Barnes Group Equity and Valuation Analysismmoore.ba.ttu.edu/ValuationReports/Fall2008/BarnesGroup-Fall2008.pdf · Balance Sheet ..... 116 Income Statement ..... 117 ... firm’s worth

Barnes Group Page 1

Barnes Group Equity and Valuation Analysis Victor Hemmati [email protected]

Michael Randell [email protected]

Travis Monk [email protected]

Taylor Pettigrew [email protected]

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Table of Contents

Executive Summary .......................................................................................... 6

Industry Analysis .......................................................................................... 6

Accounting Analysis ....................................................................................... 7

Financial Analysis, Forecasting Financials, and Cost of Capital Estimations .................... 8

Business and Industry Analysis ............................................................................ 10

Business Overview........................................................................................ 10

Industry Overview ........................................................................................ 12

Five Forces Model ........................................................................................... 14

Rivalry Among Existing Firms ........................................................................... 15

Concentration .......................................................................................... 17

Degree of differentiation and Switching Costs ................................................... 19

Economies of Scale .................................................................................... 22

Exit barriers ............................................................................................ 23

Excess capacity ........................................................................................ 24

Industry Growth ....................................................................................... 26

Threats of New Entrants ................................................................................ 29

First mover advantage ................................................................................ 29

Distribution access and relationships .............................................................. 31

Legal Barriers .......................................................................................... 33

Threat of Substitute Products .......................................................................... 34

Bargaining Power of Customers ........................................................................ 36

Bargaining Power of Suppliers ......................................................................... 37

Key Success Factors ........................................................................................ 39

Cost Leadership .......................................................................................... 40

Economies of Scale and Efficient Production ..................................................... 40

Tight cost control systems: capability ............................................................ 41

Differentiation ............................................................................................ 42

Superior quality ........................................................................................ 43

Superior Customer service ........................................................................... 43

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Firm Competitive Advantages .......................................................................... 44

Tight cost control systems ........................................................................... 44

Superior customer service ........................................................................... 45

Accounting Analysis ......................................................................................... 45

Key Accounting Policies ................................................................................. 46

Research and Development .......................................................................... 47

Currency ................................................................................................ 49

Goodwill ................................................................................................ 49

Pension Plans ........................................................................................... 52

Currency ................................................................................................ 53

Revenue Sharing Programs ........................................................................... 54

Flexibility in Accounting ................................................................................ 55


Currency ................................................................................................ 56

Goodwill ................................................................................................ 57

Pension Plans ........................................................................................... 57

Revenue sharing programs ........................................................................... 58

Evaluate Actual Accounting Strategy ................................................................. 59


Currency ................................................................................................ 60

Goodwill ................................................................................................ 62

Revenue sharing programs ........................................................................... 63

Disclosures ................................................................................................ 64


Currency ................................................................................................ 65

Goodwill ................................................................................................ 65

Pension Plans ........................................................................................... 66

Revenue Sharing Programs ........................................................................... 66

Quantitative Analysis ................................................................................... 67

Sales Manipulation Diagnostics ...................................................................... 68

Net Sales/Cash from Sales ........................................................................ 68

Net Sales/Accounts Receivable ................................................................. 69

Net Sales/Inventory ............................................................................... 70

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Net Sales/Unearned Revenue ..................................................................... 72

Net Sales/Warranty Liabilities .................................................................... 72

Expense Manipulation Diagnostics .................................................................. 73

Asset/Turnover ..................................................................................... 73

CFFO/OI .............................................................................................. 74

CFFO/NOA ........................................................................................... 75

Total Accruals/Change in Sales................................................................... 76

Financial Analysis, Forecast Financials, and Cost of Capital Estimation ........................... 78

Financial Analysis ........................................................................................ 79

Liquidity Ratio Analysis ............................................................................... 79

Current Ratio ....................................................................................... 80

Quick Asset Ratio .................................................................................. 81

Working Capital Turnover ........................................................................ 82

Accounts Receivable Turnover ................................................................. 84

Day Sales Outstanding ............................................................................ 85

Inventory Turnover ............................................................................... 87

Days Supply Inventory ............................................................................ 89

Cash to Cash Cycle................................................................................. 90

Profitability Ratio Analysis ........................................................................... 91

Gross Profit Margin ................................................................................ 92

Operating Expense Ratio ......................................................................... 93

Operating Profit Margin .......................................................................... 94

Net Profit Margin ................................................................................... 95

Asset Turnover ..................................................................................... 96

Return on Assets ................................................................................... 97

Return on Equity ................................................................................... 98

Firm Growth Rate Ratios ............................................................................. 99

Internal Growth Rate ........................................................................... 100

Sustainable Growth Rate ....................................................................... 101

Capital Structure ratios ............................................................................ 103

Debt to equity ratio .............................................................................. 103

Times interest Earned ........................................................................... 105

Debt service margin .............................................................................. 107

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Cost of Capital .......................................................................................... 108

Weighted average cost of debt ................................................................... 108

Altman Z-score ....................................................................................... 109

Cost of Equity ........................................................................................ 112

Weighted Average Cost of Capital (WACC) ...................................................... 114

Forecasting .............................................................................................. 115

Balance Sheet ........................................................................................ 116

Income Statement ................................................................................... 117

Statement of Cash-Flows ........................................................................... 117

Sales Growth ......................................................................................... 118

Profitability .......................................................................................... 120

Method of Comparables ............................................................................... 121

Price/Earnings Trailing ............................................................................. 122

Price/Book ............................................................................................ 123

Price to Earnings Growth ........................................................................... 124

Price over EBITDA ................................................................................... 125

EV/EBITDA ............................................................................................ 126

Price to Free Cash Flows ........................................................................... 127

Dividends/P TTM .................................................................................... 129

Intrinsic Valuation Models ............................................................................ 130

Dividend Discount Model ........................................................................... 131

Free cash flow model ............................................................................... 132

Residual income model ............................................................................. 133

Recommendation ....................................................................................... 134

Appendices ................................................................................................. 134

Sales Manipulation Diagnostics Tables .............................................................. 134

Expense Manipulation Diagnostics Tables .......................................................... 135

Liquidity Tables ........................................................................................ 136

Profitability Ratio Tables ............................................................................. 138

Growth Rates/Z-Score Tables ........................................................................ 140

Capital Structure Ratio Tables ....................................................................... 141

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Executive Summary

Industry Analysis

Barnes Group Inc., founded in 1857, has become a diversified leader in

engineering and manufacturing precision metal components and an industrial distributor

of maintenance, repair, operating and production supplies. Today, Barnes Group

consists of three segments - Barnes Aerospace, Barnes Distribution and Barnes

Industrial - in more than 65 locations throughout the world with nearly 6,500 dedicated

employees working towards its success (Barnes Group Inc.)

Barnes Group Inc. has six main competitors within their three segmented

industries: Alcoa Aerospace, Ladish, Triumph Group, Grainger, Fastenal Co., and

Lawson Products. Alcoa Aerospace, Ladish, and Triumph Group all compete in the

aerospace/industrial segment industry with Barnes group while Grainger, Fastenal Co.

and Lawson Products contend with the distribution segment of Barnes’ industry. These

firms manufacture similar products, which challenges Barnes Group to continually press

upon its competitive advantages in order to maintain and even gain market share.

When inspecting Barnes Group Inc. Aerospace/Industrial segment, their

competition is relatively high, yet not as stern as the distribution segment because

products in the aerospace segment in particular are precision machined and fabricated

components for original equipment manufacturer (OEM) turbine, airframe and industrial

gas turbine builders. This means that competitors are creating close, but not quite

indistinguishable products. Thus, competition has its limit. The distribution segment, on

the other hand, has an extremely high level of competition among existing rival firms.

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The model below explains the analysis of the five forces model which gives an idea of

the level of competition in each segment of Barnes’ Industries:

Barnes Aerospace/Industrial Competitive Force Degree of Competition Rivalry Among Existing Firms High Threat of New Entrants High Threat of Substitute Products Low Bargaining Power of Customers Low Bargaining Power of Suppliers High

Barnes Distribution Competitive Force Degree of Competition Rivalry Among Existing Firms High Threat of New Entrants High Threat of Substitute Products High Bargaining Power of Customers High Bargaining Power of Suppliers Low

Accounting Analysis

Annual 10K reports provided by firms allow us to compare firms based on their

financial statements. These financial reports offer keen insight into the productivity of a

given company. It’s imperative that an analyst be able to establish correlations between

a firm’s key success factors and their core accounting policies. Furthermore, identifying

the level of disclosure presented in these accounting methods helps present red flag

possibilities. Ideally, companies would disclose all of their financial information in a

constant manner from period to period. However, they often find ways to manipulate

their statements in order to appease corporate agendas and only disclose SEC required

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information. With this in mind, shareholders must be extra cautious when observing

financial statements as they much too often do not tell the whole story.

Barnes Group appears to take its financial disclosing responsibility to investors

seriously. Irregularities in financial information do not exist, and the impact of

acquisitions and goodwill can be directly linked to other aspects of the balance sheet in

the same year. The company expenses its research and development costs; however,

these costs are minimal in relation to competitors which makes it easier to validate the

firm’s worth . Although goodwill is high, its appears to be credible and not overstated.

Firms will often impair goodwill to overstate their assets. A red flag that does arise

comes in methods of the firm’s “participation” fees which are recorded as a long-lived

intangible asset. The manipulation of the amortization of this intangible asset, the

forecasted sales revenue, and the expected life of the project allows managers to

“massage” the revenue process and allows significant flexibility in future reporting.

Thus, Barnes Group go beyond the SEC’s minimum GAAP standards. While a

few disclosure issues do present themselves (valuing RSP contracts), an investor can

feel assured they are gaining a quality understanding of the firm’s financial situation.

Currency financial data, which is particularly important to global companies such as

Barnes Group, can be easily obtained in the 10K. That being said, we would like Barnes

Group to address some of their unclear disclosing practices.

Financial Analysis, Forecasting Financials, and Cost of Capital Estimations

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By formulating ratios from information provide in a firm’s 10K reports, we may

gain a better understanding of the firm’s financial position. Specifically, a good grasp

on the firm’s liquidity and profitability may be gained. Capital structure especially

can have a large impact on profit. Once we gain an understanding of these ratios, we

can forecast out future financial statement data. Additionally, with this financial

information we can calculate our WACC, or weighted average cost of capital. Those

who make decisions for a company often look to WACC to decide if a new project is

feasible. To be worthwhile, the return on a project must be higher than WACC.

Otherwise the firm will not be able to meet its obligations to bondholders and

shareholders.

Financial Ratios for Barnes Group reveal several alarming trends. From 2003-

2007 the company has remained well below the industry average in terms of liquidity.

These could be detrimental in a scenario in which a large debt obligations must be

quickly met. One explanation for this is the firm’s poor pursuit of their credit sales.

In comparison to similar firms, Barnes does not collect on payments as efficiently.

However, it should be noticed (as several ratios indicate) that Barnes Group slowly is

making process in managing their inventories which indicates they adequately sell the

products they manufacture in a relatively short time span.

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Business and Industry Analysis

Business Overview

Barnes group Inc. is a highly productive and successful corporation founded in

the year 1857 by Wallace Barnes in Bristol Connecticut. Barnes Group Inc has an

extensive background of creating innovative and technological developments in

Aerospace, manufacturing, and distribution. What began as a mere local metal parts

shop in Bristol, Connecticut, has progressed to become a primary leader in

manufacturing and engineering precision metal components. Barnes group also strives

as an industrial distributor of a wide range of maintenance, repair, operating and

production supplies.

Barnes Group is segmented into three main business categories, two of which

are primarily intertwined in productivity: the Distribution division, and the

Industrial/Aerospace Division. These segments have more than 6,500 employees, and

are branched out to more the than 65 different locations around the globe. With these

competitive forces in their favor, Barnes Group Inc. was one of the leading producers in

each of its industries.

The Barnes Aerospace Division is the more recent division, which specializes in

precision engineered components for original equipment manufacturer (OEM) turbines.

OEM accounts for 67% of this segment. The corporation also provides jet engine

component overhaul and repairs services for a large portion of the world’s military

applications and commercial airlines. These are considered aftermarket products and


account for 33% of the aerospace segment. Although Barnes’s aerospace division

accounts for only 29% of the firm’s total revenue, the segment produces 45% of the

firms total profit. The products and services accounted for $91.2 million in net sales in

2007, and have increased to $112.3 million in net sales in 2008. Barnes Group’s

Aerospace division includes a variety of core competencies. The High Temperature

Alloy dept. specializes in precision machining, numerous types of gear designs, and

advanced fabrications. The Engineering sector identifies new product introduction,

concurrent design, and cost reduction.

The Barnes Industrial Division is an industrial components manufacturer of a

large range of highly integrated set of engineered products for an assorted customer

base. These custom solutions include precision forming, nitrogen gas based products,

retention rings, engineered stampings and springs, injected molded plastic-on-metal

components, and custom assemblies (Barnes group inc.) These products are designed

to gather all customer necessities in applications including general industrial, medical

devices, consumer home products, and transportation. This segment accounts for 35%

of the revenue and 41% of the profit of the firm. The Industrial division accounts for 130

million dollars in net sales in 2007 and has increased 135.6 million in net sales for the

2008 year, making their industrial division one of the top industrial manufacturers

worldwide.

The Distribution Division of Barnes Group is a full service distributor of repair,

maintenance, and production supplies. There are acknowledged as a market leader in

the vendor-managed inventory throughout parts of Europe and North America. The

industry provides an assortment of high-volume class-c distribution replacement parts.


These class-c parts are essentially less than 25 dollars per item and make up 50% of

the firms distribution. Also, this division consists of 30% of medium volume, class-b

parts. These products range from 25 dollars to 200 dollars per item. Lastly, 20% of

Barnes distribution is involved in low volume, class-a products. Class-a items price

above 200 dollars an item. With nearly 2,000 sales employees, the distribution segment

of Barnes Group Inc. is seemingly set to increase higher and higher in productivity. This

segment accounts for 36% of the firm’s revenue. Sales accounted for approximately

139.8 million dollars in 2007, and have undoubtedly increased to 141 million for 2008.

Although distribution accounts for a large amount of the firms sales, it only produces

14% of the firm’s profit. This flexible service approach makes the Barnes Distribution

segment the optimum provider for maintenance, repair, operating and production

(MROP) needs.

Industry Overview

The precision industrial manufacturing, aerospace and industrial distribution

industries have changed dramatically over the last decade as a result in advances in

computer and information technology. As a result, the activities that drive value for a

competitive firm are more complex and require greater consideration of customer needs

than ever before. As cost reduction and consolidation impacted the industrial distribution

industry, firms evaluated ways to drive value for their customers by assuming core

business activities taking what was once an adversarial relationship and transforming it

into a collaborative one.


Industrial distribution firms are now expected to develop and manage inventory

systems and schedules that work within a framework defined by their customers. They

must act as business partners, not just affiliated businesses. The integration of

enterprise resource planning systems has enabled customers to search for the best

possible price among distributors, driving their profit margins lower, while

simultaneously integrating distributors and allowing them to fulfill additional functions

and add value where they once were not present, creating an entirely new business

model. This new symbiotic relationship has defined the recent history of the industrial

distribution industry while allowing customers to focus on what drives value for their

particular firm.

In the precision industrial manufacturing industries as well as the aerospace

industries, computer aided design and advanced modeling algorithms have enabled all

firms to innovate their manufacturing process to obtain a competitive advantage beyond

simple economies of scale. The commoditization of software tools like computer aided

design software (CAD) have shaken the large firms in the industry by allowing smaller

firms to incorporate complex and extensive design functions while also designing

complementary manufacturing processes. No longer do the largest firms have a

monopoly on creative talent simply because they have the resources to foster it.

