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BLUE JEANS CASE

PRESENTED BY:
CHETAN SIDANA
ISHITA SOOD
MOHIT GOYAL
NIKKI WARIACH
PUNEET GARG
SANYAM GROVER
INTRODUCTION OF THE CASE
• Mr. H.B. Babalola is considering to invest in denim
industry by purchasing shares of a raw material
supplier of denim , “DENTEX”. It specialized in denim
and holds 1/3rd sales of the total denim market

• He feels that “BLUE JEANS” have been a popular


apparel for many years, and are unlikely to go out of
fashion. Thus he feels the industry has low demand
fluctuations
US DENIM INDUSTRY
• The US apparel industry is large, mature, and highly
fragmented. The US market sells apparel produced both in
domestic as well as foreign locations.
• The global economic downturn has had a severe effect over the
apparel industry, but the denim market has regained its pace
relatively faster as compared to other apparel segments.
• However, in 2014, denim jeans sales has registered a drastic fall
as yoga wear is fast becoming a very popular substitute for
denim .
• As a result, US jeans manufacturers are increasingly struggling
with declining sales of their denim products. Each of these
leading players is being negatively affected by the decline in
sales of jeans in the US
Denim Industry Statistics Data

Total number of denim jeans sold worldwide annually 1,240,000,000

Size of Global denim market by sales $56,200,000,000

Size of U.S. denim market by sales $13,720,000,000

Women’s denim market size $8,550,000,000

Men’s denim market size $5,170,000,000

Global denim fabric production in meters 2,700,000,000

Average price of a pair of denim jeans $45.32

Total number of denim mills worldwide 513

Percent of U.S. consumers who own a pair of jeans 96 %

Average number of denim pants a woman owns 7

Average number of denim pants a man owns 6

Percent of Americans that wear jeans to work an average of 4 days a week 60 %

Denim Purchase by Region Share of Purchases

North America 39 %

Western Europe 20 %

Japan & Korea 10 %

Rest of the world 31 %

Sources: Retail Monitor, World Denim Market


Report, Cotton Incorporated
Denim Market Share Compared to Other Women's Men's
Denim Jeans 27 % 38 %
Pants (non-denim) 25 % 31 %
Shorts 9% 14 %
Active Pants 8% 7%
Active Shorts 5% 10 %
Dresses 17 % --
Skirts 9% --
Top Purchase Drivers for Denim Jean
Women Men
Shoppers
Fit 83 % 64 %
Comfort 75 $ 60 %
Flattering Look 71 % 48 %
Price 64 % 49 %
Quality 55 % 46 %
Durability 56 % 45 %
Q1. What conclusions are
indicated by the ratio analysis ?
Calculation
RATIO 2006 2007 INDUSTRY
1. CURRENT RATIO 237000/71000 = 223000/61000 =
(CA/CL)
3.34/1 3.65/1 3.2/1
2. QUICK RATIO 237000-118000/71000 = 223000-120000/61000 =
(CA-Inventory/CL)
1.68/1 1.69/1 1.6/1
3. ACP (114000/730000)*365 = (97000/668000)*365 =
(365/DTR)
57 Days 53 Days 55 Days
4. ITR 571000/118000 = 531000/119000 =
(COGS/Avg. Stock)
4.84 4.46 3.7
5. FATR 730000/176000 = 668000/188000 =
(Sales/Avg. Fixed
Assets)
4.15 3.55 4.5
RATIO 2006 2007 INDUSTRY
6. DEBT. RATIO 26000/413000 = 26000/423000 =
(Total Debt./Total assets)
6.3% 6.14% 33%
7. TIMES INT. EARNED 85000/3000 = 59000/3000 =
(EBIT/Interest)
28.33 Times 19.67 Times 10 Times
8. N.P. MARGIN 47000/730000 = 32000/668000 =
(NP after tax/ Sales)
6.44% 4.79% 3.3%
9. RET. on ASSETS 47000/413000 = 32000/423000 =
