Post on 25-Mar-2018
Leading a GOOD LIFELove. Innovative. Faithful. Energetic
QP Case Analysis Competition 2016
HKICPA
CONTENTS
PAGES REPORT OVERVIEW
2 Executive Summary
PAGES SITUATIONAL ANALYSIS
2 Company AnalysisStrategy Evaluation
PAGES PROPOSED STRATEGY
Option 1: Eastern China and HKOption 2: Western ChinaOption 3: ASEAN Markets
PAGES IMPLEMENTATION
PAGES CONCLUSION
PAGES APPENDICES
3
ObjectivesMarket AnalysisBusiness Model
Financial Analysis
Lists of Appendices
PAGES CORPORATE GOVERNANCE
12
6
11 Key Takeaway
Ethical Issues
67
11
Timeline and Risk Management10
8
QP Case Analysis Competition 2016
This report aims to evaluate the dilemma Good Life Dairy Company Limited
(“GLDC”) is facing and an expansion proposal into the dessert market in China.
Recommendations and the implementation are based on the analysis of the company
and the outlook of the dairy industry. It is concluded that the competition within the
dairy industry is intensified that GLDC better diversifies its services and product
offerings by entering the dessert market. It is also evident that the financial
performance is more vulnerable to risks, when compared to the industry average. A set
of tactical adjustments and investments are to be implemented in due courses to
alleviate the financial burden and ensure operational smoothness.
The ethical issues are addressed in the final part and a list of suggestions are given.
Good Life Dairy Company Limited (“GLDC”) mainly manufactures high quality dairy
products, ranging from liquid milk, ice-cream to milk powders in Mainland China. The
company plans to switch focus to high end dairy products, and advocate the ideas of
healthy eating. However, financially, its profitability has been dropping since 2014, and
its solvency is disappointingly low. Its product portfolio is also heavily tilted towards
liquid milk. With more competition in dairy products, the prospect is more questionable.
Below is a summarised SWOT analysis (Figure 1):
2
EXECUTIVE SUMMARY
SITUATIONAL ANALYSIS
• Strict control over suppliers • Intensive trainings provided to
cattle farmers • Technical centers to provide
advice
S• Product portfolio tilted towards
milk • Extensive borrowing resulting in
high debt/equity ratio • High logistics and cost of sale • Indirect control on the
outsourced supply chain
W
• Growth in urban milk consumption
• Increase in consumption of high-end milk products due to raise in income level
O T• Intense competition in dairy
products in the PRC • GLDC’s image breakdown due
to a litany of ethical issues
Figure 1: SWOT Analysis of GLDC
Company Situation
QP Case Analysis Competition 2016
Weakness 1: Low market potential
The drinking milk industry in PRC is relatively
saturated, and the projected sales are fairly flat.
The industry is predicted to have a CAGR of -0.6%,
which would not bring significant revenue growth. 1
Given the already large portion of expenditure in
advertising, further spending would raise the average
cost of production and narrow the profit margin.
Weakness 2: Ineffective to gain brand exposure through advertising
The competition within the industry is intense, and manufacturers have already spent
heavily on marketing. Mengniu and Bright Diary & Food both advertised with the
Chinese National Swim Team and Women’s Volleyball Team respectively. Further 2
advertising investment requires a high cost in order to locate GLDC in a comparable
market position. But without an effective product differentiation, the strategy cannot
gain brand exposure and boost sales proportionate to the advertising cost.
Weakness 3: Limited market share in Hong Kong
Hong Kong consumers place high trust in locally produced fresh products. Major
competitors like Vitasoy and Kowloon Dairy, have established strong consumer
loyalties. Mengniu in Hong Kong only 3
gained 0.2% market share over 5
years. The share is minimal while the 3
largest players in Hong Kong each
Euromonitor International. (2016). Drinking milk products in China. Retrieved from Euromonitor Passport database.1
Euromonitor International. (2016). Drinking milk products in China. Retrieved from Euromonitor Passport database.2
Mengniu is one of the leading companies in producing dairy products in PRC.3
3
Option 1: More Market Penetration into Eastern PRC and HK
CAGR
-0.6% 20162020
Market Size
Figure 2: Market Analysis of drinking milk industry
Evaluation of Strategies
Resistance
26.18% 22.08% 0.5%Vitasoy Nestle HK Mengniu
Market share out of all
Figure 3: Market Analysis of drinking milk industry in Hong Kong
RMB 253,387.48 million
RMB 250,191.27 million
QP Case Analysis Competition 2016
captures over 20%. It would be difficult for GLDC, as a non-local brand, to gain wide 4
acceptance in Hong Kong simply through advertising.