In conclusion, the extensive uses of information technology and computer

software has allowed businesses to open their doors enabling their suppliers to be

partners while emphasizing innovation as the core competency that drives value in any

firm. As always, the firms which show the most dynamic ability to welcome these forces


of creativity will be the ones who develop competitive advantages and define the

business environment to come.

Five Forces Model

Firm members of any industry seek profit; this simple fact sits at the core

foundation of business. The five-forces model offers a dynamic approach to analyzing

an industry’s market structure. Such data aids in recognizing industry classification and

identifying key firm profitability factors. Who, what, and how are all topics evaluated and

answered by the model. The five-forces model can be separated into two parts:

actual/potential competition and the bargaining power of buyers/sellers. Competition

may be further divided into three categories which include rivalry among existing firms,

threat of new entrants, and threat of substitute products. Each of these three categories

presents its own unique challenges to a firm. They essentially dictate the level of

competition in a given industry and affect how a firm may price its products. A firm who

maintains a high degree of competition with existing firms must be price conscious.

Furthermore, the higher the threat of new industry entrants and substitute products the

more competitive prices and margins must be. Substitute products are sometimes

unexpected and adverse effects on firm profit. As mentioned previous, the rest of the

model deals with bargaining power. A perfect firm would hold power over both suppliers

and customers; however, such a scenario fails to exist due to market competition. Two

aspects compromise bargaining power. They are price sensitivity and relative

bargaining power. Price sensitivity stems from a customer’s window of cost at which

they are willing to purchase a product. Narrowly missing a customer’s maximum price


expectancy can spell bad news for a firm. Relative bargaining power associates the

buyer’s ability to dictate costs. Suppliers lose bargaining power as more firms enter the

industry and offer buyers alternate means of acquiring a product. Seller’s meanwhile,

may build on relationships and innovation to distinguish themselves from competitors.

A conclusion from the five-forces model places an industry’s competition level among

three possibilities: high competition (cost competitive), mixed competition (elements of

both and high and low competition) and low competition (specialization). Thus, the

model measures the factors contributing to an industry’s or individual firm’s profitability.

Barnes Aerospace/Industrial Competitive Force Degree of Competition Rivalry Among Existing Firms High Threat of New Entrants High Threat of Substitute Products Low Bargaining Power of Customers Low Bargaining Power of Suppliers High

Barnes Distribution Competitive Force Degree of Competition Rivalry Among Existing Firms High Threat of New Entrants High Threat of Substitute Products High Bargaining Power of Customers High Bargaining Power of Suppliers Low

Rivalry Among Existing Firms

Within any industry, there exist only a finite amount of consumer expenditures.

With this in mind, firms must compete against one another in order to enjoy profit. Price


as well as product differentiation serve as the two main sources to drive firm

competition.

Distribution (low value):

Within the industry of maintenance, repair, operations and process distribution,

competition is very intense. The vast majority of products offered through Barnes

Distribution are sold by direct competitors, necessitating low product differentiation and

high competition on cost. The ability for Barnes to compete on non-price dimensions will

depend on the success of their customer services which reduce procurement costs,

such as their Vendor Managed Inventory System (VMI). Vendor Managed Inventory

systems are a product of increased input costs causing many companies to strive for

improved efficiency. A successful VMI system depends largely on cooperation and

shared risk between the suppliers (distributors) and the customers. Many firms within

the distribution industry record sales and receive payment when a product is used, not

when it is restocked.

Aerospace and Industrial (high value):

According to the Aerospace Industries Association, the sales growth of airplanes

has been rising steadily since 2003 at around 8% per year. Also the Industrial industry

has revealed growth in the need for precision industrial components. Precision

industrial components have been rising in tandem with the related products they

complement. Due to the broad nature of the products under the umbrella precision

industrial manufacturing, one can expect the demand for the industry to track durable

goods orders.


Durable goods orders roughly track the patterns of investment spending by

businesses, and since a large segment of our industry is designing valves for chemical

and petroleum processing, the costs of the related commodities would be an additional

factor affecting current and potential industry growth.

The increases in fuel prices as well as the need for more complex pipeline and

refining production have spurred an increased need for precision manufactured

industrial components. Similarly, increases in raw material costs, namely mined

resources, undoubtedly increases the amount of investment spending justified to bring

these raw materials to market.

Concentration

The number and relatives sizes of the firms in an industry dictate the industry’s

concentration. Concentration charts provide us a good picture of a firm’s market share.

Having a higher concentration ratio allows a large firm to more actively dictate the price

movements of products, while firms with low ratios must follow the lead of their

competition. Being able to set the market’s prices for products allows a firm to focus on

other aspects of their business while the smaller companies are kept busy trying to

compete on prices. Highly concentrated markets are harder to enter into, sometimes as

a result of big firm collaboration. On the other hand, fragmented industries can’t afford

to overprice products. In an industry composed of many small market share companies,

cost-price strategies play a prominent role in competition which in turn lead to lower

profits for everyone.



The number of Firms in an industry and their relative sizes influence the potential

and overall profitability of the industry as a whole. Within the Distribution of industrial

goods industry, there are many firms offering non-unique products and vary widely in

size. Each distributor is rather large in size, facilitating discounts on large purchases,

but aims to offer a special appeal to a specific type of firm while remaining applicable to

most firms in general. Some firms specialize in an inexpensive cost-structure of product

offerings, while other firms pride themselves on the number of products they sell. In

addition, some distribution companies market themselves as an “alternative to industrial

distributors,” facilitating a more personal relationship with customers. In order to

differentiate their sources of value, many distributors attempt to share the risk of

inventory storage and accumulation by in effect “storing” the goods at the end-users

location. By engaging in a shared risk type relationship, the distributor hope to offer the

customer increased service while increasing the switching costs associated with using

another distributor.


Concentration in the aerospace industry is relatively high. However, firms like

Barnes and specialize in manufacturing and repairing turbine engine components and

applications of “original equipment manufacturers (OEM’s)” and the military (Barnes

10k). This “job-shop” nature dictates less of a need for economies of scale in the

aerospace industry. In the industrial manufacturing industry, concentration is more

direct, or head-to-head due to the higher demand for general application products.


Degree of differentiation and Switching Costs

A firm may gain advantage over their competition through differentiation.

Differentiation refers to the likeness correlation between competing firms’ products.

Without differentiation, firms would have to compete on price alone. For example, two

products that are similar in appearance, how they conduct, and what they produce

would be classified as having a low level of differentiation between one another. The

higher the level of differentiation, the fewer firms must focus on price as a means of

competition. Therefore, differentiation can have a major impact on a firm’s profitability.

Appearance, features, quality, and build materials are all factors which may differentiate

a product

Switching costs can be observed from two different viewpoints, one of the

company and one of the consumers. The costs of a firm to discontinue its company

direction and begin to compete in a different industry are its switching costs. Low

switching costs would indicate a firm could use its resources to produce in another

industry at a relatively low expenditure, while high switching cost make it much harder

for firms to leave an industry. Switching industries could destroy a firm with high

switching costs. However, high switching cost industries do have one advantage for

established companies; they don’t have to constantly engage in price wars with

competing firms. Consequently, low switching costs allow firms to enter and leave the

industry as they please with little penalty for doing so. Switching costs for the consumer

relates to the affinity of customers switching from one firm to another in a given industry.

Low switching costs mean consumers will more readily be willing to change to a

competing product. In this case, firms will be more prices competitive



In past decade, the emergence of more usable, cheaper and efficient inventory

tracking systems and information technology has initiated retailers to push the activity of

procurement to the distributor itself. This is done by utilizing a Vendor Managed

Inventory system or VMI. In one scenario, the retailer will use an Electronic Data

Interchange (EDI) to signal to the distributor that inventory is in need or restocking.

Carefully balancing the incentives of the distributor with the needs of the firm are

essential in creating such a symbiotic relationship. As stated previously, the distributor

often offers the retailer repurchasing agreements in the event the inventory is

overstocked, or offers an option not to pay for the inventory until it is sold.

These relationships dissuade customers from looking elsewhere because the

procurement process is associated with the distributor. Simply put, the purchasing

decision is really on which distributor to use, not which product to buy from which

distributor. Achieving sustainable customer relationships in which each party commits

resources and shares risk increase the switching costs within the industry. The amount

of differentiation on the basis of activities being assumed by the distributor will only

serve to increase the switching costs associated with different distributors and drive the

purchasing decision further up corporate ladder.

Within the industry, this type of differentiation is the only non-price dimension of

their service. Many of the products sold by distributors can be found elsewhere and

there are multiple brands of exactly the same product. In order to establish a

competitive advantage, distributors must find an appeal beyond product scope.



In the precision manufacturing industry as well as the aerospace industry, the

importance for firm differentiation, and associated switching costs, depend on the

application of the associated components. For instance, in designing red valves and

compression springs, firms tend not to differentiate much on design and tend to

specialize in different processes and capacity. However, in the business of taking a

design from concept to manufacturing, fewer firms compete on heavily research-

dependent, full service manufacturers. In this scenario, firms vary widely on the service

they can offer customers and the value they add.

Customers of industrial component manufactures primarily consist of durable

goods manufactures for industries such as transportation and farm equipment.

Routinely, industrial component manufactures work directly with these customers to

customize a solution to their specific needs and incorporate their competencies into the

project of their customer (Barnes 10-k). Since these firms service the various needs of

their customers, niche specializations are needed of industrial firms to set them apart.

This distinction increases the associated switching costs because certain firms are more

able to cater to the customers than others making direct comparisons of competitors

difficult. Switching from one type of supplier to another that has different competencies,

capacities and priorities is not conducive to this high-value added industry. Therefore,

differentiation exists and switching costs are moderate.


Economies of Scale

Quickly glancing over a review of Fortune 500 companies proves a company’s

size often positively correlates with its success. In most industries, large profits result

from large operations. The longer a firm resides in an industry, the more it learns the

nuances of the business. Assuming it grows as it endures these experience, the firm

gains an advantage of new entrants to the industry. Firms in high R&D industries

understand how to finance such costs while remembering it is imperative keep up with

the technology and advances of the industry. Those firms who are new to the industry

may not have the knowledge nor financial capabilities to fund such operations.


The distribution industry in general is very imitable and therefore not a learning

industry. Although such extensive delivery operations require a logistical competency,

this is by no means an industry that precludes newcomers on the basis of learning the

best practices. Many distributors obtain distinction by having walk-in stores and others

are present on the internet or through call centers exclusively. Large economies of scale

are requisite to achieving low variable costs and competing on cost, however, this

presents the problem of overcapacity and high fixed costs that can bring this cyclical

industry down when economic growth is sluggish.


In our aerospace industry, economies of scale is not a high priority due to oem’s

and rsp’s. They allow Barnes Group to produce after-market precision component parts


that do not require large scale property plant, and equipment. As a result, Barnes Group

has only acquired one aerospace property since 1999.

Exit barriers

From time to time, firms make the decision to leave an industry. These decisions

are not without cost. The costs and regulations associate with leaving an industry are

known as exit barriers. Exit barriers may prevent a firm from exiting an industry.

Liquidation presents a huge obstacle for firms who offer specialized products. Often,

these products are hard to liquidate quickly. Losing fair value on these specialized

products as well as the extensive R&D into such product field deter firms from exiting an

industry


The exit barriers associated with the distribution industry and relatively low due to

the liquidity of the assets involved and the competitive price dimensions of the products.

The assets which are illiquid include the brand names/image, enduring customer

relationships and logistical frameworks however these are highly irrelevant in the event

of a firm exiting the industry as they have been proven inefficient to begin with. The

fixed assets include trucking operations, warehouses, administrative offices and real

estate. Although a few exceptions exist, distributors as a whole do not produce the

products they sell. In the event of a firm exiting the industry, there would relatively few

industrial machines that have very specific uses and therefore, hard to sell in a

secondary or used market.



Contrary to the distribution industry, exit barriers are high for both precision

industrial manufacturing and aerospace industries. These industries have “illiquid”

assets and their competencies aren’t easily transferable to alternative industries. As a

result, aerospace and industrials have more liberty in the selection of products that will

increase need, and therefore, be more able to change to the direction of the industry

than distribution companies. Furthermore, due to the specialization of products and

regulations implemented by both these high value industries, exiting these industries

could end up being costly.

Excess capacity

Excess capacity occurs when the supply of goods and services within an industry

is larger than the demand. To rid themselves of surplus goods, firms cut prices in

hopes that consumers will purchase more of the product. In periods of long surplus,

prices may dip to unexpectedly low prices. In order to prevent excess capacity, firms

must carefully monitor expected sales forecasts and inventory levels. By maintaining a

healthy infrastructure, they can then maximize profit on supply/demand opportunities


The distribution industry has high fixed costs, however, not high fixed costs

relative to sales. Due to the breadth/scope of product offerings, demand is dependent

on the state of the economy. When demand is low, there is competitive pressure to sell

products at discounts in order to utilize capacity. In a unique situation where commodity

and input prices are rising, either adding to or causing an economic downturn, the effect


on the industry can be two-fold. First, cutting prices when demand is decreasing is

destructive in its own; however, doing so when the cost of the goods being sold is rising

adds another painful dimension to the distributors. Therefore, one can expect the higher

the fixed costs such as phone-center style sales teams and brick-and-mortar retail

distribution, the higher the loss in the event of sluggish demand. Firms best poised to

“weather the storm” are the ones with low fixed costs and limited physical presence.


Excess capacity is more relevant to industrial manufacturing companies than to

the aerospace industry as a whole because of the similarity in the products designed

and the higher fixed to variable costs. However, both the aerospace and industrial

industries have high product life cycles due to the high costs of their customer’s

products. Within the Aerospace industry, excess capacity is more a product of aircraft

replacement cycles than economic expansions and contractions in general. Within the

business of aftermarket parts and overhaul services, backlogs are highly common.

Several companies have exclusive rights to provide aftermarket parts, overhaul and

repair services which enables them to vary turn-around rather than pricing in order to

manage demand.

Although aerospace companies have historically estimated these cycles with

high precision, significant events have caused unexpected drops in the demand for

aerospace components. The terrorist attacks of 2001 caused a severe drop in air-travel

as well as numerous cancellations of new aircraft orders.


Industry Growth

Industry growth rates allow us to market competition. In a high-growth market,

new consumers are readily available to firms who wish to advance their market share.

Firms must effectively entice these new consumers to try their product. Competition

among firms in this market is much less strenuous than one which has a slow or stale

growth rate. When industry growth rates are low, the only means of market share

growth is to take consumers away from competing firms. Aggressive pricing campaigns

often ensue in low growth rate markets


Determining the growth rate of an industry reveals the causation behind

increased profits, profit margins and market share. When industries are growing rapidly,

firms don’t have to take market share away from rivals in order to grow their profits. In

the case of the industrial supply industry, the growth is predictable and sustained. The

need for industrial, office and construction products closely monitor the growth of the

world economy. As new businesses emerge and populations increase, so does the

need for such products. Obtaining a large presence is considered an advantage,

however, firms within the industry can expect to grow their top line without having to

steal market share from rivals. Granted specialty distributors indeed do exist; many of

the products sold through the major distributors are very general and are not dependent

on one industry in particular.



Growth in the shipments of new civil and military aircraft has been consistently

increasing since the beginning of 2004. As well as increased orders, profits as a

percentage of sales, as of the third quarter of 2007, “increased slightly from 6.7

percent to 8.3 percent, which is slightly above the industry average for all

manufacturing corporations (AIA).” Consequently, demand for aerospace components

can be proxied through measuring the growth in the need for civilian travel as well as

the need for military aircraft. In 2005, the “Annual Review of Civil Aviation 2005”

reported that for the first time, scheduled airlines had transported in excess of two

billion passengers worldwide

(http://pdf.aiaa.org/preview/CDReadyMATIO07_1768/PV2007_7809.pdf).