11.38% 7.56% 4.5%
10. RET. on EQUITY 47000/320000 = 32000/342000 =
14.69% 9.36% 7%
There are two types of liabilities — operational and debt. Operational includes balance
sheet accounts, such as accounts payable, accrued expenses, taxes payable, pension
obligations, etc. Assumed total debt includes LT debt and LT debt due currently.
INTERPRETATION OF RATIOS
• LIQUIDITY POSITION : If we look at the current,
quick and Average Collection Period, the firm has
been doing slightly better than the industry. Even
in conservative terms, the firm has a very good
liquidity position i.e its current ratio is more than
2 and its quick ratio is more than 1. It has
improved all three of these ratios from 2006 to
2007
• EFFICIENCY : The inventory turnover
ratio and fixed asset turnover ratio show
us how efficient is the firm.
• ITR shows how many times inventory is
converted in sales, whereas FTR shows
how many times the sale is generated
from given fixed assets
• Both the ITR and FATR have declined in
2007 from the previous year. However it
is still significantly higher than the
industry
• SOLVENCY POSITION : The debt turnover ratio and
interest coverage ratio depicts the long term
solvency position of the firm
• The debt-equity ratio has slightly increased but given
the industry standard, this can be further increased
and given the good financial health of firm, firm can
leverage itself with the help of debt
• Interest coverage ratio has declined , probably due
to increase in debt and reduction in net profits. Even
though by industry standards it is still better off,
company should aim at reversing the trend
• PROFITABILITY POSITION : Net profit margin ,
Return on Assets and Return on Equity depict
the profitability position
• Net profit margin has fallen down. It is higher
than industry but a reduction in margin is
worrying signal
• Return on Assets and Return on Equity both
have declined partially due to reduction in net
profit and partially due to increase in asset
size and equity.
Q2. What is the firm’s current payout
ratio compared to its historical payout
ratio ?
Year EPS DPS DPR(DPS/EPS)
2007 5.87 2.2 37.48%
2006 8.82 2 22.68%
2005 7.49 1.8 24.03%
2004 6.21 1.6 25.76%
2003 6.75 1.35 20.00%
2002 4.9 0.95 19.38%
2001 3.97 0.75 18.88%
2000 2.51 0.7 27.88%
1999 1.58 0.55 34.81%
1998 1.33 0.51 38.34%
1997 1 0.5 50%
Dividend Payout Ratio
0.6

0.5

0.4
Axis Title

0.3

0.2

0.1

0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Years

The firm has a variable dividend payout ratio. It steadily declined from
0.5 to 0.2 (1997-2001) and hovered around 0.2 – 0.25.
Currently it has witnessed a sharp increase to 0.37
Q3. What is the annual growth
rates in the earnings per share
and the dividend ?
Year EPS EPS Growth Rate DPS DPS Growth Rate
% %
2007 5.87 -33.44 2.2 10
2006 8.82 17.75 2 11.11
2005 7.49 20.61 1.8 12.5
2004 6.21 -8 1.6 18.51
2003 6.75 37.75 1.35 42.10
2002 4.9 23.42 0.95 26.66
2001 3.97 58.16 0.75 7.14
2000 2.51 58.86 0.7 27.27
1999 1.58 18.79 0.55 7.84
1998 1.33 33 0.51 2
1997 1 - 0.5 -
DPS Growth Rate %
45
DPS growth has been
40 extremely volatile,
probably due to volatility
35 in growth of EPS

30

25

20

15

10

0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
EPS
Compound Annual Growth Rate (CAGR) =
-n
[(Ending Value/ Begin Value) )] – 1

