis Percentage Change in

Sales

- Percentage change in the inventory should be proportional to

the percentage change in the cost of goods sold.

- Data shows otherwise. In 1995, inventory went up by 158% as

compared to an increase in the cost of cost sold of only 97%.6

6 See Exhibit 5

Percentage Change in Account Receivable vis-à-vis Percentage

Change in Sales

- Percentage change in the account receivables should be

proportional to the percentage change in sales.

- Data shows otherwise. Accounts receivable had skyrocketed by

1,232% increase in 1995 while sales only increased by 97%. 7

Discussion

The negative operating cash flow was a result partly of the

FFC’s investment of operating cash to acquire inventory. However,

there was a low inventory turnover8, which implies a relatively

poor sales performance and, therefore, excess inventory. Data

also showed that the percentage increase in inventory is not in

proportion to the percentage increase in the cost of goods sold.

Thus, it did not support the assumption that sales and profits in

1995 were held back due to constraints in the production capacity

since inventory turnover implies otherwise.

There is a decrease in the ROE despite the increase in sale

and net income due to IPO, as the equity increase by Php1.1

billion resulting to the increase in the stockholder’s equity.

Thus, the ratio of net income to stockholder’s equity decreased.

About Php 476 million were used in the expansion of the operation

capacities and to acquire additional equipment. Long-term effect

of these investments is expected but not yet reflected in the

short-run or in the same accounting period.

7 See Exhibit 58 See Exhibit 4

About Php500 million of the said proceeds was used as

working capital in the form of livestock inventories and raw

materials which was reflected as additional assets for the

company but was not converted into income for the said accounting

period. Thus, ratio of net income to assets (ROA) decreases

which results to the decrease of ROE-as ROA and Leverage (or

ratio of assets to equity) are factors of ROE (ROE = ROA x

Leverage).

Based on the evaluation of the company’s strengths and

weaknesses and the opportunities and threats posed by the

expansion, it is recommended NOT to proceed with the expansion

through the construction of new chicken dressing plants and new

feed mills.

Despite FFC’s strengths and limited internal weaknesses,

several macroeconomic and external factors, mostly beyond the

control of the company, hinders the possible increase in sales of

the company and outweigh the potential benefits of expansion.

Although the expansion will result to the increase in the

production capacity of the company and while it can be assumed

that market demand for the products of FFC will increase,

increase in sales and net income is still uncertain given the

tight competition and supply glut in the industry.

Cost of inputs and operating costs are increasing but prices

of products cannot be increased by same proportion due to the

competition. “Competition is keeping tight rein on prices, particularly in the chicken

business, even as the industry continues to operate in an environment of increasing

costs of production”. In addition, the industry is bracing for the

entry of imported frozen chicken in 1998 which will aggravate the

competition in the industry since if the trade barriers in the

Philippines are lowered due to liberalization agreements, this

will result to lower cost of imports, thus lower price for import

products. These would mean a decline in the FFC’s net income

which in effect will decrease the company’s ROE.

The expansion, if approved, is expected to be financed by

short-term notes. However, given the company’s liquidity ratios

(despite the slight increase) and the negative operating cash

flow, it shows that it is not in good standing in relation to its

ability to pay its short-term obligation. Similarly, it is not

advisable to finance the project by a long-term debt since the

leverages are not satisfactory9. Also, it would also be not

advisable to finance a long-term project by a short-term debt

given the company’s standing.

In addition, there is still a high cost of borrowing which

would increase interest expense for the company.

Recommendation

It is recommended for the company to improve its ROE by

improving its profitability /cost control (ratio of net income to

sale), efficiency (ratio of sales to assets) and leverage

(assets/equity). Specifically, following courses of actions are

recommended:

9 See Exhibit 3

1. Implement strict collection Policy. It is recommended to

improve the collection period and account receivable

turnover ratio to increase cash on hand and to improve

company’s liquidity. Percentage increase in the sales should

be almost of same proportion with the percentage increase in

the account receivables.

2. Review Manpower. It is recommended to further evaluate the

current system of operation of the company to determine if

the workforce of over 1,700 employees is being maximized.

Further assessment is recommended to identify if it is

optimal to hire 1,700 employees or if a certain system can

be improved that may lower the necessary workforce.

Likewise, trade-off between investing in machineries

(automation) and hiring manpower can be further studied.

3. Evaluate macroeconomic factors to determine possible price

increase. Further study of the macroeconomic variables is

suggested to determine if the company can increase price of

the products given the macroeconomic condition, and if

possible, to assess the extent in which the company can

increase price that would still result to increase in

profit. Macroeconomic analysis should be done to identify

the product’s elasticity, market demand and supply, which

will be the basis for the computation of change in profit

relative to change in price.

4. Exercise Company’s Bargaining Power. Since FFC has a large

market share in the industry, it can used its bargaining

power to enter in an exclusivity contract with its suppliers

such that suppliers will give lower prices of inputs to FFC

compared to others in the market. Similarly, they may

bargain for longer payment terms.

5. Look for alternative sources of inputs. Due to rising cost

of inputs, further study can be done to know if there are

other possible or alternative sources of inputs for the

company’s products that may lessen its cost of production.

6. Review the maintaining inventory level and its turnover

period. The average inventory turnover period has increased

in 1995. The average inventory turnover periods (day) in

1993 and 1994 are 78.97 and 70.17, respectively; it has

significantly increased to 103.40 in 1995.10 Hence, the

movement of the inventory slowed down. A possible major

implication of this is the increase in the average holding

cost of their products which directly affects the cost of

sales. Therefore, resolutions to lower down the average

inventory turnover period can improve the Company's income

and, thus, can help improve the ROE.

10 See Exhibit 4

Appendices

Exhibit 1

Exhibit 2

Exhibit 3

Exhibit 4

Exhibit 5

Exhibit 6