Based on this survey by the Aerospace Industries Association, the average

growth rate of the industry was 5.19% over the last 10 years. It is important to note

the effect of the terrorist attacks of 9/11 (September 11th, 2001) on civilian air

travel, and commercial airlines and its effect on industry growth in the previously

mentioned time period. Even though profit margins have improved slightly in the

short term, prices have grown at an rate of only 1.32%

(www.bts.gov/.../html/air_travel_price_index.html)

since 1995.

Conclusion

We feel the growth in air-travel will directly contribute to the growth in

aerospace sales. Although it is generally thought that rapid sales growth directly

correlates to higher profit-margins, we believe profit margins will remain relatively


constant in the industry because of the stagnant prices of air-travel and the

consistent and estimable growth expected in the future.

18.57%

5.69%

-8.02%

5.95%

-8.08% -8.81%

8.63%

12.62%

7.48%

12.82%

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Aerospace Aircraft Industry Growth


Threats of New Entrants

Successful markets will always entertain new prospective firms. When an

industry is experiencing large profits, everyone wants a piece of the pie. The ability for

firms to enter new markets, however, is not always easy. Established firms in the

industry will often go to great lengths to aggressively price products so that new firms

can’t compete. Factors which must be contemplated include economies of scale, first

mover advantage, access to channels of distribution and relationships, and legal

barriers. Only after analyzing these factors should a firm makes decision on whether to

enter a market.

First mover advantage

History has shown that the first firms to enter a market enjoy a competitive

advantage over those who follow suit into the industry. This is known as the first mover

advantage. These firms get to set standards for the industry. They are able to build

close relationships with suppliers and acquire resources for production without having to

compete with other firms. When there are only a small limited number of suppliers and

resources, firms who have the first mover advantage possess and distinct advantage in

the industry. Patents and brand name prominence often result from the first move

advantage. Customer loyalty built during the initial industry phases can last a lifetime.

Today, many firms whose product quality levels have dipped still enjoy modest profit

due to name recognition.



First mover advantage can be best described as the advantage achieved by the

initial firms entering the business as they have the opportunity to establish best

practices and customer/supplier relationships. In the case of the distribution industry,

there are moderate advantages associated with this effect. First off, buyers who engage

in the Vendor Managed Inventory model and more likely to have higher switching costs

and be less likely to shift the important responsibility/activity of procurement to an

unproven partner. Mistakes in inventory delivery of critical components can cause

severe economic harm to the customers involved, so a trusting relationship with the

distributor is necessary for a successful firm. However, due to the non-specific and

existence of substitute products, it is difficult for firm to compete on non-price

dimensions. This opens the door for new entrants and erodes most any advantage

associated with the first movers in an industry.


The business of maintenance, overhaul and repair services for aircraft engines

has high first-mover advantage, while similar services for generalized components do

not. It is often the case that a single aerospace company will offer the support services

for an entire engine family through exclusive relationships with the engine

manufacturers. For Example, Barnes Group offers support for most every jet-turbine

engine General Electric produces. Similarly, Triumph Group offers support for various

Pratt & Whitney, Honeywell, and Garret engines.


Opposed to the engine overhaul services mentioned above, more generalized

components like engine casings, heat exchangers and air seals can be provided by a

variety of different firms, thus necessitating no first mover advantage.

We would characterize the first mover advantage as moderate for the aerospace

MRO industry as a whole.

Distribution access and relationships

As firms grow, their business becomes more complex in terms of managing daily

operations. Customers, suppliers, distributors and must all be consistently monitored.

Establishing close relationships with suppliers help keep product cost as low as possible

while continually upgrading distribution practices enhances the growth of a firm. These

relationships and expansionary methods directly influence a firm’s competitiveness in

an industry.


Limited or restricted access to mechanisms to get a product to the customer (not

distributor in the firm sense) can serve as severe barriers to entry. In the distribution (in

the firm sense) industry, there are very few barriers to entry in achieving access to

channels of distribution because of the intense competition in the trucking and

transportation industries and the ease of obtaining the assets to bring products to

market. However, in developing economies, multinational corporations routinely have

difficulty establishing a competitive position without partnering with an existing firm. Due


to the high amount of international sales to most large distributors, this could restrict

future competition.

The costs of delayed or failed delivery of products (inventory) can cause extreme

economic harm to the customer if the items are essential business items. This risk

places importance on the continued track-record of an existing firm or partner and

places significant pressure on firms to regularly deliver on their word. The reliability of

this continuing relationship is paramount to the success of any distribution firm.

Several firms within the industry actually create a portion of the products they sell in

hopes of achieving a brand name differentiation. This exclusive access to these

products creates barriers in the input side of the relationship and access aspect of the

business. Several large industrial distributors strive to obtain an exclusive agreement

with suppliers, or achieve exclusivity through outright acquisitions. If the products that

are exclusively offered through a single distributor are unique, significant barriers to

entry and exist for that niche of the industrial distribution industry.


Within the Aerospace MRO industry, access to channels of distribution is

moderately restrictive. Commercial airlines, Original Equipment Manufacturers and

independent service companies compete for hanger space while commercial airlines

often have their own service stations. In addition, the Federal Aviation Administration

requires repairers of engines to have a certified repair station. Achieving hangar space

near large air-traffic “hubs” is a significant barrier in gaining access to reparable aircraft.


Legal Barriers

Legal barriers may pose challenges to firms hoping to enter an industry. Patents, fees,

and regulations are all examples of legal ramifications for any given industry entrant.

Many of these documents request extensive background information. Examples of

legal documents include licenses, regulations, and contracts. The more legal barriers

there are the less likely start-up companies will venture into an industry.


Legal barriers can shield currently competing firms from potential competition in

the event of legal protections that ensure an inefficient market, or protections that

ensure intellectual property rights. There are few legal barriers to new entrants in the

industrial distribution industry that prove to be material. Interstate commerce and

taxation are a few that arise, however none of which are significant enough to dissuade

potential competitors. The availability of GSA contracts (General Services

Administration) is essential to obtaining U.S. Government clientele. Many large

distributors possess such a contract, however, emerging distributors do not, inhibiting

them from competing on future government purchases.


Several legal barriers preclude entrance into the aerospace MRO industry.

Obtaining FAA licenses for repair stations is timely and required for any repairer of


critical aircraft components (mostly turbine engines). In addition, some OEM

manufacturers require similar certification prior to repairing their products

Threat of Substitute Products

Substitute products are those that are viewed as alternatives to a given product.

They serve a similar purpose and may be interchanged buy purchasing customers.

Substitute products can cause consumers to use less of a good or to not purchase it all

due to having an alternative that is of a higher quality or offered at a lower price


Substitute products can take a variety of forms depending on the industry being

discussed and these forces work to decrease the profit margin of the affected firms. In

the distribution industry, the major threat of substitutes arises from forward integration

on behalf of the buyers and direct sales by the manufacturers of the products. The term

“disintermediation” is widely cited in trade publications as an inevitability that will negate

the activities of a distributor. The advances in information technologies have created

concerns about the future of the industry and the need to store large amounts of

inventory in anticipation of customers’ needs. Although much consolidation has taken

place within the industrial distribution industry, many see these developments as

constructive and a force that drives sales instead of suppresses them.

Due to the general and non-specific nature of many of the goods offered through

distribution businesses, the suppliers to the distributor lack the bargaining power to


make the customer come directly to them. In exception of large bulk orders, many firms

depend on industrial distributors to bring them input goods at the lowest costs. Some

distributors specialize in common parts sold in small amounts and others specialize in

higher value added goods. The differing appeals in both cost structure of product

offerings, and the accessibility albeit brick-and-mortar physical locations or online

presence only, characterize the needs of the many customers and the specialization of

the industrial distributor firms themselves.


The threat of substitute products in the aerospace industry comes primarily from

products that fulfill similar functions rather than similar forms. Substitutes to air-travel

include public transportation, railroads and automobile transportation. In addition,

several factors such as flight delays, increasing fees and tighter security contribute to

declines in the appeal of civilian air-travel. Corporations have been increasingly finding

ways to converse over long distances without a physical presence. Therefore, we would

say there are many substitutes available. The American Consumer Satisfaction Index

conducts a consumer sentiment survey over time of the airline industry as a whole.

Since 1995, the index has declined significantly and many critics attribute the decline to

the previously mentioned factors. Nevertheless, there exists no substitute for trans-

Atlantic flights, as well as no substitute that can achieve a lower travel time.

Another significant factor affecting substitute travel methods are oil prices.

Although all methods of transportation utilize oil as their primary fuel source, air-travel is


disproportionally affected by increases in oil prices. Airplanes are the least efficient form

of travel as far as usage of oil.

Bargaining Power of Customers


The relative bargaining power of the buyers in an industry influences the potential

profitability of the industry as a whole. If individual firms are easily imitable and their

competencies highly general, they most likely lack the power to bargain with their

suppliers. The firms in the distribution industry must be large enough achieve

economies of scale for their logistical needs and to obtain discounts on large purchases

of high volume items. Due to the large scope of product offerings, this characterization

is inherently limited.

In high value added goods such as hydraulics and specialty machines, suppliers

have significantly more power than in low value added goods such as fasteners and

abrasives. This is evident in the profit margins of the different firms within the industry,

as they tend to specialize in different goods.

The large number of industrial distributors and the lack of significant non-price

dimensions to compete on allow for many distributors of similar size, decreasing their

power to bargain with suppliers as a whole.



The bargaining power of customers is strong in the aerospace MRO industry.

“Original equipment manufacturers…have significant pricing leverage over suppliers

and may be able to achieve price reductions over time (Barnes 2007 10k).” There exist

a high number of aerospace firms that produce fabricated metal components. OEMs

have been recently using aggressive auction strategies to reduce the prices they pay to

their suppliers (Aerospace customers).

Several aircraft manufacturers, most notably Boeing, have been employing

virtual supplier portals. These online networks enable suppliers to bid against each

other for production contracts based upon the desired specifications, quantities and

deadlines. This environment puts significant emphasis on price and forces suppliers to

cut costs in order to compete.

Bargaining Power of Suppliers

Demand from customers largely dictates the bargaining power of a supplier. For instance,


As stated earlier, the relative bargaining power of an industry is paramount in

understanding the current and potential profitability of that industry. In the circumstance

of general, non-specific products such as abrasives, epoxies, fasteners, and cleaners,

the bargaining power tends to rest with the distributors as their large size and customer

relationships trump the need for that one brand of product. However, certain products


that are unique and require research and development as well as patent protection,

such as power-tools, cutting machines and hydraulics, tip the scales in the opposing

direction and enable the suppliers to better bargain with the distributors.

Aerospace and Industrial (high value)

The inputs required for metal fabrication in the aerospace industry are largely

commodities, and allow for little negotiation on price dimensions. Furthermore, the high-

grade steel, aluminum and titanium and other special metals used in aerospace

components are periodically offered through a “limited number of primary

suppliers.”(Barnes 10k, 2007) Suppliers of raw materials have significant leverage

because of the large number of buyers and the significance of the raw material to the

end product.

0

50

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Dec

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-02

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Inde

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Metal Index

2005 = 100

•Copper•Alluminum•Iron Ore•Tin •Nickle •Zinc•Lead•Uranium


Key Success Factors

The type of business strategy a firm takes is crucial when trying to add value to a

firm. The two types of strategies firms can undertake are cost leadership and

differentiation. In order for firms wanting to acquire a competitive edge in low value

industries, they must follow the cost leadership strategy. Also, for a firm to obtain a

competitive advantage over high value industries, they must follow the strategy of

differentiation. Although high value industries, such as aerospace and industrials, and

low value industries, such as distribution, follow their respective strategies, they tend to

use competitive advantages from both strategies.

56

58

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62

64

66

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1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

ACSI Airlines

ACSI Airlines

Linear (ACSI Airlines)


Cost Leadership

The products distributed in this low value industry are not unique, and its

competitors carry substantially similar products. Firms in this distribution industry must

stress a heavily priced competitive industry. In order to keep the price of products and

cost of distribution in this industry low, achieving superior performance is crucial to the

survival of the firm. Cost leadership might be the best way to achieve superior

performance for low value distribution firms. A few characteristics help to attain superior

performance are economies of scale and scope, tight cost control systems, and limited

investment in Research and Development. Although these characteristics are vital to

firms desiring to achieve superior performance in a low value distributing industry, some

of the cost leadership strategies are enforced by high value industries, such as

aerospace and industrial.

Economies of Scale and Efficient Production

It is important for firms in a low value distribution industry to become highly

efficient in order to mass distribute their products at low costs. Expansion is the

essential method for acquiring additional resources needed to distribute their products

at low costs. The low value distribution industry consists of Barnes competitors

Grainger, Alcoa and Fastenal. According to the table below, Barnes distribution

competitors realize the important of expansion. Alcoa spent close to seventeen billion

last year on PP&E (Alcoa 2007 10-k). Also, Barnes distribution has obtained 5

acquisitions since 1999. Furthermore, Barnes distribution operates in 40 countries


(Barnes 2007 10-k). There is also emphasis in the high value industrial industry.

Although all three of Barnes segments only accumulated 231 million in PP&E in 2007,

Barnes industrial segment has acquired 9 acquisitions since 1999 (Barnes 10-k).

However, Barnes has not expanded to the degree of most of its competitors in the

aerospace industry. Barnes aerospace has accounted for only 1 acquisition since 1999

Barnes 10-k). Since Barnes aerospace does a majority of business through revenue

sharing programs and OEMs, expansion is not essential for the aerospace division of

Barnes.

PP+E (millions)

Tight cost control systems: capability

Firms that achieve cost leadership must focus on tight cost controls. Wherever

feasible, firms must cut costs of distribution that are not critical to the firm’s core

competencies. This allows firms in the low value distribution industry to sustain an

advantage in a heavily price competitive industry. Since low value distribution firms

distribute in mass quantities, they yield high fixed to variable cost ratios. To help

suppress these high fixed costs, firms must attempt to expunge unnecessary costs.

Some unnecessary costs the distribution industry deals with are procurement and

2003 2004 2005 2006 2007 Barnes Group 154 166 157 210 231 Alcoa 12,557 12,592 13,163 14,813 16,879 Ladish 90 85 99 112 144 Triumph Group 249 234 237 294 324 Grainger 731 761 771 792 878 Fastenal Co. 170 193 224 264 277


transaction costs. Barnes VDI system helps to reduce these costs in a productive and

timeliness manner (Barnes 10-k). Other costs the distribution industry must diminish are

R&D and brand advertising. Firms in the distribution industry do not spend capital on

R&D because the products they distribute are similar and sold in high volumes.

However, Barnes has acquired brand names, such as Kent, Kar and Bowmans in order

to offer quality, brand name parts (Barnes 10-k).

Conclusion

Barnes distribution stresses a tight cost control system in order to keep fixed

costs down. Since Barnes distribution uses a vendor management inventory system

they can try to suppress unnecessary costs more efficiently. Expanding your business

is beneficial for distribution firms that use vendor management technology. However,

firms in the distribution industry all acquire superior brand names in order to supply their

customers with a higher quality product. This accumulates large, unnecessary costs.

Differentiation

The aerospace and industrial industries choose to enforce a differentiation

strategy. This strategy is more concerned with how to differentiate their products from

their competitors than acquiring low cost. Aerospace and industrial industries follow the

differentiation strategy for superior quality/variety and reliable customer service (Barnes

10-k). Although firms in the distribution industry compete on cost leadership, they also

use the differentiation strategy to provide reliable customer service. These key


performance indicators help firms in industrial and aerospace industries adjust to the

specific needs of their customers.

Superior quality

Superior quality is a key performance indicator for Barnes aerospace and

industrial industries. They produce components for OEMs and individual customer

needs. This commitment to quality ensures customers will maintain their relationship.

