Forest Industry

You are evaluating two companies in the forest industry. Both companies are public, and are integrated companies that own or lease timber properties, harvest trees, and make building supplies and paper products. This industry is very volatile. Their profiles, from published annual reports:

Company #1A North American–based producer of building materials including oriented strand board, medium-density fibreboard, hardwood plywood, lumber, I-joists, specialty papers, and pulp. The company is also the United Kingdom’s largest producer of wood-based panels, including particleboard and value-added products. The company employs over 2,600 people in North America and 1,000 in the United Kingdom.

Company #2The company is a leading Canadian integrated forest products company. The company employs approximately 6,800 people. The company has extensive woodlands operations and manufacturing facilities in British Columbia and Alberta, and a lumber remanufacturing plant in the United States.

The company is a major producer and supplier of lumber and bleached kraft pulp. It also produces semi-bleached and unbleached kraft pulp, bleached and unbleached kraft paper, plywood, remanufactured lumber products, hardboard panelling and a range of specialized wood products, including baled fibre and fibremat. Products are sold in global markets.

You have limited industry norms, which relate to years prior to those presented for the two companies; industry norms are difficult to establish for the current years.

Select set of ratios for the forest industry in Canada

20X3 20X2 20X1Debt to equity (%) 81 68 72Operating profit margin 15.8 13.4 7.7 Return onassets 7.6 6 0.7Return on equity 17.4 12.5 1.5 Current ratio 2.1 2.1 1.9

Summarized financial data for each company is shown in Exhibit 1. A standard financial statement analysis form is included.

The companies both have unqualified audit reports and have similar accounting policies except for the following:

1. Company #1 uses FIFO while Company #2 uses weighted-average cost for inventory.

2. Both companies use a combination of straight-line and units-of-production amortization methods for capital assets, but Company #1 uses useful lives that are approximately 25% longer than those used by Company #2.

General Requirements:

Provide an analysis that compares Company #1 and Company #2 from the perspective of 1. a potential short-term creditor 2. a potential common stock investor

Assume a tax rate of 40% for both companies. There are work sheets at the end to help with your analysis. 1324Specific Requirements:

Please refer to the Case instruction sheet on FOL

Exhibit 1COMPARATIVE FINANCIAL STATEMENTS(IN MILLIONS)Balance SheetCompany 1 Company 220X6 20X5 20X6 20X5AssetsCash and cash equivalents $ 20 $ 67 $ 208 $ 17 Temporary investments – – 24 – Accounts receivable 267 242 304 321 Inventory 492 500 312 353 Future income tax 23 30 13 28 Total current assets 802 839 861 719

Property, plant, & equipment 1,984 1,903 1,469 1,518 Other assets 27 22 230 190 Total assets $2,813 $2,764 $2,560 $2,427

LiabilitiesCurrent liabilitiesBank debtAccounts payable $ 323 $ 316 $ 480 $ 364 Current portion of long term 4 15 53 49 Total current liabilities 327 331 533 413

Long-term debt 1,077 921 556 384 Other liabilities 96 97 170 65 Future income tax 38 112 147 363 1,211 1,130 873 812 Total liabilities 1,538 1,461 1,406 1,225 Shareholders’ equity

Preferred shares 60 60 – – Common shares 889 880 657 657 Retained earnings326 363 497 545 1,275 1,303 1,154 1,202 Total liabilities and equity $2,813 $2,764 $2,560 $2,427

Income statement Company 1 Company 220X6 20X5 20X6 20X5Net sales $2,066 $2,134 $ 1,986 $2,265 Costs and expensesManufacturing/product costs 1,793 1,722 1,759 1,622 Amortization and depletion 148 144 106 113 Selling and administration 90 90 58 67

2,031 1,956 1,923 1,802 1325Operating income 35 178 63 463 Interest expense 52 40 64 60 Other (income) expense (62) 25 (9) (6) Income before income tax 45 113 8 409 Income tax expense (recovery) 26 (34) (18) 84 Net income $ 19 $ 147 $ 26 $ 325 Dividends

Preferred $ 2 $ 2 – – Common $ 54 $ 50 $ 74 $ 25

Financial Statement Analysis Company 1 Company 2 20X6 20X5 20X6 20X5

Profitability—base denominator on year-end figures

Return on long-term capital, after tax* _____ __________ _____

Return on total assets, after tax _____ _____ _____ _____

Return on common shareholders’ equity _____ _____ _____ _____

Operating margin _____ _____ _____ _____ * Include all long-term credit elements as long-term debt

Efficiency—base denominator on year-end balances

Asset turnover _____ _____ _____ _____

Accounts receivable turnover* _____ _____ _____ _____

Inventory turnover _____ _____ _____ _____ * assume all sales on account

SolvencyLong-term debt to equity* _____ _____ _____ _____

Long-term debt to total capitalization _____ _____ _____ _____

Debt to total assets _____ _____ _____ _____

Times interest earned _____ _____ _____ _____ • Include all long-term credit elements as long-term debt

Company 1 Company 220X6 20X5 20X6 20X5 LiquidityCurrent ratio _____ _____ _____ _____

Quick ratio _____ _____ _____ _____

Cash Flow from Operations 20X6

Cash flow from operations Company 1 Company 2 Net incomePlus/less: non-cash charges _____ _____

Changes in working capital _____ _____

Accounts receivable _____ _____

Inventory _____ _____

Future income tax—current _____ _____

Accounts payable and accrued liabilities _____ _____

Future income tax—non-currentCash flow from operations ______ _____