Weakness 1: Customer's low purchasing power
The purchasing power of customer in western China
is still too low to consume high quality product. The dairy
product consumption is converged in cities , due to 5
divergence in economic development. Despite the launch
of China Western Development in 2000, the divergence
of consumers market still exists, implied by the
differences of per capita GDP. Per capita GDP in
western areas in 2015 was only RMB 41,019 . Moreover, in rural area, only pastoral 6
herders in Xinjiang, Inner Mongolia and Tibet have high consumption of self-produced
dairy products. These factors make it hard for market development in western China.
Weakness 2: Limited seizable market share
The market competitions in the western areas with relatively higher economic status,
such as Inner Mongolia, Chongqing and Ningxia are intense. Local dairy companies,
together with the two large dairy companies - Mengniu and Yili, based in Inner
Mongolia, are well-established and with stable market shares. The potential market
share of western China is limited, as many competitors own a certain share in the dairy
market. It is hard for GLDC to compete and generate significant revenue in short 78
terms.
Euromonitor International. (2016). Drinking milk products in Hong Kong, China. Retrieved from Euromonitor Passport 4
database. Zhangyue Zhou, Weiming Tian, Jimin Wang, Hongbo Liu and Lijuan Cao: Food Consumption Trends in China, April 2012. 5
Wikipedia: List of Chinese administrative divisions by GDP per capita. Retrieved from https://en.wikipedia.org/wiki/6
List_of_Chinese_administrative_divisions_by_GDP_per_capita Dairy Industry in Chongqing and Sichuan, 2014, April. Consulate General of the Netherlands in Chongqing: 7
Market Structure Analysis on Ningxia Dairy Processing Industry, Qiang Yi. 2015, November. Aussie-Sino Studies, Vol.1, Issue 8
4.
4
Option 2: Entry into Western PRC
National Average: RMB 49,99217.95%
Figure 4: GDP per capita in PRC
QP Case Analysis Competition 2016
Weakness 1: High associated costs from
acquisition of foreign manufacturers
Acquiring foreign dairy products manufacturers for the expansion
into Southeast Asian markets requires a large amount of capital.
However, the limited capital of GLDC hinders the acquisition.
Firstly, its cash and cash equivalents which decreases by 65% in
2 years. Adding further is the dramatic increase in bank loans by 9
420%, meaning GLDC needs a large amount of
liquid assets for future interest payments,
suggesting that the current assets available for
the acquisition is very limited. Worse still, the
debt ratio of GLDC increased by 15% in 2 years, inferring that the future cost of debt
will be high and it is difficult for GLDC to raise fund from debt financing. As a result, the
high acquisition cost and the limited capital of GLDC increase the business risk.
Weakness 2: Fierce competition in the ASEAN markets
Fierce competition in the ASEAN markets is also another obstacle for the expansion
strategy. As 60-80% market shares are dominated by 5-6 domestic and foreign dairy
manufacturers in ASEAN markets , it is difficult for GLDC to further expand into these 10
markets. For example, Nestle Philippines Inc solely dominated 50% market share of
drinking milk products in Philippines while Dutch Milk Ladies Industries and F&N Foods
dominated more than 25% of the market share in dairy products in Malaysia and
Singapore markets respectively. The already-fierce competition in ASEAN markets 11
may lead to lower projected sales growth of GLDC and detrimentally affect its
profitability in these markets.
GLDC Limited Company Report 9
Euromonitor International. (2016). Drinking milk products in ASEAN. Retrieved from Euromonitor Passport database.10
Euromonitor International. (2016). Drinking milk products in Philippines. Retrieved from Euromonitor Passport database.11
5
Option 3: Entry into ASEAN markets
2014 2015
Figure 5: Financial Deterioration of GLDC
Cash
Bank loans
Debt-Equity Ratio
RMB 67 M RMB 23 M
RMB 125 M RMB 650 M
50.75% 58.74%
QP Case Analysis Competition 2016
Despite the weaknesses, strategy 1 stands out to be more viable. However, instead
of expanding into the Hong Kong market and spending lavishly on advertising, we
will launch our corporate food catering business in some coastal cities in PRC.