Superior Customer service

Superior customer service is a high priority for firms, like Barnes and Triumph, to

supply precision components for OEM’s. Contracts with these customers provide

overhaul and repair service on these precision engine components once completed

(Barnes + Triumph 10-k). Once they have finished producing their client’s products,

superior customer service will be critical in order to maintain “long standing customer

relationships.” The aerospace firms provide overhaul/ repair services on their precision

components as well (Barnes 10-k and Triumph 10-k). Without providing superior

customer service, aerospace firms that provide overhaul and repair services would have

a hard time finding potential customers. Furthermore, the industrial industry also

competes on superior customer service. They are similar to aerospace industry in that

they provide precision parts that fit a customer’s specifications (Barnes 10-k). High

costs of products in these aerospace and industrial industries make it hard to persuade


potential future customers to take a risk doing business with a precision component

supplier.

The distribution industry also relies on superior customer service. Since the

products in this industry are not unique, distributing firms provide automated systems to

assist customers in picking “reliable service options” (Barnes 2007 10-k and Grainger

10-k).

Conclusion

Aerospace, industrial and distribution industries all require superior customer

service because of the highly competitive nature of these industries. Aerospace and

industrial industries enforce it in order to offer unique and customized products. The

distribution industry requires it in order to improve productivity while reducing their

customers costs.

Firm Competitive Advantages

After exploring the high and low value industry success factors and analyzed the

firm’s competitive strategies, we have concluded that Barnes implements a cost

leadership strategy for the low value distribution industry. On the contrary, Barnes high

value aerospace and industrials tends to favor the differentiation strategy. However,

both high and low value industries use some of the tools of the opposing strategy.

Tight cost control systems


Barnes distribution industry relies heavily on tight cost control systems. The

vendor managed inventory system gives Barnes a competitive advantage because it

allows them to operate with a “well-diversified customer base” and wide variety of

replacement parts.(Barnes 10-k). Since the distribution industry is based in over forty

countries, the automated VMI system will help increase profitability of their customers

while cutting costs of production.

Superior customer service

Barnes aerospace industry has acquired a competitive advantage because they

provide revenue sharing programs with their OEM customer, General Electric. This

gives Barnes “exclusive rights to supply aftermarket parts for the life of the program”

(Barnes 10-k). These aftermarket parts require “overhaul and repair services.” Also,

since Barnes has rights for the life of the program, continuing to provide superior

customer service will allow Barnes to keep their exclusive manufacturing rights with

General Electric.

Accounting Analysis

Accounting analysis is applied in order to find out how accurately a firm’s

accounting practices “capture its underlying business reality.” (Palepu & Healy) A firm’s

accounting policies, estimates, and degree of accounting flexibility can lead to

distortions in a firms accounting statements. Accounting analysis attempts to identify

these distortions and then “undo” them by adjusting a firm’s accounting numbers using


cash flow and footnotes. This process can be divided into six steps. The first step of

accounting analysis is identifying a firm’s principal accounting policies. The second step

is to assess the level of a firm’s accounting flexibility used to choose different policies

and estimates. The third step is evaluating the accounting strategy used by the firm. In

the fourth step, an analyst must evaluate the quality of disclosure present in a firm’s

accounting statements. The fifth step is marking questionable accounting with a “red

flag” to indicate that the analyst needs to closely examine the item to make sure and

gather more information to make sure it is legitimate. The sixth and final step in the

accounting analysis process is “undoing” accounting distortions. Accounting analysis is

an important step in the business valuation process as a precursor to financial analysis.

Proper accounting analysis provides more accurate accounting data which is essential

for a valid assessment from financial analysis.

Key Accounting Policies

A firms key success factor, which add value to the firm, give the company a

advantage to make them appear more valuable to stockholders. The success factors

help the firm determine what kinds of accounting policies they will undertake. The types

of policies a firm exercise shows where distortion can potentially exist. The policies that

Barnes uses are: research and development, goodwill, currency, pension Liabilities, and

revenue sharing programs. GAAP allows limited flexibility in most accounting policies,

but does not emphasize constraint on disclosures. Therefore, it is crucial to evaluate


the firm’s success factors and accounting policies to uncover any distortions the firm

might have recorded.

Research and Development

Due to the uncertainty of revenues that R&D will produce, GAAP rules state that

R&D should be treated as an expense. The expensing of R&D causes expenses to be

overstated and net income to be understated. This will affect the balance sheet by

understating equity and assets. This affects some industries more than others. The

Low value distribution industry puts no emphasis on research and development

because they mass produce similar products instead of creating new product designs.

Conversely, High value industries, like aerospace, contain large amounts of R&D

expenses. According to Barnes and Triumph’s 10-ks, they both produce components

and assemblies for operating equipment manufacturers (OEM’s). Triumph invested

close to 10 billion dollars in R&D last year. However, Barnes aerospace did not account

for any R&D expenses for the last 5 years (Barnes 10-k). Barnes does not invest R&D

into aerospace because 64% of their aerospace business is through revenue sharing

programs with General Electric (Barnes 10-k). The reason Barnes revenue sharing

program with General Electric can still be successful without R&D is because they own

exclusive rights to supply GE with “designated aftermarket parts for the life of their

aircraft engine program” (Barnes 10-k). However, they have to pay GE “participation

fees” to continue supplying them with aftermarket parts (Barnes 10-k). More importantly,

Barnes states that the parts they manufacturer are “custom parts made to fit their

customer’s specifications.” (Barnes 10-k) Since Barnes does not have to compete on a


majority of its business or design new products, they do not call for R&D. Due to the

lack of R&D spending, Barnes expenses could appear lower compared to Triumph.

This will cause Barnes net income to appear larger and possibly more inviting to

investors.

On the other hand, The high value industrial manufacturing industry require

smaller amounts research and development expenses in order to remain competitive.

Barnes and Ladish, their industrial competitor, provide precision components that fit the

needs of their customers (Barnes 10-k, Ladish 10-k). Since it fits the needs of their

customers, they do not have to spend significant funds to develop new products. As the

chart below indicates, Barnes has spent 6 million dollars a year while their competitor

Ladish has account for no R&D expenses.

Industrial R&D yearly expenses

Although 6 million dollars a year is not a significant amount of funds, it is important

because it will cause Barnes expenses to be slightly higher than its competitor. When

R&D expenses are higher, it causes net income to appear lower. Consequently, a firm

with a lower net income can seem less favorable to investors. To deal with this problem,

R&D could be reported as an asset instead of an expense. Since there will be more

( In Millions) 2003 2004 2005 2006 2007

Barnes 5 6 6 6 6

Ladish 0 0 0 0 0


assets and less expenses, net income could seem slightly higher. This could make

Barnes appear more inviting to some investors. Although this seems inviting, since

GAAP requires all R&D to be expensed, they cannot be recorded as an asset.

Currency

Barnes Group, like most any international corporation, is exposed to a certain

amount of market risk concerning the fluctuating value of foreign currencies when

selling and operating in different countries. Barnes Group has distribution,

manufacturing, and sales facilities located overseas and the majority of these foreign

operations use the local currency as their functional currency. Barnes Group’s financial

statements are presented in U.S. denominated dollars so changes in exchange rates

between U.S. dollars and foreign currencies presents exposure to translation risk when

financial statements denominated in foreign currencies are translated to U.S. dollars.

Goodwill

Goodwill is defined as the difference in purchase price of an acquisition to the

fair-value of book assets. In the case of Barnes group, there is a significant amount of

goodwill (24.69%) and other intangible assets relative to total assets. The value of

goodwill is telling because it reveals the actual purchase price paid for a firm relative to

the firm’s book assets, and therefore, represents hidden, or intangible, benefits

associated with the acquired company. An opposing view of goodwill is that it is the

excess purchase price of an acquired company representing the premium the buyer

paid in the acquisition.


In 1999, Barnes Group Inc. named Greg Milzcik CEO and through his direction,

the company initiated an acquisition strategy to spur growth. As discussed in the

industry overview, there is trend of consolidation within the industrial distribution and

precision manufacturing industries. Barnes group sought to expand its geographical

presence by acquiring several firms in Europe as well as add product scope in its

distribution, industrial and aerospace units.

Acquired Company Pur. Date Country Purchase Price Description

Toolcom Supplies Aug-05 UK $13.4 million Distributes MRO Supplies

Kent Jul-06 UK/France $41 million Dist. Adhesives, Sealants etc.

Service Plus Distributors Aug-05 US $13.7 million Dist. Gas springs, dampers

Hänggi Mar-06 Switzerland $137.3 million Custom Micro-punching

Nitropush Nov-06 France Undisclosed Associated Spring

Spectrum Plastics Molding Apr-06 US $7.6 million Precision injection molder of plasti

Kratz-Wilde/Apex Manufacturing Aug-00 US $41 million Fabrication of aerospace compone

Seeger-Orbis GmbH& Co Jan-02 Germany $20 million Associated Spring

Kar Products Feb-03 US $78.5 million Distributes MRO Supplies

This strategy added significant amounts of goodwill to Barnes Group’s balance

sheet and posed the potential risk of impairing goodwill, thus decreasing net income.

(reference 10k). As mandated by GAAP, goodwill is tested annually or spontaneously if


significant events might affect goodwill. There exists significant pressure to not allow

earnings to reverse in any quarter, and to impair goodwill would cause an asset to be

written down and flow through the income statement. In addition, managers are

routinely compensated through stock options, and increasing earnings, even if it is done

artificially (inorganically), can lead to an agency problem.

It is difficult to examine whether or not these recent acquisitions have led to

synergies and cost-reductions along with changing Barnes Groups competitive position.

The complexity, scope and interdependency of the related business segments

(aerospace, industrial and distribution) makes it highly unlikely Barnes Group would

write down the amount of goodwill associated with that individual business. Simply put,

the discounted cash flow approach of valuing goodwill can be adjusted, and even

manipulated, to show the advantages their corporate and business strategy regardless

of what happens in any individual industry or market.


In 2002, GAAP prohibited companies from amitorizing goodwill because it

doesn’t share the characteristics of property, plant and equipment and other depreciable

assets. Therefore, companies are required to test for an impairment of goodwill by

analyzing significant events that might decrease the competitive advantage of the

acquired firm(s).

Pension Plans

An additional policy that firms must reflect on when making accounting choices is

determining costs associated with pension and benefit plans. Undoubtedly Firms decide

on which plan best suites there financial needs, as well as their employees. These

could include defined benefit or defined contribution plans. The primary difference

0 5 10 15 20 25

Barnes Group

W.W. Grainger

Ladish

AIT

Goodwill/Total Assets (%)

Source: Yahoo Finance


between these two plans is that a defined benefit plan is a plan in which the amount of

benefits paid to an employee after retirement is fixed in advance in accordance with a

formula given in the plan. Contribution plans are plans that distribute surplus by giving

to each policy the excess of premiums and interest earned over the expenses of

management, cost of insurance, and the policy value at the date of computation.

Barnes Group Inc. primarily has their plan based through the defined benefit plan.

These benefit pension plans are future financial obligations that Barnes Group must

document as liabilities. These liabilities are in present value of future payments owed to

the firms’ employees. The present values of these future expenses are calculated by

using discount rates estimated by Barnes Group and are subject to error.

Currency

Barnes Group, like most any international corporation, is exposed to a certain

amount of market risk concerning the fluctuating value of foreign currencies when

selling and operating in different countries. Barnes Group has distribution,

manufacturing, and sales facilities located overseas and the majority of these foreign

operations use the local currency as their functional currency. Barnes Group’s financial

statements are presented in U.S. denominated dollars so changes in exchange rates

between U.S. dollars and foreign currencies presents exposure to translation risk when

financial statements denominated in foreign currencies are translated to U.S. dollars.

According to Barnes Group’s 10-K issued February 25, 2008, “During 2007,

approximately 41% of (their) sales were from facilities outside of the United States.


Also, (they) have 12 manufacturing facilities and 23 distribution/sales centers outside

the United States and Canada.” This presents a variety of different risk factors, such as

foreign price and currency controls, exchange rate fluctuations, and limited ability to

transfer funds between countries due to tax consequences.

There are a variety of ways a corporation can address currency risk by investing

in derivative financial instruments such as “buying protective or offsetting positions and

hedges in certain currencies to reduce (their) exposure to currency exchange

fluctuations.” However, even when measures are taken to offset the risk of foreign

currency fluctuations, there is no assurance that these measures will be adequate or

effective to protect (them) from the exposure for which they are purchased.” [Barnes

Group 2007 10-K] Also, according to Barnes’s 2007 10-K, “The Company does not

hedge its foreign currency net investment exposures except for its investment in Barnes

Group Canada Corp. In 2007, the Company entered into a series of forward currency

contracts to hedge a portion of its foreign currency net investment exposure in Barnes

Group Canada Corp for the purpose of mitigating exposure to foreign currency volatility

on its future return on capital.” [Barnes 2007 10-K]

Revenue Sharing Programs

A significant amount (64%) of Bares Aerospace Sales is attributed to repairing,

overhauling and creating aftermarket parts for various General Electric jet engine

families. As consideration to be the exclusive provider of such products/services,

Barnes group pays “participation fees” which are recorded as long-lived intangible


assets. This intangible asset acts as a reduction to sales over the life of the engine

program. Therefore, there is significant discretion in determining the amount

“participation fees” to be reduced from overall sales of that group. Inside the companies

10k, they explicitly describe the potential risk of impairing this intangible asset. Needless

to say, the manipulation of the amoritization of this intangible asset, the forcasted sales

revenue, and the expected life of the project allows managers to “massage” the revenue

process and allows significant flexibility in future reporting. For these reasons, we would

signal severe risks to a potential valuation analyst.

Flexibility in Accounting

GAAP allows firms some flexibility when recording financial statements. This is

intended to give firms the chance to reveal their financial information in a more useful

way. Unfortunately, this allows firms to distort the information to make it more inviting to

investors. The following section helps recognize the amount of flexibility the firm uses

for each key accounting policy.


The accounting policies for Research and development have no flexibility. GAAP

states that R&D must be expensed at the time it occurs. This is essential because when

a firm expenses R&D, the company is not obtaining revenue from these operations. To

address this setback firms can capitalize the knowledge achieved from R&D as

intangible assets once recognized. However, it is impossible to predict the amount of

R&D projects will actually benefit the firm. If Barnes industrial sector reported failed

R&D projects as assets, then expenses would be slightly understated and assets would


be slightly overstated on the firm’s balance sheet. Although recording R&D as an asset

has benefits and dilemmas, GAAP will not allow firms to record R&D in this manner.

Currency

According to GAAP’s SFAS No. 133, “Accounting for Derivative Instruments and

Hedging Activities,” it is required that all derivative instruments be recorded on the

balance sheet at fair market value. Due to the increasing value of “market risk sensitive

instruments,” the SEC has issued amendments that “require increased disclosure of

accounting policies for derivative financial instruments and derivative commodity

instruments in the footnotes to the financial statements.” Also, “the amendments

expand existing disclosure requirements to include quantitative and qualitative

information about market risk inherent in market risk sensitive instruments.”

[http://www.sec.gov/rules/final/33-7386.txt] The close monitoring of these operations

defined collectively as “market risk sensitive instruments” by the SEC leaves little room

for policies concerning matters of accounting flexibility that could present significant

instances of accounting distortion in Barnes’s financial statements. Items 305(a) and

9A(a) of FSAB’s FAS No. 119 "Disclosures about Derivative Financial Instruments and

Fair Value of Financial Instruments" require that companies disclose quantitative

information concerning derivative instruments using one or more of three alternatives.

These alternative include: (1) “Tabular presentation of fair value information and

contract terms relevant to determining future cash flows, categorized by expected

maturity dates;” (2) “Sensitivity analysis expressing the potential loss in future earnings,

fair values, or cash flows from selected hypothetical changes in market rates and

prices;” (3) “Value at risk disclosures expressing the potential loss in future earnings,


fair values, or cash flows from market movements over a selected period of time and

with a selected likelihood of occurrence.” [FAS No. 119 Items 305(a) and 9A(a)]

Companies must apply these criteria to each category of market risk exposure but may

choose to use different alternatives for each of the different categories.

