Valuation of a company with high inventories and debt

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Hi,

We are just in the middle of modelling the financial statements of a meat company, with high level of inventories (think 9 months of salesm ham company). This company has a level of debt, we suspect associated to that inventory. That debt has a cost, so when we calculate the equity value of the company via EV-Debt+Cash we come up with a value near 0.
Our question is the following, is there any adjustment to be made to these kind of companies (meat, wineries etc) carrying a high proportion of inventories on the balance sheet?

At the beginning we discussed the option of liquidating inventories and then cancel out the debt "linked" to them. However, this is an absurd given that the company is acquired on an on-going basis, not liquidation value.

Another option would be to keep that "linked" debt out of the math (think working capital adjustment), but is that fair from a valuation perspective?

Any input??
Thanks

Comments (8)

 
Oct 16, 2017 - 2:18pm

With sales of 29 million, and cash flow of 0.8 million, the company has the ability to generate cash, but poorly. In terms of leverage, with 32 million of assets the company has 5.5 million of equity.
Debt with cost of 13.8 million, we believe mainly associated with those inventories, but we do not know if there is any adjustment in case a company is holding high levels of inventory due to the nature of its activity (wineries, meat companies).

Thank you

 
Oct 16, 2017 - 12:14pm

a) If you haven't already, do a real DCF - capturing change in net working capital - to take into account the CF impact of all that inventory
b) Model out historical inventories to find out if the current levels are unusually high. It may be totally normal for this company to have inventory spikes then convert it all to cash, but you'll want to make sure.

 
Oct 16, 2017 - 2:27pm

The level of inventories is common for these companies (cured Iberian ham needs 9 months) so you need that level of inventories to operate.
Working capital increases with sales under normal circumstances, but there is no big change.
The issue here is, you need to finance those inventories, in this case with debt we believe, so the EV- net financial debt shows a bad picture for equity holders.
Any advice on this?

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