To enshrine the value proposition of Good Life - providing high quality dairy products,
we propose to diversify the company’s product offerings and services. Aligning with
the company’s blueprint of providing more “high-end” food, we intend to open “GLD”
(Good Life Dessert) - the dessert flagship stores to meet customer’s demands.
Market size and growth of the business
While the Chinese are more health-conscious, the ice-cream and frozen dessert
market is expected to have a 1% CAGR in 2016. Essentially, single portion dairy 12
ice cream products would benefit a 4% CAGR. Further, the peculiar Chinese eating
culture dislikes a dessert after meals at a restaurant. But youngsters prefer a 13
separate dessert time. Thus it opens up opportunities of establishing a chain selling
innovative and more swanky dairy desserts.
Recent trends
There is a notable growth of consumer interest in traditional Chinese flavours like red
and green beans, and the new flavour green tea, over the past 5 years. The frozen
desert sector is expected to see a 3% of volume growth in the next 5 years. The
major driver for its growth will be tangyuan, which is associated with narrow scope of
innovation out of traditional aspects. It could be the untapped area for product 14
development, which welcomes innovative features on the traditional products.
Euromonitor International. (2016). Ice Cream and Frozen Desserts in China. Retrieved from Euromonitor Passport database.12
gbtimes. Chinese dessert culture: nonexistent or a well-hidden treasure? (2011, June 2). Retrieved from http://gbtimes.com/13
life/chinese-dessert-culture-nonexistent-or-well-hidden-treasure Euromonitor International. (2016). Ice Cream and Frozen Desserts in China. Retrieved from Euromonitor Passport database.14
PROPOSED STRATEGY 6
Objectives
Market Overview
QP Case Analysis Competition 2016
Core values of the strategy
Developing Gelato tangyuan suits the consumer preferences. The product is flavoured
Gelato ice-cream in ordinary ice-cream mochi wrapping, in the size of traditional
Chinese tangyuan. Our Gelato tangyuan aims to promote the concept of "union" and
deliver the healthy and high quality values. It could be served either directly as dessert,
or in the form of hotpot, of which the soup could be in low-sugar dark chocolate and
green tea latte flavours. One of the major ingredients of both is GLDC milk, of which
the richness is featured in the product. Given the rising health awareness of
consumers, the product emphasises on its healthiness by using low-fat and skimmed
milk, with low-sugar formula. The product will be mid-priced to be more down-to-earth
and raise brand awareness. Feedbacks from consumers are collected regularly to
modify the product. Tangyuan aside, various dairy desserts, ranging from red bean
dairy ice-cream to green tea milk pudding, would also be introduced.
The Retail and Flagship Store Concept
Initially, Gelato tangyuan will be launched through two channels. Firstly, the packaged
tangyuan and its liquid milk products will be sold in retail stores. It exposes the
products to middle-to-high income customers. Secondly, a flagship store will be set up
to promote GLDC products. Gelato tangyuan will be served with flavoured hotpot,
which is positioned to be premium dessert. Other products, including packaged
desserts, liquid milk and milk powder, are also available for sales. The store enables
GLDC to reinforce its brand image of serving high-quality and healthy products.
Business Model7
L I F E
Love Innovative Faithful EnergeticPromoting the
concept of “union”Defying traditions and
diversifying product portfolioDelivering high quality and healthy products
Targeting energetic customers
QP Case Analysis Competition 2016
Further Promotions
If the product could capture sufficient market attention and generate a substantial
growth in revenue, GLDC could have short-term collaborations with high-end brands to
offer desserts featuring the Gelato tangyuan and liquid milk. Potential partners would
be Godiva and Agnes b Cafe, which offer premium chocolate. GLDC Gelato tangyuan
could be served with the partners' signature chocolate hot pot. Such teaming up further
draws attention from loyal customers of these established brands, which adds value to
the brand name of GLDC and elevates the brand image.
Marketing strategies: "CCFF Love" Marketing campaigns
To promote our Gelato tangyuan, online and offline marketing campaigns will be
launched. One of the values of our strategy is Love which is for "union". We will focus
on 4 kinds of love -- love for country
and couple; family and friend
(CCFF).
As shown, limited editions of Gelato
tangyuan in different flavours will be
offered occasionally. Coupled with our digital marketing campaigns called 微信传情, it
is expected that the the marketing campaigns can effectively promote our brand and
attract more energetic customers.
A. Current Financial Problems
Problem 1: Exceptionally high Debt-Equity Ratio
GLDC’s debt-equity ratio is incredibly higher than that of industry average. This could
be explained by the extensive investment in milk products and technical support for
local farmers. It could easily render GLDC susceptible to smaller scale of risks.