Goodwill

Managers have significant flexibility in their discretion in impairing goodwill. In

2002, GAAP mandated that the amortization of goodwill is no longer acceptable and

required firms to undergo impairment testing to determine if the goodwill on their books

had been adversely affected by external events.

In general, estimating the fair value of goodwill is problematic for a variety of

reasons. First off, classic accounting asserts that there are no plugs in accounting.

However, the nature of acquisitions and the structure of equity in a firm can drastically

change the purchase price of the target firm. Many other impediments exist, but the

useful conclusion is that there is a discrepancy in describing goodwill in terms of

discounted future cash flows. For these reasons, GAAP does not explicitly endorse any

one model for estimating impairments in goodwill.

Pension Plans

The discount rate is an estimation used to discount future payments to the

present value. For example, a rise in the firms’ discount rate would lead to a decrease

in these payments, which in conclusion, would alter the firms’ net income. With this in

mind, the discount rate is ultimately the major resource in providing companies with

their future outcomes. Barnes group, as well as its entrants, does an exceptional job of


concealing how they obtain information to produce these discount rates and expected

returns when determining the present value of these future expenses. The following

chart displays the discount rate used by Barnes Group Inc. and its competitors within

the industry.

The table below indicates that Barnes Group appears to strictly follow industry

averages when determining the appropriate discount rate for pension and benefit plan

assets. It is essential to point out that the industry is presently experiencing a reverse

trend in their discounts rates. A probable reason could be the added need for

conventional accounting that yields less aggressive estimates, which ultimately alters

the effect of these rates. Nevertheless, these companies share similar alterations in

rates throughout the same span of time as one another. This can result from many

different changes with economical issues, rise and fall of supply and demand and even

the threat of new entrants within the market. Barnes Group briefly explains that

projections are updated annually with respect to the corporation’s assets, historical

returns, and the current economic environment.

Revenue sharing programs

Pension Plan discount Rates

2003 2004 2005 2006 2007

Barnes Group Inc. 6.75% 6.25% 5.48% 5.75% 6.22%

W.W. Grainger 6.5% 6% 5.75% 5.5% 5.36%

Fastenal 7.3% 5.6% 5.42% 5.48% 6%

Lawson Products 4.5% 3.7% 3.6% 3.49% 3.05%


The rules that apply to property, plant and equipment also apply to the

amortization of limited-life intangible assets. A company is expected to perform a

“recoverability test” in order to determine the future cash flows associated with the

intangible asset. In the case of Barnes group, the company performs annual impairment

testing in order to determine if the sum of the expected future net cash flows

(undiscounted) is less than the carrying amount of the asset. This allows significant

flexibility in writing down, or impairing, intangible assets.

Although the “participation fees” are characterized as “long-lived” intangible

assets, they are nonetheless limited-life intangibles. The 2007 annual report states the

potential life of these revenue sharing programs are “up to 30 years.” Forecasting future

revenue over such a long period of time is inherently problematic because of the

assumptions involved in the recoverability test of future cash flows. Therefore, potential

impairments may exist in the future, allowing near-term earnings to be

uncharacteristically high.

Evaluate Actual Accounting Strategy

The actual account strategy help determine between the two types of disclosures a firm

will undertake. High disclosure goes beyond the standards of GAAP. However, low

disclosure does the minimum amount that GAAP requires and is prone misrepresenting

the value of the firm.



Research and development is stressed differently in each of Barnes three

industries. There is no emphasis in the low value distribution industry, and small

amounts in the high value industrial and aerospace industries. Since R&D is recorded

as an expense aerospace industry, it is difficult to verify the value of firm. Also,

expensing large amounts of R&D might cause firms in this industry to start concealing

other expenses. Since Barnes does not invest funds into R&D in their aerospace sector,

it is easier to validate its worth and avoid concealing other expenses. Also, since Barnes

industrial only spends six million dollars a year on R&D, it is not probable that the value

of this industry is heavily distorted.

Conclusion

It is clear that analyst don’t have to worry about Barnes distribution and

aerospace industries distorting R&D because they have not accumulated any expenses.

Furthermore, due to the low amounts of R&D expenses, it appears Barnes does not try

to hide any of the research and development spending in industrial sector.

Currency

According to Barnes Group’s 2007 10-K, “The Company uses financial

instruments to hedge its exposure to fluctuations in interest rates, foreign currency

exchange rates and to hedge its foreign currency net investment exposure, but does not

use derivatives for speculative or trading purposes or to manage commodity exposures.

Fluctuations in the market value of derivatives that hedge net investment in foreign

operations are recorded as “foreign currency translation” under “accumulated other non-


owner changes to equity.” Barnes states, “The Company’s policy for classifying cash

flows from derivatives is to report the cash flows consistent with the underlying hedged

item.” [Barnes Group 2007 10-K] For accounting policy related to foreign currency

translation related to international operations, Barnes’s Group states: “Assets and

liabilities of international operations are translated at year-end rates of exchange;

revenues and expenses are translated at average annual rates of exchange. The

resulting translation gains or losses are reflected in accumulated other non-owner

changes to equity within stockholders’ equity.” For the section outlining Quantitative

and Qualitative Disclosures About Market Risk in Barnes 2007 10-K, Barnes satisfies

the second alternative expressed in Items 305(a) and 9A(a) of FSAB’s FAS No. 119

which requires “Sensitivity analysis expressing the potential loss in future earnings, fair

values, or cash flows from selected hypothetical changes in market rates and price.”

According to Barnes, “The currencies of the locations where the Company’s business

operations are conducted include the U.S. dollar, Brazilian real, British point sterling,

Canadian dollar, Chinese yuan, Euro, Korean won, Mexican peso, Singapore dollar,

Swedish krona, Swiss franc and Thai baht. The Company is exposed primarily to

financial instruments denominated in currencies other than the functional currency at its

international locations. A 10% adverse change in all currencies at December 31, 2007

would have resulted in a $.2 million loss in the fair value of those financial instruments.”

[Barnes Group 2007 10-K] The derivative instruments that are encompassed by this

forward looking statement include forward currency contracts to protect from changes in

foreign exchange rates. Concerning hedging of risk attributed to foreign currency net

investment, Barnes Group does not use hedging excerpt for its investment in Barnes


Group Canada Corp. [Barnes 2007 10-K] According to Barnes Group, corporate policy

requires that transaction exposure and foreign currency commitments be managed by

individual operating units in order to obtain “acceptable levels of foreign currency

exposures.”

Goodwill

Barnes Group utilizes the discounted cash flow approach in estimating

impairments in goodwill. Specifically, the company references “changes in the global

economy and local economies, industries and markets in which the Company sells

products or services, and the execution of management’s plans, particularly with

respect to integrating acquired companies” as potential events that would initiate

impairments to goodwill.

Foreign Currency Translation: Gain or (Loss) (in 000s)

Year 2003 2004 2005 2006 2007

Gain/Loss (654) (695) (243) (295) 96

Fair Value of Derivates: Net Asset or (Liability) (in 000s)

Year 2003 2004 2005 2006 2007

Gain/Loss 109 (742) (3316) 195 (9106)


Revenue sharing programs

There exists a large degree of discretion in determining future cash flows

associated with the Revenue Sharing Programs. Therefore, Barnes has low disclosure

when recording RSP’s. Management must estimate the life of the related engine

families and the demand for aftermarket products and maintenance/repair services.

Additionally, jet engine life-spans are quite long, and estimating the rate of amortization,

or depreciation, of these exclusive arrangements can last “up to thirty years.”

Assessing the accuracy of managements forecasting of future revenues is

particularly problematic because of the required industry expertise and the knowledge of

the exclusive arrangements themselves. Therefore, the attention in evaluating the

degree of conservatism or aggression in accounting strategy, lies in the amortization of

the intangible asset, not the value itself.

Barnes group is somewhat clandestine when it comes to describing the potential

value of these contracts. The company has discussed which engine families are

involved, but has failed to provide reasoning as to how they expect to recover and

create value from these “participation fees.” It is also unclear whether Barnes group

would impair the intangible asset in response to innovations and new jet engines

entering the market. Although their agreements relate to the large numbers of “wide-

body” aircraft, principally the Boeing 737 and Airbus A320, it is unclear whether the

company would be aggressive or conservative in impairing these contractual rights as

new engines, regulations and input costs affect the market. Barnes Group chose not to

write down any of these intangibles in the years 2005, 2006 and 2007.


This presents several scenarios of interest to a valuation analyst. Surely, the

current balance of the “participation fees” will be completely depreciated within a thirty

year period. However, if the company recognizes an impairment due to changes in

market conditions (which we find unlikely) then net income will surely be impacted. In

addition, management cites comparing actual revenue with projected revenue in

determining the lives of these intangibles. Therefore, results in the near term may be on

the optimistic side, not recognizing impairment losses or amoritizing the value of the

contract over too long a period, adversely affecting future revenues unassociated with

the current project.

Disclosures

According to GAAP, the amount of information disclosed in a company’s financial

statements is left up to the firm to decide. Unfortunately the firm has the option to

disclose a minimum amount and it can become tough to find the true value of the

company. Estimating a firm’s disclosure can help do two things. It can help find the

true value of the firm and help locate any potential red flags.


It has been determined that R&D expenses are not very flexible. However, the

types of items that are declared as R&D expenses determine the small amount of

flexibility a firm will have. Barnes industrials break R&D expenses into design,

development, prototype work and testing of new products (Barnes 10-k). Although

Barnes lists several R&D items for their industrial sector, the firm does not disclose the


amount each item contributes to the research and development expense. This could be

due to the overall small amounts of R&D costs the firm spends.

Currency

Barnes Group provides an adequate amount of information in their 10-K to

adhere to the requirements mandated by the SEC concerning disclosure of accounting

policies that relate to derivative financial instruments and the disclosure of quantitative

and qualitative information about the market risk inherent to derivatives and related

financial instruments. Information concerning the value of derivates and foreign

currency translation and Barnes’s policies relating to these operations seem to be

clearly stated in their 10-K. Their disclosure of accounting policies and operations

related to foreign currency management seem to be sufficient and have no qualities that

would lead one to suspect the presence of possible distortion or manipulation of

accounting numbers.

Goodwill

Barnes group is very descriptive in presenting events that would materially affect

the balance of goodwill. That being said, the company has failed to impair goodwill in its

recent history, causing significant doubt in managements’ willingness to impair goodwill.

This uncertainty of future impairments is significant enough do describe on the

companies 10k, further complicating the role of a valuation analyst.

We would like Barnes group to go beyond the anecdotal explanations of potential

impairments to goodwill, and discuss specifically quantitative measures that would lead

to write downs of this intangible asset.


Pension Plans

The companies accumulated benefit obligation for all of its defined benefit plans

was $367,038 in 2007. In 2006, these obligations accumulated to $361,968, which

illustrates the development of the company in terms of setting the appropriate amount of

cash flows aside to assure a sturdy benefit plan for their employees. For most, this is

essential in terms of importance to their employees, as well as the importance of the

company itself with balancing cash flows, good will, etc.

Revenue Sharing Programs

In determining the accuracy of management’s expectations of future cash flows

related to the revenue sharing programs, significant amounts of disclosure are

necessary in determining the recoverability of this intangible asset. Principally, the

expected lives of the related engine families, the necessity for aftermarket, repair and

overhaul services and the popularity of the engines themselves. Additionally,

competition from oem manufacturers, airlines and military users will enhance price

pressure and erode the exclusivity and value of the contractual agreement.

Barnes group has been hesitant or reluctant to describe in detail their valuation

methods in ascertaining the useful lives of these agreements. The aforementioned

characteristics have not been addressed, even sparingly, allowing for high degrees of

uncertainty as to their potential recoverability. Neither on the company website

(www.barnesgroupinc.com), or in the 10k does the company describe the likelihood or

the various scenarios in which recoverability would be affected causing impairment.


In addition to their lack of disclosure, industry expertise would be important in

determining the market dynamics associated with the products and services Barnes

group provides. For example, the relative reliability of the engines, the input costs

associated with using such engines and the forces affecting profitability in the

aftermarket and repair industry are all significant in assessing the recoverability of the

“participation fees.”

We feel the high level of intangible assets ($380,486,000, 21.47% of Total

Assets, 2007) and the lack of disclosure lends itself to potential manipulation.

Quantitative Analysis

Business managers utilize financial statistics present the current status of the

firm. By using these numbers as a means of valuation, companies may be analyzed

and compared in like terms with competitors. Additionally, quantitative analysis provides

corporate decision makers with measures to determine firm progression. Potential

investors and security analysts use this disclosed information to make observations

about the firm. GAAP provides managers with flexibility in reporting financials of the

company. Therefore, managers can variably choose what information to disclose and in

what format, all depending on public perception goal. “Big Bath” scenarios aside,

managers generally wish to display their firm as a profitable, succeeding company.

They are heavily influenced by incentive laden contracts which give them benefits when

the meet certain criteria. These situations are known as agency costs. Agency

dilemmas arise when firm managers do not make decisions in the best interest of


shareholders. Understanding financials and being ability to identify deceptive

accounting techniques enables investors to more appropriately calculate firm value.

Red flags in operations can potentially be recognized through carefully calculated

diagnostic ratios.

Quantitative measures may be divided into two groups: sales manipulation

diagnostics and the expense aspects of accounting. Sales manipulation ratios all center

around, not ironically, net sales. These ratios divide net sales by other accounting

figures such as cash from sales and accounts receivable. On the other hand, the rest of

quantitative measures search reported expenses for discrepancies. Red flags are raised

when variances can’t be justified. These ratios test the validity, correctness, and

accountability of a firm’s financial statements.

Sales Manipulation Diagnostics

Sales Manipulation Diagnostics allow us to analyze relationships between a

firm’s net sales and significant items on its balance sheet. These ratios can be

compared to similar firms in an industry to help validate the credibility of a firm’s

accounting methods. A five-year period gives great insight into company trends, and by

analyzing these one can search for red flags. Red flags are abnormalities in the firm’s

financial statements. The ratios will help determine if these red flags are company

specific or apply to the industry as a whole.

Net Sales/Cash from Sales


Nets sales over cash from sales shows the relationship between a firms sales

during a period and the amount of sales that were purchased with cash. Ideally, a firms

ratio is near 1:1. At that ratio, a firm is efficiently receiving compensation for their sales.

The higher the ratio, the more a red flag is raised because firm sales are not

recognizing cash for its sales. As can be observed in the graph, Barnes Group as well

as its competitors maintains a steady ratio close to 1 with the exception of Ladish. With

less than .02 changes from year to year Barnes effectively acquires cash for its sales.

Therefore, since its ratios fall in line with the norm, no red flags appear.

Net Sales/Accounts Receivable

The ratio of net sales to accounts receivable shows how a firm’s accounts

receivable supports its sales. Therefore, a company who makes a significant amount of

sales on credit will have a lower ratio than one that receives cash for its sales.

Generally, if a company’s sales increase over time so will its accounts receivable,

0.940

0.960

0.980

1.000

1.020

1.040

1.060

1.080

2003 2004 2005 2006 2007

Net Sales/Cash from Sales

Barnes Group

Alcoa

Ladish

Triumph Group

Grainger

Fastenal co.

AIT


though necessarily in a proportionate manner. It’s important to remember to deduct

doubtful accounts from receivables before calculating this ratio.

Over the past few years, Barnes group has seen its net sales/accounts

receivable ratio lower which indicates a higher percentage of its sales are performed on

a credit basis. Managers tend to aim to avoid this occurrence. In contrast, Barnes

Group’s competitors have seen their net sales/accounts receivable ratios increase over

the past five years. To fall more in line with the practices of the industry, Barnes Group

must strive to collect cash for their sales quicker. In this situation, a red flag arise

because the ratios of Barnes Group’s competitors have risen during the period. Based

on this information, Barnes Group needs to focus on restricting the amount of account

receivables it takes on.