-10
= [(5.87/1) ] – 1
= 1.1936 – 1
= 19.36%

DPS
Compound Annual Growth Rate (CAGR) =
-n
[(Ending Value/ Begin Value) )] – 1

-10
= [(2.20/0.5) ] – 1
= 1.1597 – 1
= 15.97%
Q4. Is there any reason to believe that
the firm has changed its dividend
policy ?
The company has followed a policy of increasing
dividends since 1997 (Exhibit 2).
2004 onward there has been a an absolute increase in
DPS of $0.20
There has been a dip in the EPS in 2004 and 2007. For
2007 we see decrease of 10% in sales and a decline in
cost of sales of 8%. Thus lower profits.
There has also been a purchase of land and building –
lower cash flows – lower dividend payout.
Q5. Risk is affected by many factors.
How each of the following affect the
firm-specific (unsystematic) risk
associated with Dentex?
(a) The firm’s geographical location
(b) The product line
(c) Its use of Debt. Financing
(d) Foreign competition
(a)The geographical location is to the
advantage of the company since
Americans don’t wear traditional
clothes.
(b)Compared to other western countries
like UK where clothing has to be more
formal, people in states wear jeans even
at work.
(c)Geographical location of the
company/product does not pose any
risk.
(b) Dentex is primarily a denim manufacturer. While this
fabric may be popular, any change in demand will certainly
have an impact on Dentex.
Other firms have a diverse product line to reduce risk, Dentex
is following the opposite strategy.
Demand for denim jeans is price inelastic. The price range is
wide for jeans. And there is no question of jeans going out
of style. Reasons:
• Comfortable
• Do not require frequent washing/cleaning
• Versatile
• Durable and long lasting
• Affordable
(c) Dentex uses a modest amount of financial
leverage as its debt ratio is less than the
industry average (6 versus 33 %). The firm does
not use an excessive amount of debt financing,
so there is no reason to conclude it has much
financial risk.

Debt as a percentage of total funds is 7%.


(d) Foreign competition is fierce in textiles, so
the investor needs to determine if foreign
producers manufacture denim and, if so, to
what extent it competes with Dentex’s
denim.
China is the world’s largest supplier of denim.
This can pose a threat to dentex. If USA as a
country levies any import duties as part of its
foreign trade policy it may protect its
domestic denim industry.
Q6. Does Dentex’s P/E Ratio suggest
the firm is undervalued ?
• The P/E ratio for Dentex is $50/$5.87 = 8.5, which is
low. Interpreting this Ratio is difficult.
• Low P/E ratios are an indication of lower future
earnings and dividends and one will avoid this
stock.
• Some suggest buying low P/E stocks on the grounds
that bad news (if it does occur) has already been
discounted in the price of the stock. The strategy is
to buy low P/E stocks that are currently out of favor.
• Investing in low P/E stocks is one of the anomalies
to the efficient market hypothesis.
Q7. Why is the growth rate in the
dividend not sustainable ?
• The growth rate for Dentex cannot continue
indefinitely, because the earnings cannot sustain that
growth.
• In addition, The company has increased the dividend
even though earnings declined.
• This reduces the earnings that are retained to finance
future growth.
Q8. If a dividend growth rate of 4%
can be sustained, is the stock a good
purchase if the required return is
9.5% ?
The dividend-growth model for stock valuation is V =
D0(1 + g)/k - g

If Dentex is comparable to the market (i.e., if


beta = 1.0), k = 9.5%, g = 4%
V = [Ending Value(1+g)]/(k-g)
V = [$2.20(1 + .04)]/(.095 - .04) = $41.60.

Since the current price is $50, the stock is overvalued in the


market and should not be purchased. An investor can go for
short selling.
Q9. If the beta coefficient were 0.8 and
the sustainable growth is assumed to
be 4%, should the stock be purchased
if the risk-free rate is 3.5% and the
anticipated return on the market is
9.5% ?
k = Rf + (Rmm - Rf)beta.

K = Risk adjusted required rate of return


Rf = 3.5% (given)
Rmm = 9.5% (given)
Beta = 0.8 (given)
k = .035 + (.095 - .035)0.8 = 0.083
Since the beta coefficient is less than 1.0, the return on the
stock is less volatile than the return on the market. This lower
volatility reduces the require return;

V = [$2.20(1 + .04)]/(.083 - .04) = $53.21.


The stock is undervalued in the market at $50. One should go for
a long position vis-a-vis the stock.

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