Love Flavours Festivals
Country Tangerine National day
Couple Red rose Valentine's DayThe Lantern Festival
Family Star fruitMid-Autumn FestivalWinter Solstice FestivalLunar New Year
Friend Pineapple International Friendship Day
8
Financial Analysis
Figure 6: Details of “CCFF Love” Marketing Campaigns
QP Case Analysis Competition 2016
Problem 2: High cost of sales and distribution cost
Since GLDC has spent heavily on advertising to promote its brand image, there was
an around 16% increase in sales and distribution cost. However, revenue increased
only by 14%, potentially suggesting the ineffectiveness of its marketing strategies.
Problem 3: Unreasonably high finance costs
The exorbitant finance costs may be due to the exacerbating debt-equity ratio. When
GLDC sought to borrow loans from financial institutions, the high ratio became a
barrier and GLDC had to secure the loan with more costs.
B. Investment Strategies
A “target funding acquired” is set at 80% of the total operation expenses for the next
financial period. It is to ensure sufficient cash for expenses and emergency uses.
Notably, crowdfunding will be used to raise fund from GLDC's milk station owners in
order to secure better milk quality and enough funding. Preference share with higher-
than-average dividend return will be issued to the owners. It is expected to raise 23%
of the total fund needed from the milk station owners. As the milk station owners
become the shareholders of GLDC, they will have higher incentives to improve and
therefore to ensure higher quality of milk.
9
Funding Arrangement
(in million RMB) 2016 2017 2018 2019 2020 2021
Target funding acquired for next period 52.63 74.27 195.43 328.82 446.22 /
Cash remained from previous financial period / 0 87.96 94.86 195.29 352.09
Sales revenue collected / 79.16 356.97 960.13 1620.69 2202.49
Long-term bank loan (3-5 years) / 30 0 0 0 0
Issuance of right share (new share) / 100 0 0 50 0
Issuance of preference share / 0 0 50 0 0
Loans repayment / 0 (10) (10) (10) 0
Total funding acquired / 209.16 434.93 1,094.99 1,855.98 2,554.58Expenses of the present financial period / 121.2 340.07 899.70 1,503.89 2,026.91
Cash remaining / 87.96 94.86 195.29 352.09 527.67
(Figure 7)
QP Case Analysis Competition 2016
The timeline of the proposal follows the company’s three main objectives -
diversification in product portfolio, targeting high-end markets and financial prudence.
Operations aside, GLDC will implement a set of risk management systems to monitor
potential risks and act swiftly in cases of risk materialisations:
Ways to mitigateRisks Evaluations
Drop in seasonal sales
Food Quality Control
• CCFF Love marketing campaigns will launched occasionally to create constant hooks to the public
Severity
Poss
ibilit
yCapital risk (i.e. poor effect on issuing new shares)
• GLDC will form a synergy between external milk stations and its manufacturing centres to ensure a more consistent food quality control
• Crowdfunding is a means to render incentives for better quality control
• More roadshows will be implemented before and after the announcement of issuing new share to arouse public’s attention
Severity
Poss
ibilit
y
10IMPLEMENTATION
Severity
Poss
ibilit
y
Health Dessert Series in retail stores
Flagship premium dessert stores
Figure 8: Implementation Timeline
Figure 9: Risk Evaluation Matrix
QP Case Analysis Competition 2016
David Chan, CFO of GLDC, was informed by Lucy Lee, the business analyst, about
having low levels of melamine in milk from two of the dairy farmers.
Problem 1: Cover-up of the problem
David asked Lucy not to disclose the issue to the third party, implying his intention to
conceal the problem from the officials and the public.
Problem 2: Corruption
David hinted that he would reward Lucy by recommending her for the CFO post
upon his retirement, showing traits of corruption.
Remedial Actions
According to “Code of Ethics for Professional Accountants” (“COE”) published by
HKICPA, David Chan, as a CPA, should maintain information that "represents the
facts accurately and completely in all material respects " (COE Section 320.3A). 15
When David was notified about the issue, upon verification of the test results, he
should have ceased receiving raw milk from the two dairy farmers, reported to the
officials, and traced the contaminated products. If the products were already in the
market, he should have informed the public, made an open apology on behalf of
GLDC and recalled the products. If the products were in the inventory, he should still
have reported to the relevant authorities and discharged the products before they
were sold in the market.