Net Sales/Inventory

2003 2004 2005 2006 2007

Barnes Group 7.478 7.159 7.084 6.603 6.811

Alcoa 7.489 7.829 7.825 8.844 10.071

Ladish 6.062 5.001 5.182 5.341 5.645

Triumph Group 4.975 5.381 5.146 5.470 5.535

Grainger 10.806 10.501 10.656 10.384 10.650

Fastenal Co. 7.727 7.621 8.299 8.635 8.724

AIT 7.950 8.491 8.210 8.099 8.524

0.0002.0004.0006.0008.000

10.00012.000

Net Sales/Accounts Recievable

Barnes Group

Alcoa

Ladish

Triumph Group

Grainger

Fastenal Co.

AIT


A net sale over inventory ratio is a great way to show how a firm’s sales are

supported by its inventory. Successful companies most often attempt to strictly

regulating their inventory levels which in turn leaves them with a high ratio. A red flag

could be discovered if a firm’s ratio was significantly lower than its competitors, which

would indicate inventory levels being too high for the industry. The graph shows Barnes

Group has rather quickly built up a large inventory in comparison to its past. This may

be partly explained by the fact of its asset acquisition policies and the slowdown of

aircraft sales after 9/11 and raising gas prices. There is no major red flag in this case

because other firms in the industry are also experiences lower net sales/inventory

ratios. However, it is important to note that Barnes Group’s ratio dropped at higher rate

than any of its competitors. This is because Barnes Group has begun to focus more of

their business efforts on their aerospace division. The aerospace division has much

lower inventory levels than industrial or distribution because most aerospace products

are made to order. In fact, Barnes has a backordered to last for the next one and a half

years; this allows inventory to remain low. Essentially, aerospace products are shipped

after production in a relatively short amount of time.


Net Sales/Unearned Revenue

Unearned Revenues for firms could not be found in their 10k’s.

Net Sales/Warranty Liabilities

Only a few of the firms offered warranty liability numbers. With such a limited number,

we chose not to use it as means of comparison.

Sales Manipulation Diagnostics Conclusion

The observations provided by these three sales manipulation ratios are very

insightful. These ratios indicate that Barnes Group may have tried to manipulate its

accounting methods in order to mislead investors about firm value. The firm’s net

sales/accounts receivable ratio is especially troubling because it moves in the opposite

2003 2004 2005 2006 2007

Barnes Group 8.115 8.094 6.922 6.331 5.832

Alcoa 8.520 7.910 7.578 7.984 9.245

Ladish 4.104 4.028 3.414 3.460 3.593

Triumph Group 2.942 3.169 3.224 3.103 3.183

Grainger 7.058 7.208 6.985 7.112 6.782

Fastenal Co. 4.272 4.030 4.213 3.968 4.086

AIT 9.505 9.782 9.976 10.076 9.916

0.000

2.000

4.000

6.000

8.000

10.000

12.000

Net Sales/Inventory

Barnes Group

Alcoa

Ladish

Triumph Group

Grainger

Fastenal Co.

AIT


direction of the industry. Thus, Barnes Group financial statements must be read and

interpreted with caution.

Expense Manipulation Diagnostics

As the name implies, expense manipulation diagnostics help determine if a firm

has altered their value by manipulating expenses on their financial statements. Distorted

numbers as well as visible irregularities in the industry may hint an inaccurate firm

valuation. A comparison with competitors of Barnes Group Inc. will present important

information in searching for company red flags. These diagnostics take us more deeply

into the dynamics of a firm, not just their mere cash to cash cycles.

Asset/Turnover

Asset Turnover Ratio offers a great means to compare companies of different

sizes on equal terms. It accomplishes this by demonstrating the relationship between a

firm’s assets and its sales. Firms who possess higher asset/turnover ratios experience

more success than those who have lower ratios. One way a firms ratio can go down is

it fails to impair goodwill. By looking at the graph, one can conclude that Barnes Group

is located near the middle of the industry for this ratio. Barnes Group ratio would likely

be higher if it didn’t have such a large Aerospace division. The firms in this industry with

higher ratios are more focused on the distribution that aerospace.


CFFO/OI

CFFO/OI distinguishes the amount of cash received from operations with the

actual amount of operating income that is reported on the income statement. Having to

payout differed taxes can severely hamper this ratio, while understating expenses

makes it appear higher than it really is. Most firms set out to have a ratio near 1:1. Over

the past five years, Barnes Group’s ratio has steadily decline to less than one to one.

This seems to be a trend within the industry as competitors have also seen their ratios

go down. This may be explained by deferred taxes that firms have had to pay out, a

common practice in this industry. This makes their cash flows appear high in some

years and the penalty is paid later on. Specifically, Ladish had a large sum of deferred

taxes due in 2004. Since Barnes Group’s ratio moves with the industry, there is no red

flag concern.

0.000

0.500

1.000

1.500

2.000

2.500

3.000

2003 2004 2005 2006 2007

Asset Turnover

Barnes Group

Alcoa

Ladish

Triumph Group

Grainger

Fastenal Co.

AIT


CFFO/NOA

Cash flows from operations over net operating assets is a great way to analyze a

firms depreciating practices. Since net operating assets include plant, property, and

equipment, how a firm chooses to depreciate these assets has a significant impact on

this ration. An overstatement of depreciation leads to a higher CFFO/NOA. However, in

general a higher ratio is seen as a positive because it dictates that a firm is utilizing their

assets to successful garner cash proceeds. Barnes Group has a low CFFO/NOA.

Although it doesn’t differ from the norm of its competitors, we would still like to see this

ratio at a higher point. One reason why its ratio may be low is due to its recent

acquisition. It normally takes time to learn how to effectively optimize cash flows from

new assets.

-1.000

0.000

1.000

2.000

3.000

4.000

5.000

6.000

2003 2004 2005 2006 2007

CFFO/OI

Barnes Group

Alcoa

Ladish

Triumph Group

Grainger

Fastenal Co.

AIT


Total Accruals/Change in Sales

The total accruals/ change in sales ratio shows how much of a company’s sales

are supported through receivables. The higher percentage of sales that a firm has on

account, the higher the ratio will be. Firms ideally want their ratios to hover around 1.

Competitors’ ratios vary over the past five years. Barnes Group has maintained a

relatively low ratio.

-0.200

0.000

0.200

0.400

0.600

0.800

1.000

1.200

1.400

1.600

1.800

2003 2004 2005 2006 2007

CFFO/NOA

Barnes Group

Alcoa

Ladish

Triumph Group

Grainger

Fastenal Co.

AIT


Low ratios (such as .257 in 2006) indicate that a large amount of Barnes Group’s

sales are not made on credit account. This makes sense because many product orders

which Barnes Group completes are paid for advance, with some items not being

processed until 18 months later. By looking at the company’s financials, one may

observe their continually low amount of sales done on account.

Diagnostics Conclusion

Barnes Group does a satisfactory job of disclosing their financials. Continuniuity

from year to year as well as value movements in accordance with the industry indicate

that the firm is doing nothing out of the ordinary to mislead investors. Information

provided by the diagnostics present challenges that Barnes Group is currently facing.

The company is having difficulty in moving inventory in their distribution sector relative

-1.000

0.000

1.000

2.000

3.000

4.000

5.000

6.000

7.000

8.000

2003 2004 2005 2006 2007

Total Accruals/Change in Sales

Barnes Group

Alcoa

Ladish

Triumph Group

Grainger

Fastenal Co.

AIT


to their competition. In addition, the firm is slowly taking on more credit orders, which

limits their ability to instantly invest into feasible expansionary projects.

Financial Analysis, Forecast Financials, and Cost of Capital Estimation

Analyzing and Forecasting corporations’ financials, along with estimating the

cost of capital for the company help in the assessment of understanding where the

company stands in terms of their industry, and their competitors.

Initially, we observe the profitability and increase of a firm using financial

ratios categorized into two key objectives, the ratio analysis and cash flow analysis.

The cash flow analysis allows us to observe the company’s liquidity and to assess the

management of operating, investment, and financing cash flows. The ratio analysis

enables the business owner/manager to spot trends in a business and to compare its

performance and condition with the average performance of similar businesses in the

same industry (BIZMOVE.com).

Next, using the financial ratios formerly stated, we forecast the financial

statements. Forecasting the statements can help identify trends in the marketplace

and also aids in the ability to project Barnes’ future financial statements up to ten

years out.

The concluding section of the analysis is the cost of capital estimation. The

cost of capital for all publicly traded companies is the cost of equity plus the cost of

debt. The capital asset pricing model and regression analysis of a corporation

significantly assist analysts’ in creating an approximate cost of capital.


Financial Analysis

The purpose of financially analyzing a corporation is to assess the performance

of a firm in relation to industry averages and acceptable ratios established through time.

There are many different financial ratios for Barnes Group Inc. and its competitors.

These ratios help to precisely evaluate a company’s overall financial productivity and

wellbeing. These ratios are broken down into 3 categories: profitability, liquidity, and

capital structure. Investors and creditors can apply these ratios to see development in a

company and an industry. With financial analysis, we will have a grasp on how Barnes

Group reacts and relates towards their competitors.

Liquidity Ratio Analysis

Liquidity ratios measure a corporation’s ability to turn their assets into cash,

basically meeting their short-term financial obligations. The most commonly used ratios

include the current ratio, quick asset ratio, accounts receivable turnover, days sales

outstanding, inventory turnover, days supply inventory, and working capital turnover.

These ratios are important to investors, creditors, and the firms because they are used

to derive the credit risk of a company. Creditors, in addition, use these ratios to produce

agreements within their contracts requiring firms to sustain certain levels of leverage

and liquidity


Current Ratio

The current ratio, also known as the “gross working capital,” can be defined as a

liquidity ratio that computes a company’s ability to pay short-term obligations calculated

by dividing the company’s current assets by their current liabilities. This ratio also helps

to give an all around idea as to the efficiency of the company’s operating cycle. The

current ratio deals with current assets such as accounts receivable, marketable

securities, inventories, and prepaid expenses. Current assets are usually not incredibly

profitable but tend to add liquidity and security to a firm's operation. The current

liabilities are generally debts due within one years’ time period. Current liabilities

include accounts payable, current maturities of long-term debt, short-term loans from

financial organizations, expenses incurred but not paid, and dividends declared but not

paid.

0.0000

1.0000

2.0000

3.0000

4.0000

5.0000

6.0000

7.0000

8.0000

2003 2004 2005 2006 2007

Current Ratio

Barnes Group

Alcoa

Ladish

Triumph Group

Grainger

Fastenal Co.

AIT

Industry


The graph above indicates that the current ratio for Barnes Group over the past

five years has been significantly lower than the industry average. Barnes has shown a

steady current ratio of 1.5 to 1.7 in between the years 2003 to 2007. This statistic

indicates that their current assets to current liabilities ratio is substantially lower than

their competitors. This could affect them when dealing with large debt obligations.

Quick Asset Ratio

The quick asset ratio is essentially the measure of company’s liquidity and

capability to meet its obligations. Taking the corporations cash plus cash equivalents

plus accounts receivables over current liabilities creates the quick asset ratio, which is

also known as the “acid-test ratio.” This signifies the company’s financial strengths and

weaknesses by establishing the company’s short-term stability. This, of course does

not account for the inventory that the company possess. By excluding inventory from

the ratio, the formula focuses on corporations’ liquid assets, and helps decide if the

corporation can meet its current liabilities with its convertible assets if sales ceased.


The graph above indicates the quick asset ratio for Barnes Group and its competitors

for the years 2003 through 2007. Shown above, Barnes group is lacking in percentages

relative to their other entrants in the industry, sitting just above 1 in 2003, and below 1

throughout the years prior to 2007 . This signifies that Barnes Group has become less

able to meet its current obligations in recent years. In relation to the industry as a whole,

Barnes Group fails to adequately position itself so that it can effectively cover its current

liabilities with liquid assets.

Working Capital Turnover

The working capital turnover ratio is a measurement comparing the value of

working capital to the generation of sales over a given period. Working capital can be

calculated as current assets minus current liabilities. Essentially, working capital is the

money used to fund operations which generate a firm’s sales. The working capital

0.0000

0.5000

1.0000

1.5000

2.0000

2.5000

3.0000

3.5000

4.0000

2003 2004 2005 2006 2007

Quick Asset Ratio

Barnes Group

Alcoa

Ladish

Triumph Group

Grainger

Fastenal Co.

AIT

Industry


turnover ratio provides some useful information as to how effectively a company is using

its working capital to generate sales. Firms assess working capital to finance

operations and purchase inventory. These operations and inventory convert into sales

revenue for the corporation. The working capital turnover ratio is used to examine the

affiliation between the capital used to fund operations and the sales produced from

these operations. Therefore, with this being said, the higher the working capital

turnover, the more the revenue, and the better overall performance of the corporation.

The actual ratio of working capital turnover is the corporation’s net sales, over the

working capital, which is of course the current assets- current liabilities ratio.

Shown above, Barnes Group has a relatively higher percentage of working capital

compared to the competitors in the market. With turnover ranging from 7 to about 9,

0.0000

5.0000

10.0000

15.0000

20.0000

25.0000

30.0000

35.0000

40.0000

2003 2004 2005 2006 2007

Working Capital Turnover

Barnes Group

Alcoa

Ladish

Triumph Group

Grainger

Fastenal Co.

AIT

Industry


Barnes Group is second in the market, right under Alcoa Inc. From the years 2003 to

2007, Barnes has gained positive recognition in terms of actually generating sales.

Accounts Receivable Turnover

The Accounts Receivable turnover, also called receivables ratio, is a ratio that

displays the number of times in each accounting period that a firm converts sales into

cash. This ratio is calculated by dividing the average quantity of receivables into annual

credit sales. This is critical for the corporation because it indicates firm's efficiency in

extending credit as well as collecting debts, all of which contribute to the firm’s liquidity.

The receivables turnover ratio is an activity ratio, measuring how efficiently a firm

uses its assets. In order to gain revenues, and assess capital, having a firm grasp of

your assets is a key factor in recognizing what a company is doing right, or wrong. With

this in mind, u can conclude that a high ratio means either that a company operates on

a cash basis or that its extension of credit and collection of accounts receivable is

efficient. A low ratio, in contrast, implies that the company should re-evaluate its credit

policies in order to guarantee the proper collection of imparted credit that is not earning

interest for the firm.


The graph above indicates Barnes Group Inc. Accounts receivable turnover from

2003 to 2007. In prior years to 2007, Barnes experienced a higher percentage in

Accounts Receivable turnover, steadily declining until reaching 2007, from 8 to about 6.

These percentages indicate that Barnes is not significantly strong at collecting their

debts. A more efficient firm would quickly resolve accounts receivable by collecting their

dues. The quicker payments are collected, the faster a firm may reinvest the money into

firm operations. Thus, by having a lower than industry average accounts receivable

turnover, Barnes Group fails to maximize its liquidity potential and efficient levels of

extending credit.

Day Sales Outstanding

0.0000

2.0000

4.0000

6.0000

8.0000

10.0000

12.0000

14.0000

2003 2004 2005 2006 2007

Accounts Recievable Turnover

Barnes Group

Alcoa

Ladish

Triumph Group

Grainger

Fastenal co.

AIT

Industry


The Day Sales Outstanding ratio is a measure of the average number of days

that a company takes to collect revenue after a sale has been made. The DSO ratio is

calculated by taking a firms’ accounts receivables and dividing them by the firms total

credit sales. The total of the two accounts are then multiplied by the number of days

outstanding. Due to the high importance of liquid assets, especially cash, in a business,

it is in a company's absolute best interest to gather outstanding receivables as soon as

possible. By promptly turning sales into cash, a firm has the chance to put the cash to

immediate use again, possibly making more revenue from this liquid return. The DSO

can play a variety of import roles within a firm’s cycle.

The ratio can find out whether a company is trying to cover up feeble sales, or is

generally just being unsuccessful at bringing in capital. The most efficient way to find

this out is by classify the DSO as low or high number. A low DSO number usual states

the company takes less time to collect all of their accounts receivable. A high DSO

number illustrates that a company is selling their products by establishing credit with

their customers, which in turn, takes a longer time to collect actual money.


