Expert Answer:Case Study Report on Hill Country Snacks Food (800


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Hill Country Snack Foods Co. (CASE FACTS)
The Chief Executive Officer of Hill Country Snack Foods had never enjoyed analyst conference
calls, but in late January of 2012, Howard Keener was yet again asked about the company’s cash
balances, capital structure, and performance measures. One analyst complained that Hill
Country’s growing cash position, absence of debt finance, and large equity balance made it
difficult for a company in a mature industry to earn a high rate of return on equity, and
recommended a more aggressive capital structure. “Maybe I don’t fully understand capital
structure theory and practice,” replied Keener, “but I have observed that companies don’t get into
trouble because they have too much cash; they get into trouble because they have too much
debt.” Hill Country had seen its sales and profits grow at a steady rate during Keener’s tenure as
CEO, and at the end of 2011 the company had zero debt and cash balances equal to 18% of total
assets and 13% of market capitalization. Having just celebrated his 62nd birthday, Keener was
approaching retirement, creating speculation by investors and analysts that the company might
change to a more aggressive capital structure in the near future.
Company Background
Hill Country Snack Foods, located in Austin, Texas, manufactured, marketed, and distributed a
variety of snacks, including churros, tortilla chips, salsa, pretzels, popcorn, crackers, pita chips,
and frozen treats. Although many of its products had a Southwestern flair, it also offered more
traditional snack foods, which were purchased by end consumers thousands of times every day in
supermarkets, wholesale clubs, convenience stores, and other distribution outlets. The company’s
growth and success was driven by its efficient operations; quality products; strong position in a
region that was experiencing both population and economic growth; and its ability to expand its
presence beyond the aisle into sporting events, movie theaters, and other leisure venues where
consumers were more likely to purchase snack foods. Many of Hill Country’s products were also
sold through school systems, which required the company to reduce the fat and sugar content of
its products. This was just one example of the company’s continual work to solicit, collect,
analyze, and internally distribute customer feedback so the company could quickly react to
customer requirements or preferences, and reinvent and expand its products as required to
succeed in the rapidly changing marketplace.
HBS Professor W. Carl Kester and Babson College Professor Craig Stephenson prepared this
case solely as a basis for class discussion and not as an endorsement, a source of primary data, or
an illustration of effective or ineffective management. Although based on real events and despite
occasional references to actual companies, this case is fictitious and any resemblance to actual
persons or entities is coincidental.
Copyright © 2012 President and Fellows of Harvard College. To order copies or request
permission to reproduce materials, call 1-800-545-7685, write Harvard Business Publishing,
Boston, MA 02163, or go to This publication may not be digitized,
photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard
Business School.
Hill Country’s Corporate Culture
Hill Country was a well-managed company, where all decisions were made according to one
criterion: will this action build shareholder value? This singular management focus came directly
from Howard Keener, the company’s CEO for over fifteen years, who strongly believed that
management’s job was to maximize shareholder value. This philosophy was applied at every
level of the organization and in all operating decisions. Many managers talk about shareholder
value, but Keener was proud of the fact that, at Hill Country, shareholder value was a way of life,
not just a talking point. Keener and other management insiders also held a significant proportion
of the company’s common stock, approximately one-sixth of the 33.9 million shares outstanding,
so this focus on building shareholder value was also personally beneficial to the members of the
management team.
Another important component of company culture was a strong commitment to efficiency and
controlling costs. The snack foods industry was very competitive, with Hill Country facing off
against industry giant PepsiCo and smaller companies like Snyder’s-Lance every day. Efficient
operations and tight cost controls were necessary conditions for success; the company could not
rely on price increases in this high rivalry industry. Operating and capital budgets were lean and
aggressive, and Keener himself was actively involved in both the budget approval process and in
ensuring the business was managed to the numbers in the budget. Unfavorable cost variances
resulted in management action to bring costs back into line with plans, even when the cost
increases were due to external factors. Management didn’t always have a solution to unfavorable
variances, but they did all they could to keep costs under control.
The final component of Hill Country’s culture and managerial philosophy was caution and riskaversion. The company invested in new capacity and new products when attractive opportunities
were identified, but it did not make high-risk bets in its product markets. Growth was low-risk
and incremental, driven by extensions of existing products and the acquisition of smaller
specialty companies. This strategy produced sales growth rates that were steady, if
unspectacular, but also increased the likelihood that customers would respond favorably to the
company’s new products. Management avoided great leaps in its product markets, instead
believing a series of small but successful product launches, combined with the company’s
operating and cost efficiencies, would quickly contribute positive operating profits.
Hill Country’s culture of risk-avoidance was also manifested in its financing decisions. The CEO
had strong preferences for equity finance and against debt finance, and the company was
managed consistent with these beliefs. Debt was avoided, investments were funded internally,
and the balance sheet was strong. The company also held large cash balances to increase both
safety and flexibility. Some members of the analyst and investment communities questioned
these policies, but CEO Keener believed they were appropriate for the company.