As consumers in Eastern PRC are pursuing a higher living standard, it is opportunistic
for GLDC to target the high-end market, in particular the dessert market to capture a
larger market share.
In this case, "material respects" refers to the test result of the melamine milk. The result directly affects the business 15
development and investor decision of GLDC, constituting part of the materiality.
11CORPORATE GOVERNANCE
Ethical Issues
Key Takeaway
QP Case Analysis Competition 2016
12
Position Product Price Place Promotion
Middle-high end Gelato tangyuan Retail stores:middle Retail stores CCFF Love
campaigns
Energetica. Tangyuan: red bean, green bean fruits
Flagship store:middle to high Flagship stores a. Digital
b. Soup: green tea latte, dark chocolate milk
Partner stores:middle to high Partner stores b. Physical
Fat Air
Traditional ice-cream Mainly cream: 10%+ 50% air
Gelato Mainly milk, less cream: 5-7% 25%-30% air
APPENDICES
GLDC LimitedPro Forma Profit & Loss Statement(All figures are in RMB million)
2014 2015 2016 2017 2018 2019 2020 2021Revenue 15,500 17,700 19,824 21,061 22,807 24,758 26,608 28,189Cost of sales (11,730) (13,500) (15,120) (16,058) (17,369) (18,801) (20,133) (21,253)Gross Profit 3,770 4,200 4,704 5,003 5,438 5,957 6,475 6,936
Other Income 115 125 136 146 157 172 186 199Sales and distribution costs (2,895) (3,365) (3,809) (4,126) (4,435) (4,828) (5,205) (5,528)Administrative Expenses (520) (580) (650) (704) (756) (824) (888) (943)Other operating costs (56) (40) (29) (30) (32) (35) (38) (41)Operating profit 414 340 352 289 372 442 530 623Finance costs (Assuming 5% reduction from 2016) (138) (204) (194) (182) (171) (159) (148) (136)
Profit before taxation 276 136 158 107 201 283 382 487Taxation 69 34 40 27 50 71 96 122Profit after taxation (attributable to shareholders) 207 102 119 80 151 212 287 365Dividends: proposed EPS (RMB) 83 41 47 32 60 85 115 146
Appendix 3 (above): Comparisons between ice cream and gelatoAppendix 4 (left): Marketing Strategy Overview
Appendix 2: GLDC Limited Pro Forma Profit & Loss Statement
Cash Flow Projection(in million RMB) 2017 2018 2019 2020 2021Annual inflation rate 2.63% 2.63% 2.63% 2.63% 2.63%
Sales Revenue
RetailStage 1: Beijing 79.16 174.16 208.99 250.79 300.95
Stage 2: SH and GD 0 160.91 354.00 424.80 509.76Stage 3: Other coastal area 0 0 327.06 719.53 863.44
ImpulseStage 1: Beijing (1 shop) 0 21.90 26.28 32.85 41.06
Stage 2: SH and GD (2 shops) 0 0 43.80 54.75 68.44Stage 3: Other coastal area (17 shops) 0 0 0 137.97 418.84
Total sales revenue 79.16 356.97 960.13 1620.69 2202.49Cost of sales Food supplies (%) / 80 78 75 70
Staff (%) / 20 22 25 30Estimate cost of sales 55.41 245.43 650.09 1074.59 1432.51Gross profit margin Retail 30% 31% 32% 33% 34%
Impulse 35% 36% 38% 38%Gross profit 23.75 111.54 310.04 546.11 769.98Other Normal Operating Expense 19.79 89.24 240.03 405.17 550.62Additional Machine 8 0.21 0.42 1.51 2.22Expansion of kitchen 30 0 0 0 0Maintenance of kitchen 0.5 0.51 0.53 0.54 0.55Staff training 5No. of outlets 1 3 10 20No. of outlets to be constructed 1 2 7 10Total rental expenses and construction cost 1.80 5.32 18.28 36.64Additional promotion expenses 2.00 2.30 2.65 3.04 3.50Product developments 0.50 0.58 0.66 0.76 0.87Total Operating Expenses 65.79 94.64 249.61 429.30 594.40Estimated Total Expenses 121.20 340.07 899.70 1,503.89 2,026.91Unlevered FCF (49.95) 13.76 37.99 52.92 111.34PV of Unlevered FCF (49.95) 12.39 30.89 38.91 73.74NPV of Unlevered FCF 105.98
Appendix 1: Cash Flow Projection