FIN 5104
Corporate Finance

UST Case

Ken Atavatkul
Yi-Fan Lin
Jingjing Xu

Fall 2013

1. What are the primary business risks associated with UST Inc.? What are the attributes of UST Inc.? Evaluate from the viewpoint of the bondholder.
(i) Brand name and market position: UST possesses strong brand name and high market share. For UST inc, the company is identified as the leading producer of moist smokeless tobacco products and well known for its conservative debt policy. Superior
(ii) Cash flow generating capacity: UST is a company with a continuous increases in sales, profit, and cash flow. Sales, earnings and cash flow have grown at 10-year CAGR of 9%, 11%, and 12%, respectively. Superior
(iii) Cyclicality of revenues: Medium degree of demand elasticity and its revenue has grown at CAGR 9% for 10 years. Superior
(iv) Product diversification: Low diversification. UST’s tobacco product contributes 96.8% of total revenue. Wine and other only has 3.2%. For tobacco product lines, UST reacted slowly to against its price-valued competitors by promoting new products. Moreover, UST had been criticized recently for a reduction in innovation and tardiness of new product introductions. Poor
(v) Geographic diversification: Only focus on North American market. No immediate opportunity for international expansion. Good
(vi) Asset tangibility: For tobacco industry, companies’ major assets should be equipments, properties and plants. Therefore, for the total asset, UST’s tangible asset should be one of major fractions. Good
(vii) Litigation risk: Unstable. Overall speaking, smokeless tobacco manufacturers have historically faced less exposure to health related lawsuits than cigarette manufacturers. Recently, UST also faced a pending dispute whereby Conwood alleged that UST violated antitrust and advertising law and participated in anti-competitive conduct. Poor
Does it have high business risk? UST’s business risk is low because except product diversification, stable sales cyclicality and low leverage give us the signals of low business risk. However, in terms of litigation risk, UST is easier to face lawsuits or legislative changes which may increase its business risk.
2. Discuss UST’s past financial performance. Is the past performance expected to continue in the future?
Table 1 UST Historical Financial Performance

5-Year CAGR
10-Year CAGR
Net Sales
5%
9%
EBIT
6%
11%
EPS
9%
13%

5-Year Average
10-Year Average
Gross Profit Margin
79.7%
77.3%
Net Margin
32.7%
31.3%
ROE
122.8%
89.1%
Dividend Payout Ratio
57.8%
61.6%
The table above indicates that the gross profit margin, net margin and dividend payout ratio keep steady over past 10 years while average ROE has a big increase. That’s because UST’s net income keeps increase in the past 10 years, at the same time its shareholders’ equity barely increase even decrease a lot during 1994-1996. However, itscompound annual growth rates of Net Sales, EBITand EPSdecline in the past fiveyear compared with those in the past ten years. Thoseslowing-down growth rates raise the doubt that UST may not keep the excellent financial performance in the future.What’s worse, suffering from theincreasingcompetition, UST is losing marketshare in its core operation,the premium smokeless tobacco market. Furthermore, the price value products in the industry has a dramaticincrease in market share, yet UST just entered in and only has a 0.6% market share in 1998. For those reasons, we think if UST doesn’t implement any improvements, it won’t keep thegood performance in the future.
3. (a) Compare UST’s financial performance and capital structure to other tobacco firms.
Table 2 Summary Financial Information for UST and other Tobacco Companies

UST
Phillip
Morris
North
Atlantic
Trading
RJR
Nobisco
Dimon
Standard
Commer.
Univer-sal
Median
(ex UST)
Gross Profit Margin
80.1%
41.7%
65.4%
46.2%
12.3%
9.7%
14.3%
28.0%
Net Margin
32.9%
10.3%
1.1%
3.5%
2.4%
1.8%
3.0%
2.7%
Return on Equity
103.4%
49.3%
NM
8.4%
12.5%
22.5%