As indicated above, Barnes group is the third highest company in of their Days Sales

Outstanding. In 2003, Barnes Group’s days sales outstanding stood at 48 while

gradually increasing to 53 in 2007. This indicates Barnes group credit sales, explaining

the liquidity of accounts receivable, etc.

Inventory Turnover

The Inventory Turnover ratio is a percentage that shows how often the inventory

of a firm is sold and replaced over a specific period. The inventory ratio is generally

calculated by taking net sales and dividing by the firm’s inventory, but occasionally this

ratio can also be calculated by taking the cost of goods sold and dividing that by the

firms average inventory. Although the first calculation is more frequently used, the cost

of goods sold may alternate with sales because the net sales are recorded at market

0.0000

10.0000

20.0000

30.0000

40.0000

50.0000

60.0000

70.0000

80.0000

2003 2004 2005 2006 2007

Days Sales Outstanding

Barnes Group

Alcoa

Ladish

Triump Group

Grainger

Fastenal Co.

AIT

Industry


value, whereas inventories are typically recorded at cost. This ratio is ideal in situations

where a company has large, important assets tied up in inventory. This ratio is also

most useful when tracking turnover, which is critical to successful financial planning. If

the firms’ inventory is turning rather slowly, it may possibly indicate that it may be

hurting your cash flow. So with this in mind, we can conclude that low turnover rates

mean that there have been poor sales within the company, therefore, leaving the firm

with excess inventory. A high ratio can either mean that there have been strong sales or

insufficient purchasing.

The graph above displays the Inventory turnover for 2003, through 2007. Fastenal

Co. Corporation is among the lowest of the competitors in this division. Barnes Group

is more towards the higher end of the chart, averaging from 5 to about 3 in 2007. For

the inventory turnover division, having the highest percentage is definitely better to

having the lowest percentage rate. If your rate is high, you are receiving cash for your

0.0000

1.0000

2.0000

3.0000

4.0000

5.0000

6.0000

7.0000

8.0000

2003 2004 205 2006 2007

Inventory Turnover

Barnes Group

Alcoa

Ladish

Triumph Group

Grainger

Fastenal Co.

AIT

Industry


goods, and selling them at with good time span. If your rates are lower, this could mean

that you have an excess of goods, and are losing capital. Or a lower rate could imply

that you are just not selling your inventory, and basically leaving your inventory idle,

costing the firm money for storage. Barnes group has done a fine job in maintaining

their inventory inflows and outflows.

Days Supply Inventory

Days supply inventory is a financial measure of the amount of days it takes for a

firm to turnover its entire supply of inventory. The ratio is calculated by the number of

days in a year divided by the inventory turnover ratio, which is the cost of goods sold

divided by the inventory. This allows the firm to, day-by-day, keep track of what they

own and how often they turnover their products. This information is crucial to a

company because it identifies where and how the company creates the most revenue.

Also, this will identify potential theft and looting from inside the firm, which decrease

gross profit.

0.0000

50.0000

100.0000

150.0000

200.0000

2003 2004 2005 2006 2007

Days Supply Inventory

Barnes Group

Alcoa

Ladish

Triumph Group

Grainger

Fastenal Co.

AIT


The graph above displays the Days Supply Inventory for Barnes Group Inc. and

competitors from 2003 through 2007. The graph indicates that Barnes is below the

average of its competitors. The graph also illustrates that Barnes has had a steady

stream in their percentages for the past five years. This equation measures Barnes

Group inventory, explaining the amount of days correlating with the firms inventory

turnover ratio . The days supply inventory is lower for Barnes Group as opposed to their

higher inventory turnover average.

Cash to Cash Cycle

The Cash-to-Cash Cycle, also known as cash conversion cycle, is a financial

ratio, which shows how long a company has to finance its own stocks for. This

expresses the length of time, in days, that it takes a company to change resource inputs

into cash flows. The cash conversion cycle measures the amount of time each net

input dollar is tied up in the production and sales process before it is changed into cash

through sales to customers. This is an important calculation in determining where the

cash flow is going in terms of liquidity, stabilization of the company, and capital gains.

0.0000

50.0000

100.0000

150.0000

200.0000

250.0000

300.0000

2003 2004 2005 2006 2007

Cash to Cash Cycle

Barnes GroupAlcoa

Ladish

Triumph GroupGrainger


The cash-to-cash cycle shown above, displays Barnes Group Inc. and their competitors

for the years 2003 through 2007. In the past few years, Barnes has steadily approached

the industry average in terms of cash-to-cash cycle. This could be due to Barnes

becoming more lax on their credit terms with customers, and superior management of

inventory levels.

Ratio Performance Trend

Current Ratio Below Average Steady

Quick Asset Ratio Below Average Slightly Declining

Working Capital T/O Above Average Stable

Accounts Receivable T/O Below Average Declining

Inventory T/O Average Declining

Cash-to-cash Cylce Below Average Increasing

Overall Below Average Slightly Declining

Profitability Ratio Analysis

Profitability ratios allow us to relate revenues and expenses. Specifically, these

ratios indicate how this relationship results in profits for a firm. All of the following ratios


include company sales which can be located on the top line of the income statement.

Profitability ratios play a major role in determining firm value, and trends in these ratios

may help create expectation for firms in the future.

Gross Profit Margin

The higher the gross profit margin, the more adapt a firm is at covering its fixed

costs and overhead expenses. This in turn may lead to higher net income. To calculate

the gross profit margin, subtract the cost of goods sold from net sales and then divide

that number by net sales. Essentially, gross profit margin indicates the percentage of

sales which result in profit before taking into account non production costs.

As one can see, Barnes Group has maintained a steadily increasing gross profit margin

over the past five years. In relation to the industry average, Barnes Group has a high

margin. However, the industry average is increasing at a slightly quicker rate than that

of Barnes. This means that in relation to their competitors, Barnes Group is slowly

losing their price premium advantage. The gap between Barnes and the industry

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

2003 2004 2005 2006 2007

Gross Profit Margin

Barnes Group

Alcoa

Ladish

Triumph Group

Grainger

Fastenal Co.

AIT

Industry


average was near 10% in 2003 but down to 6% in 2007. In the past, Barnes’ profit

margin has allowed them to efficiently pay off debts and still have money to fund

positive npv projects. The company has managed their cost of goods well but has not

been able to maintain sales at the same increasing rate of the industry.

Operating Expense Ratio

To compute the operating expense ratio, selling and administration expenses are

divided by sales. An optimal firm wishes to maintain an efficient low ratio. Limiting

selling and administrative expenses enables a firm to maximize their net income. A

lower operating expense ratio may indicate that a firm is placing priority on cost control

methods.

Over the past five years, Barnes Group has not done a good job in managing its

operating expenses. The operating expense ratio of the firm over the past five years as

steadily hovered near (.3) while the industry average has mainly been below. By having

these higher operating expenses, Barnes Group is sacrificing net income gains. A

0.0000

0.1000

0.2000

0.3000

0.4000

0.5000

0.6000

0.7000

2003 2004 2005 2006 2007

Operating Expense Ratio

Barnes Group

Alcoa

Ladish

Triumph Group

Grainger

Fastenal Co.

AIT

Industry


careful reexamination of administrative costs may be in order for Barnes Group. By

minimizing these costs, shareholders will see company value increase.

Operating Profit Margin

Operating profit margin allows us to analyze a firm’s profitability after taking out

operating expenses. To reckon the operating margin, operating income is divided by

net sales. Operating margin can be obtained by subtracting selling and administrative

expenses from gross profit.

This graph shows that while steadily inclining, Barnes Group has remained slightly

below the industry average for profit margin. However, if it continues at its current rate,

Barnes Group should approach the industry average within the next few years. One

can see that the sharp decline in the industry average from 2003 to 2004 mirrored and

partly resulted from the decline of Triumph Group’s operating profit margin. Barnes

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

2003 2004 2005 2006 2007

Operating Profit Margin

Barnes Group

Alcoa

Ladish

Triumph Group

Grainger

Fastenal Co.

AIT

Industry


Group must further reassess business practices because low operating profit margins

indicate a firm is burdened with high operating costs due to inefficiencies in operations.

Net Profit Margin

One of the best ways to view a firm’s performance is by looking at its net profit

margin. Net profit margin takes into account the true bottom line between revenues and

firm costs. The ratio, which is found by dividing net income by sales, indicates the end

earning its pockets in relation to total sales. For instance, a 20% net profit margin

signals a twenty cents profit for every dollar of sales. Thus, in order for this margin to

increase, a firm but either lower s the costs while maintaining revenues or increasing

the revenues at a higher rate than their increasing costs. By managing production and

selling efficiency, a firm can expect to have a higher net profit margin.

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

2003 2004 2005 2006 2007

Net Profit Margin

Barnes Group

Alcoa

Ladish

Triumph GroupGrainger

Fastenal Co.

AIT


The engine part distribution and aerospace industries have seen a significant rise in net

profit margins over the past five years. The industry average itself has nearly doubled

since 2003. Although Barnes Group has remained below the industry, its net profit

margin in 2007 is less than a quarter of the industry average. This implies there is great

room for improvement in net profit margin for Barnes. By improving net profit margin,

share price ought to increase accordingly. One way Barnes could increase their profit

margin is by focusing business operations more on their aerospace division which

provides them with their highest profit margins. The clear winner in the net profit margin

comparison is Fastenal Co. In addition, it’s quite apparent that Ladish has restructured

the way it does business. In 2003 the company had net income of .01%! However, in a

five year span the company has moved above the industry average.

Asset Turnover

Asset turnover ratio provides insight into a firm’s assets’ impact on their sales. A

larger ratio in relation to competitors’ implies that a firm is effectively maximizing their

assets to generate revenues. Generally, companies with a large amount of expensive

long-term assets such as dynamic construction and mechanistic production processes

pay heavy attention to their asset turnover ratio.


On average, firm’s in this industry do a good job in generating sales off of their assets.

This can been seen in the yearly average of nearly 1.5. This average would indicate that

for every $1 of assets firms were generating $1.5 of sales. There is a reason to be

concerned with the direction of Barnes Group’s asset turnover ratio. In 2003, the firm’s

ratio was near that of the industry average. By 2007, Barnes Group’s asset turnover

ratio had dropped to 1.07; this happened while the industry average steadily increased.

A decline raises concerns over Barnes Group’s ability to successfully generate revenue

with the resources they have.

Return on Assets

Thanks to the financial principals of the time value of money, we expect that for

every dollar we invest to receive a higher amount in return. This higher return comes

from expected compensation for delaying compensation of money. For this very reason,

return on assets is one of the most important financial ratios. By dividing net income by

0.0000

0.5000

1.0000

1.5000

2.0000

2.5000

3.0000

3.5000

2003 2004 2005 2006 2007

Asset Turnover

Barnes Group

Alcoa

Ladish

Triumph Group

Grainger

Fastenal Co.

AIT

Industry


the companies previous year’s assets, we can see just how effectively invested money

into assets generates profit.

In the past five years, the industry average for return on assets has nearly doubled,

though has shown signs in the past years that it is slowly tapering off. Barnes Group

has seen its return on assets steadily increase as well. This is quite an accomplishment

since Barnes Group has been very active in acquiring assets in the past few years

(such as Kent) and has a large amount of goodwill which appears to have been

overvalued. Sometimes it is hard to effectively utilized newly acquired assets because

a firm may not be familiar in maximizing the output of the assets at the lowest possible

cost.

Return on Equity

Return on equity measures how shareholder wealth results in returns for a firm.

This can be calculated by dividing net income by total shareholders’ equity. Since

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

2003 2004 2005 2006 2007

Return on Assets

Barnes Group

Alcoa

Ladish

Triumph Group

Grainger

Fastenal Co.

AIT

Industry


shareholder equity is vital to a large firm’s growth, this ratio ranks near the top in valuing

firm profitability. By comparing return on equity and the cost of equity, we can establish

if the firm is properly utilizing its assets (some acquired by means of equity funding) to

generate profit

This graph illustrates that firms in Barnes Groups’ industry have enjoyed rising

returns on equity in the past five years. In the 2007 Barnes Group surpassed the

industry average of 19.18%. Compared to other economic sectors, this industry enjoys

a relatively high return on equity. Asset turnover, profit margin, and firm capital structure

all impact return on equity. Having a higher return on equity attracts shareholders,

especially when it significantly eclipses an investor’s expected rate of return on their

investment into a firm.

Firm Growth Rate Ratios

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

2003 2004 2005 2006 2007

Return on Equity

Barnes Group

Alcoa

Ladish

Triumph Group

Grainger

Fastenal Co.

AIT

Industry


By comparing growth rates of firms within an industry, we can get a good

inclination of what is expected to occur in the future. The larger the growth rate, the

higher potential return on a firm from an investor’s point of view. We will look at the

following growth rates: Internal Growth Rate (IGR) and the Sustainable Growth Rate

(SGR).

Internal Growth Rate

The internal growth rate operates under the assumption that all new capital for

the firm is taken from the firms cash flows of previous periods. Thus, this rate assumes

no additional capital rose through debt or equity means. To calculate the internal

growth rate, a firm’s return on assets is multiplied by its plowback ratio. A plowback ratio

is the percentage of net income a firm holds and moves to its retained earnings. This

ratio can be stated as (1-divend payout ratio). The drawback to the IGR is that it can’t

formulate a rate for firm’s who have no dividend payout. In such cases, IGR will equal

the return on asset rate.

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

18.00%

2003 2004 2005 2006 2007

Internal Growth Rate

Barnes Group

Alcoa

Ladish

Triumph Group

Grainger

Fastenal Co.

AIT

Industry


This industry has seen a rise in firm internal growth rates. Surprisingly, although both

are large, reputable and established, Grainger and Alcoa have very differing internal

growth rates. Barnes Group finds itself below the industry average by about 3% a year.

This indicates that Barnes Group has room to improve its operating procedures (limiting

costs). With overstated goodwill, internal growth rate will suffer because some of the

goodwill “assets” do not have the appropriate means to generate sales and in turn net

income.

Sustainable Growth Rate

The sustainable growth rate takes into account a firm’s capital structure. A firm’s

capital structure is composed of its debt and equity which when added together must by

accounting rules equal the firm’s assets. This growth rate assumes the firm does not

alter its capital structure from its current state. We get the sustainable growth rate

multiplying a firm’s ROE by its plowback ratio. If the firm does not pay dividends, its

SGR will be its ROE.


Over the past five years, Barnes Group has had a relatively volatile sustainable growth

rate in relation to the industry average. In 2003 it had a higher rate, in 2004 a lower rate,

in 2005 a higher rate, and a lower rate in both 2006 and 2007. This correlates with

Barnes Groups return on equity; it is unsteady yet rising over time. This may caution

those interesting in investing for the short-term in the company because year-to-year

returns are not easily predicted. However, over a longer period of time, Barnes Group

appears to be sufficiently compensating investors.

Ratio Performance Trend

Gross Profit Margin Over-Performed Slightly Increasing

Operating Expense Ratio Under-Performed Steady

Operating Profit Margin Under-Performed Slightly Increasing

Net Profit Margin Under-Performed Increasing

Asset Turnover Under-Performed Decreasing

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

2003 2004 2005 2006 2007

Sustainable Growth Rate

Barnes Group

Alcoa

Ladish

Triumph Group

Grainger

Fastenal Co.

AIT

Industry


Return on Assets Under-Performed Increasing

Return on Equity Average Slightly Increasing

Overall Under-Performed Slightly Increasing

Capital Structure ratios

Capital structure measures how companies finance their growth and operations.

Two ratios that help represent capital structure are times interest earned and debt

service margin. According to Wikipedia, “A firm’s debt to equity ratio indicates the

relative proportion of debt and equity used to finance a company’s assets.”

