Benefits, justifications and risks

Financial Analysis of the coffee and tea companies

Working Paper 12 presents the financial evaluation of a typical CPMCC and of the NTC. Several simulations of the expected financial performance of the proposed companies have been carried out to explore the conditions that would lead to sustainability in the long term, to engineer sound financing, and to determine the sensitivity of the expected results to changes in the critical parameters used to build the financial models.

Investment costs have been estimated by independent consultants. With respect to the Nshili Tea Company, a firm with wide experience of tea factory construction and operations in Kenya has been recruited. For coffee, the services of a consultant familiar with the coffee processing plants recently established in Burundi have been used. Products and raw material prices have been discussed in the two sections above. The cost of labour and professional staff reflects current private sector practices in Rwanda. Employees of the coffee processing plants will be mostly cooperative members, plus few external professional technicians. Management will be provided by TWIN for 5 years, including the financial controller services. With few exceptions, employees will be paid only for the duration of the harvesting washing and hulling campaign. The employees of the tea factory will include national technicians with good experience, recruited from the staff of OCIR-Thé, and will be paid for the entire year since the factory works all the year around. Other inputs in the production process have been estimated by the national consultant in the case of coffee. In the case of tea, they have been derived from the average costs of the public factories of OCIR-Thé, which may result in a degree of overestimation. Import duties and corporate income tax rates reflect the GoR fiscal laws in force in May 2002.

CPMCCs. An indicative model of one CPMCC has been elaborated to explore the conditions and limits of the financial viability of the proposed enterprises. The financial engineering package used in the model includes USD 150 000 of private equity capital, USD 400 000 long-term loan, and overdraft facilities peaking at about USD 250 000. Under this funding package, the company would acquire about USD 600 000 of fixed assets, a peak of about USD 200 000 of working capital, and would be able to finance differed revenue expenditure incurred during the first three years of operations, totalling about USD 100 000.

In accordance with the project policy stated at the end of Chapter VII, the project-supported CPMCC will borrow from the Rwanda Development Bank on terms and conditions applicable to private business. However, gearing ratios and lending terms must comply with the criteria mentioned in Chapter VII. The financial analysis model assumes that the long term loan will be for seven years, with no interest paid in the year the loan is made, at a real rate of interest of 8% thereafter, inclusive of all RDB fees and commissions. Overdraft facilities granted by the RDB and/or by commercial banks are also assumed to cost the borrowers 12% per annum, also inclusive of fees and commissions. These rates must be agreed upon during loan negotiations.

If carried out with adequate resources, and following private enterprise commercial procedures, the construction of the washing stations and of the hulling plant would take a few months, with production starting in year 2 from the company establishment, and reaching full capacity in year 4. The slow pick up of production is due to ensuring the right quality of the fresh cherries. Better capacity utilisation is possible by processing some inferior quality cherry or hand produced parche as well, but these operations must be kept separate. In these cases, the raw materials will be bought at prices comparable to those paid by traders, and have not been taken into account.

The financial projections show that dividends will be payable from year 6 onward. The total amount of payable dividends would equal the original amount of paid-in share capital by the end of year 9, despite payment of income tax at 40% over the same period. The companies will keep an adequate gearing ratio, below 3:1 at all the times. The expected dividends policy can be implemented with the Net Worth constantly kept above the nominal value of the original equity investment. During year 9 or 10 the cooperatives will be in a position to acquire control of the companies, and to increase the price of the fresh crop by about one third. The projections are at constant prices, and the future situation of exporting companies that borrow funds in Frw, may improve as a result of a possible appreciation of the USD with respect to the Rwanda currency in the course of time. This may accelerate the take over of the companies by the primary societies.

Sensitivity of the expected financial results of the coffee companies. These favourable results are fairly sensitive to:

• marginal changes in the projected average price of products;
• small increases in the investment costs;
• oversized technical and administration staff and excessive employment of labour; and
• higher interest rates on borrower funds payable during construction and start-up of operations.

These risk factors are moderated, on the one hand, by the conservative assumptions built in the computer model used for the analysis, and, on the other hand, by the likely impact of inflation and of the future external value of the Rwanda currency. There are ways also to reduce the cost of the fixed assets, by fabricating parts of the required equipment in Rwanda. All efforts must be made by the CPMCCs to control investment, start-up costs, and operating expenses, and to produce the quality of output required to obtain remunerative prices. Rigorous management and no interference with appropriate conduct of business by external factors, are essential for achieving success by the coffee companies. Deviation from these practices would jeopardise the chances of the cooperatives to acquire control of the companies in a reasonable time, and would endanger their financial sustainability when the cooperatives finally are in full control of the enterprises.

Nshili tea factory. The preliminary financial plan of the tea factory presented in Working Paper 12 envisages private equity capital of USD 1.25 million, a RDB loan of USD 3 million, and commercial banks overdraft facilities peaking at of USD 1,25 million. These amounts would fund fixed assets costing USD 4.6 million, working capital peaking at USD 700,000, and differed revenue expenditure peaking at a little over USD 1.2 million, amortised over 3 years, starting in year 4. In the case of the tea factory also, the financial projection shows that the company will keep an adequate gearing ratio, below 3:1 throughout the project, and that the expected dividends policy can be implemented with the Net Worth constantly kept above the nominal value of the original equity investment. The accumulated amount of payable dividends is expected to equal the total amount of paid-in equity capital by the end of year 8. By the end of year 9, the cooperatives would have acquired all their shares, assumed full control of the Nshili Tea Co, and will be in a position to double the price paid for the green leaves to cooperative members.

Sensitivity of the financial results of the Nshili Tea Company. The financial model of the Nhili Tea Company is more robust that that of the CPMCCs. Higher investment costs of the order of 15%, however, would require a larger RDB long-term loan or more equity investment, or a management contract grant, or a combination of these. Higher interest rates on borrowed funds during factory construction and start up will have a similar effect. The risk of lower prices for the company output is much less than in the case of coffee, the assumed grade structure of the products is, in theory, rather conservative, given the potential of the growing area, the experience of the Rwanda technical personnel, and the international reputation of Rwanda tea. Larger staff costs will have a negative impact, and must be carefully kept under control by the manager during the interim period, and by the cooperative shareholders once in control. Any increase in staff cost would reduce operating margins, and lower the chances of increasing growers’ prices. The same risk moderation factors discussed for the coffee companies, in particular the possible depreciation of the Rwanda currency over time, will apply to the tea company as well.

Return of funds to the Treasury. The project funds used to pre-finance the shares of the primary societies will be returned to the RNB by the RDB when the fund-in-trust holding the shares of the societies is liquidated. Funds used to extend long term loans by the RDB will be returned pari passu with the repayment of the amortisation of the loans extended to the companies.

During the first 10 years of their operations, under the option of establishing four CPMCCs, the expected accumulated payment of corporate income tax by the four companies would total about USD 350 000. The accumulated corporate income tax payable by the Nshili Tea Company during a similar period is estimated at over USD 900 000.