Financial Performance
The combination of good products, efficient and low-cost operations, and all-equity funding had
produced consistently strong financial results, as presented in Exhibit 1. Sales had increased at a
steady rate, and except for the difficult economic years of 2007 and 2008, net income had
followed a similar growth pattern. The company had experienced a decrease in earnings in 2007,
and struggled to increase profitability in 2008, but growing sales and continued attention to costs
drove large increases in net income since the recession ended in 2009. Return on asset and return
on equity numbers had similarly increased in the past few years, with return on assets reaching
10%, and return on equity exceeding 12% in 2011. Hill Country’s cautious growth strategy also
allowed the
company to pay continuous and growing dividends; carefully considered and controlled growth
meant the company’s cash flow was sufficient to fund both capital investments and dividend
payments to shareholders. The dividend payout ratio had been just below 30% of net income in
each of the past five years, and management planned to maintain this distribution ratio.
The company’s cash position and conservative capital structure, however, had a negative impact
on its financial performance measures. Return on assets was reduced by Hill Country’s large
cash balances in two ways. The interest rate earned on invested cash was barely over 0%,
contributing almost nothing to net income, and more cash meant more total assets. Return on
equity was similarly reduced by the avoidance of debt and complete reliance on equity capital.
Hill Country’s common stock was widely held by investors and covered by analysts, reflecting
the stock market’s favorable opinion of the company’s products, prospects, and management.
Many members of the investment community were also frustrated by the company’s excess
liquidity and lack of debt finance. Even modest reductions to cash, increases to debt, and
reductions to owners’ equity would significantly increase return on equity. There was no clear
consensus about this issue, however, as others worried about the wisdom of demanding changes
from a successful company.
Capital Structure
Cash holdings of U.S. non-financial corporations had increased to record levels by the end of
2011;1 thus Hill Country’s large and growing cash balances were not unusual. The company’s
capital structure with zero debt finance, in contrast, was fairly unique, particularly within its
industry. Both PepsiCo, the giant in snack foods, and Snyder’s-Lance, a competitor of similar
size and scope utilized debt finance, as shown in Exhibit 2. PepsiCo’s debt-to-capital ratio was
49.6%, but it earned bond ratings of “Aa” from Moody’s and “A” from Standard & Poor’s, due
to its strong interest coverage and low level of business risk. This ratio was lower for Snyder’sLance, but debt still provided nearly one-fourth of the company’s investment capital. None of
their debt was publicly held, however, so Snyder’s-Lance was not rated by any credit agency.
The question posed to Keener in the January analyst conference call reflected the opinion of
many shareholders that the company would benefit from a more aggressive capital structure
policy. Debt was less expensive than equity due to its contractual nature and priority claim, and
interest payments were deductible for income tax purposes. In addition, interest rates were at
unprecedented levels in early 2012: market yields on 10-year treasury bonds were under 2%; and
publicly-traded 10-year bonds issued by “A” rated corporations were trading at 3.8% yields to
maturity. These data and other current information about interest rates and bond ratings are
presented in Exhibit 3.
A pro forma financial analysis is presented in Exhibits 4 and 5, which was prepared to address
speculation about how a change to Hill Country’s capital structure would affect its financial
results. Exhibit 4 shows the company’s actual 2011 financial results and pro forma restatements
of 2011 results under three alternative capital structures: 20% debt-to-capital; 40% debt-tocapital; and 60% debt-to-capital. Exhibit 5 presents the details and assumptions of the
recapitalizations that produce the alternative pro forma capital structures, in every case assuming
the company issued debt and used the proceeds, plus $55 million of excess cash, to repurchase
common stock at the end of January 2012. The pro forma analysis also assumes the repurchase
premiums paid above the current market price of $41.67 per share increase as the stock
repurchase increases in size. Other alternatives exist to significantly increase the proportion of
debt in the firm’s capital structure—issuing debt to fund a large specially-designated dividend,
for example—but Exhibits 4 and 5 present an analysis that
1 “Largest Public Companies Continue to Hoard Cash at Record Levels; 1000 of the Largest
Now Hold $850 Billion in Cash on Hand,” REL Research, December 8, 2011.
estimates the financial impact of increasing debt and decreasing equity in Hill Country’s capital
structure through a stock repurchase.
Given the company’s culture of caution and risk-aversion, it would be unrealistic for analysts
and external shareholders to expect a major and immediate change in the use of debt finance, no
matter how attractive the pro forma results presented in Exhibits 4 and 5. The recent birthday and
pending retirement of CEO Keener, however, whose personal preferences had a substantial
influence on company culture, created speculation that a more aggressive capital structure might
be implemented in the near future. The questions being considered by many members of the
investment community were, “What is the optimal capital structure for Hill Country Snack
Foods, and how large are the payoffs associated with a change to a more leveraged capital

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