(http://en.wikipedia.org/wiki/Debt_to_equity_ratio). When a firm account for considerable

amounts of debt to finance assets, the firm will be exposed to considerable risk. It is

important to closely observe a firm’s balance sheet so that analyst can accurately

measure the amount of risk a firm encounters.

Debt to equity ratio

If a firm has a high D/E ratio, they have accumulated more debt than they are

implementing growth. Consequently, the firm becomes riskier. The graph below

illustrates the debt to equity ratios of Barnes compared to its competitors.


For the last several years Triumph, Grainger (GWW), Ladish, AIT, and fastenal

have kept their D/E ratio under 1. However, for consecutive year Barnes and Alcoa

have accounted D/E ratios above 1. Although their ratios have been above 1, Barnes

D/E ratio decreased from 1.72 in 2004 to 1.51 in 2005 (Barnes 10-k). Their decreased

D/E ratio is a result of Barnes paying $15.16 million of long term debt between 04’ to 05’

(Barnes 10-k). Additionally, Alcoa’s D/E ratio rose from 1.35 in 2004 to 1.52 in 2005

(Alcoa 10-k). From 2006 to 2007, Barnes and Alcoa further separated themselves from

their competitors. Barnes D/E ratio decreased from 1.57 to 1.35 and Alcoa’s D/E ratio

fell from 1.54 to 1.42 (Barnes + Alcoa 10-k). Although Triumph, Grainger, and Fastenal

all have D/E ratios below one, these competitors were the only firms that increased their

D/E ratios last year. Triumph jumped from .73 in 2006 to .96 in 2007, Grainger

increased their ratio from .4 in 2006 to .47 in 2007, and Fastenal rose from .13 in 2006

to .15 in 2007 (TGI, GWW, and Fastenal 10-K).

Conclusion:

00.20.40.60.8

11.21.41.61.8

2

2004 2005 2006 2007

D/E Ratio

Barnes

GWW

triumph

LDSH

AIT

Alcoa

Fastenal


Barnes’s D/E ratio has been similar to Alcoa’s D/E ratio in recent years. However, both

Alcoa and Barnes have a significantly higher D/E ratio compared to Triumph, Grainger,

and Fastenal. Moreover, Barnes recent decrease in debt has lowered their D/E ratio

below Alcoa. Although they have recently been decreasing their debt to equity ratio,

Barnes still has trouble increasing the equity of their firm without subjecting themselves

to large amounts of debt. Therefore, Barnes is still a risky firm when it comes to

financing growth and operations.

Times interest Earned

The ability of a firm to meet its commitments is determined by measuring the

company’s times interest earned ratio. This ratio is determined by dividing operating

income by the interest expense. The higher the ratio, the better performance a firm can

achieve. The chart below illustrates times interest earned for Barnes and their

competitors.

Times interest earned


Over the past few years, Barnes’s times interest earned ratio has decreased.

The largest decrease came between 2005 and 2006 when it dropped from 7.4 to 2.85

respectively (Barnes 10-k). Barnes times interest earned ratio plunged because the

interest expense increased relative to operating income. Barnes’s interest expense

increased from $17,551 in 2005 to $23,691 in 2006 (Barnes 10-k). Grainger times

interest earned ratio took a steep jump from 2.82 in 2004 to 45.6 in 2005. In 2007,

Grainger reached a TIE ratio of 102.15(Grainger 10-k). Grainger’s a significantly higher

times interest earned ratio is significantly higher compared to Barnes and their

competitors (Grainger 10-k). In 2007, Barnes had the 2nd lowest times interest earned

ratio of 2.7 (Barnes 10-k). Therefore, Barnes ability to meet their commitments

compared to their competitors is not probable due to their small TIE ratio.

-20.00

0.00

20.00

40.00

60.00

80.00

100.00

120.00

2004 2005 2006 2007

Barnes

GWW

triumph

LDSH

AIT

Alcoa

Fastenal


Debt service margin

The debt service margin portrays the capacity a firm has to dispose of its debt.

In order to pay off debt, a firm must divide its cash flows from operations by installments

on long term debt. High debt service margins indicate a firm is achieving superior

performance. Over the past few years, Barnes debt service margin ratio has slowly

increased to the 07’ 6.06 ratio (Barnes 10-k). As the chart indicates, Barnes has a

consistent debt service margin with a majority of their competitors.

Debt Service Margin

However, Barnes has been slightly outperformed by AIT and Alcoa, while being

significantly outperformed by Grainger. Barnes debt service margins have been low

0.00

50.00

100.00

150.00

200.00

250.00

300.00

350.00

2004 2005 2006 2007 Years

Barnes

GWW

triump

LDSH

AIT

ALCOA

FASTenal


because they lack the cash flows from operations achieve a debt service margin like

AIT, Alcoa, and Grainger. Barnes cash flows from operations included $69,652 in 2005,

$114,321 in 2006, and $120,318 in 2007 (Barnes 10-k).

Cost of Capital

Weighted average cost of debt

In order to find a firm’s cost of debt, analyst must find the amount of interest a

company forfeits on liabilities and other debt instruments. In order to calculate the cost

of debt analyst must find the weights of each type of liabilities. You compare the

amount of debt for each liability and divide it by the amount of total liabilities. After that,

you multiply the weight by the interest rate of the liability. Notes payable, current portion

of long term debt, long term debt, and other liabilities are all disclosed in Barnes 10-k.

Barnes 2007 10-k stated that notes payable had an interest rate of 6.51%. The current

portion of long term debt had interest rates of 7.8% and 3.5%. In order to find the rate

for current portion of long term debt, you multiply each interest rate by a weight of 50

percent. After that, you add the weighted interest rates together to acquire an average

interest rate of 5.65%. Long term debt had notes of 7.66%, 7.8%, 9.34%, 3.75%, and

3.375%. We took the average of the five notes and estimated that long term debt had

an interest rate of 5.91%. To find other liabilities, we used the6.22% pension liability

discount rate for 2007 (Barnes 10-k).The last two interest rates we found were for

accounts payable and accrued liabilities. We used a 3 month AA nonfinancial

commercial paper rate issued on 10/29/2008. The commercial paper rate is found on


the St. Louis Federal reserve bank’s website. The address is

http:/research.stlouisfed.org. We found that Barnes weighted average cost of debt is

4.9.

Weighted Average Cost of Debt

Name of liability Debt Interest rate Weight WACD

Notes payable 7,322 6.51 0.83% .054

Accounts payable 187,136 2.74 21.14% .58

Accrued liabilities 107,202 2.74 12.11% .33

Current portion of long term debt 42,660 5.65 4.82% .27

Total current liabilities 344,320

Long term debt 384,482 5.91 43.43% 2.57

Other liabilities 156,586 6.22 17.69% 1.10

Total liabilities 885,388 100% 4.9

Altman Z-score

The Altman Z-score is a bankruptcy prediction model produced by a man name

Edward Altman in the 1960’s. This model indicates the possibility of bankruptcy through

default risk and credit risk for a firm. This ratio is calculated by taking a firms working

capital and multiplying it by 1.2, the retained earnings and multiplying that by 1.4, the

operating income by 3.3, and the sales, adding all of those solutions together and


dividing them by the company’s total assets. That total number will then be added to

the product of the net worth multiplied by 0.6 over the company’s total debt.

[Variables] [Equation] a = working capital 1.2 a + 1.4 b + 3.3 c + d + .6f b=retained earnings e g c = operating income (bizwiz) d = sales e = total assets f = net worth and g = total debt (Bizwiz)

The Z-score measures the probability of insolvency (inability to pay debts as they become due).

1.8 or less indicates a very high probability of insolvency.

1.8 to 2.7 indicates a high probability of insolvency.

2.7 to 3.0 indicates possible insolvency.

3.0 or higher indicates that insolvency is not likely (Bizwiz)

The graph on the following page displays z-scores.


Information was gathered from the financial statements of Barnes Group and

three of its most successful competitors in order to gauge bankruptcy potency. The Z-

Score model has been configured to assign different weighting to each of these ratios in

proportion to their importance (myspm.com). As the graph indicates, Barnes Group’s z-

score is about average in relation to its competitors. Grainger is far away best suited

handle any additional firm risk. One explanation for Grainger’s high z-score is their

superior commitment to credit risk management and their extraordinary retained

earnings/total assets ratio (1.07). A noticeable alarming trend for Barnes Group is that

over the past five years, the firm’s z-score has dropped more than 1.3. Now, with a

higher probability of insolvency, investors must be leery of potential bankruptcy issues

concerning the firm. When bankruptcy occurs, shareholders are only compensated for

their investment after all debts have been paid. Thus, firms with higher bankruptcy

2003 2004 2005 2006 2007

Barnes Group 3.6484 3.1031 3.5811 2.5878 2.2805

Grainger 7.2050 8.8885 8.7199 8.4576 8.8581

Triump 2.3161 2.4453 2.5644 2.5904 2.9756

Alcoa 2.2911 2.2244 1.5189 2.4659 2.4074

0.00001.00002.00003.00004.00005.00006.00007.00008.00009.0000

10.0000

Altman Z-Scores

Barnes Group

Grainger

Triump

Alcoa


Cost of Equity

The final step in our analysis involves estimating the cost of equity in order to

discount the expected future cash flows to the return required by shareholders. We

utilized the capital asset pricing model (CAPM) and the “back-door” cost of equity model

in estimating Barnes Group’s cost of equity.

The capital asset pricing model uses the beta coefficient to represent the

correlation of the market returns to the individual stock’s performance. The capital asset

pricing model assumes the riskiness of the firm over the observation period remains

constant, or stationary. The CAPM model also assumes that the only risk the investor is

compensated for is systematic or market-wide risk. Additionally, the model assumes the

risk free rate to be independent of the responsiveness of the firm’s returns to the

market.

The CAPM model is as follows:

The first step in estimating the cost of equity through the CAPM model is to

estimate the firm’s beta coefficient through regression analysis. After using time

horizons of 24,36,48,60 and 72 month observation periods and three month, six month,

two year, five year, seven year and ten year t-bills as the risk free rate, it was

determined a 24-month time horizon as well as a 3-month t-bill returned the highest

explain ability. Our regression yielded an adjusted R² of .6486 indicating the model


explained 64.86% of the output taking into account the sample size. Assuming a 95%

confidence interval, the beta of Barnes Group is 2.7735, with the upper and lower

bounds being 3.6462 and 1.9010 respectively. A 95% confidence interval implies that if

an additional observation was taken, assuming stationary data, there would be a 95%

chance the beta would fall within the lower and upper bounds.

Assumed Cost of Equity

22.67% 3.81% 2.77 6.8%

Lower Bound

16.56% 3.81% 1.90 6.8%

Upper Bound

28.60% 3.81% 3.65 6.8%

3.81% 10 10/1/08

6.8% &

In addition to the CAPM analysis, we used the alternative or “back-door”

approach in estimating the cost of equity. This method evaluates the relationships

between the market to book value of a firm and its return on equity taking into account

the growth rate in the firm’s.

The alternative cost of equity is as follows:

1


18.95%

Conclusion

After consideration of the advantages and disadvantages of both the CAPM and

the alternative cost of equity model, we decided the CAPM model best describes the

actual cost of equity. Although the alternative cost of equity was within the upper and

lower bounds of the CAPM estimate, we feel the reliance on forecasted financial

statements presented too many risks to be credible. The CAPM model reflects the

stocks experience in the eyes of the investment community over a period of time and

thus is a better measure of actual cost of equity. Furthermore, Barnes Group has been

increasing its indebtedness and pursuing an aggressive acquisition strategy over the

past 5 years, and the forecasted financial statements may be too reliant on past

performance.

Weighted Average Cost of Capital (WACC)

The weighted average cost of capital is the cost of financing a firm pays to support its

assets. In order to compute the WACC, a weighted average of the interest rates on the firm’s

debt is obtained and reduced by the proportion of the value of the firm debt has contributed.

Secondly, the interest paid on debt is tax deductable and therefore, must be reduced by one

minus the tax rate. Finally, the cost of equity financing must be taken into account. The cost of

equity has more conceptual and abstract characteristics because the firm has already received

the financing for their equity and no future payments are required to support that equity.


Therefore, estimating the cost of equity has more to do with the behavior of the stock price in

response to changes in the market and investors attitudes toward risk.

To obtain Barnes Group’s weighted average cost of capital, we added our market

capitalization (Nov. 3; $13.96) of $$744,002,039 to the book value of our

liabilities($885,338,000) to obtain the total value of the firm. Secondly, we took the proportion of

each form of financing and multiplied it by the weighted average cost of the form of financing to

get the weighted average cost of capital before tax (WACCBT). Finally, we decomposed our

WACCBT and multiplied the weighted average cost of debt divided by the total value of the firm

by one minus the tax rate and added it to the weighted average cost of equity to obtain our

weighted average cost of capital after tax.

Cost of Equity(CAPM)

Equity Value/ Firm Value Cost of Debt

Debt Value/ Firm Value

Tax rate WACC(BT) WACC(AT)

22.67% 45.66% 4.90% 54.34% 20.30% 13.01% 12.47%

As mentioned previously, our cost of equity derived through the CAPM model

was 22.67% and our weighted average cost of debt was 4.9%. The tax rate for Barnes

Group in 2007 was 20.3% and the firm is financed by 45.66% equity and 54.34% debt.

After the appropriate weights have been applied, the weighted average cost of capital

before tax is 13.01% and the weighted average cost of capital after tax is 12.47%.

Forecasting

The process of forecasting involves examining past performance across a variety

of metrics in an attempt to forecast future financial statements. Our forecasted financial


statements will be the basis for our subsequent valuation. Inherently, forecasting is

simply our best possible expectation for future performance, based upon historical

trends and rational expectations of market and industry forces. We will forecast the

income statement starting with expectations of future sales growth, and fit these

assumptions into a common size balance sheet reflecting our expectations of various

factors affecting the profitability of the industry, and our firm in particular. At this point

we will be able to ascertain future net income, thus retained earnings (assuming a

constant dividend payout), finally connecting the forecasted income statement to the

balance sheet through the asset turnover metric (sales/assets). This will enable us to

forecast future cash flows and use our findings in our valuation. Forecasting will be

limited to a ten year time horizon and will remain relatively conservative in estimating

changes in profitability and capital structure ratios.

Balance Sheet

Forecasting the balance sheet was especially tricky for our company because of the

changes undergone since 2001 in acquiring distribution and aerospace companies.

Consequently, Barnes group has borrowed heavily and invested in revenue sharing programs in

which they pay participation fees for the right to repair certain General Electric engines. In

order to realistically forecast the investments in intangible assets, we assumed the present

amount of intangible assets would remain constant as well as the balances for goodwill as we

can’t foresee future acquisitions.

In transposing the income statement to the balance sheet, we utilized the asset

turnover ratio to infer total assets because of the consistency in this ratio over time.

Secondly, we forecasted a time series of asset turnover as the company realizes the sales of


their revenue sharing programs. In order to support the increase in sales, current assets

increased in a similar proportion to total assets, while the overall decline in assets relative to

sales is attributed to the stagnant goodwill, and intangible asset accounts.

Income Statement

The income statement is the most important financial statement in prospective

financial statement forecasting because it involves future sales growth and firm/industry

profitability. Various assumptions need to be made regarding sales growth, product mix,

new entrants, pricing and profit margins. These assumptions will be grounded in

business reality and have been fluently explained in our business and industry overview.

We will begin our forecasting by forecasting future sales growth.

Statement of Cash-Flows

Forecasting statements of cash flows is essential to understanding a company’s

financial position in the future. For cash flow from financing activities, we ignored increases

and decreases in long-term debt and instead only accounted for dividends, as they are much

more estimable. For cash flow from investing activities, we focused on the changes in

property, plant and equipment, holding it’s percentage of total assets constant as we

increased assets along with sales. Cash flow from operating activities was forecasted as a

percentage of net income and held constant over the forecasted horizon. Given these free

cash flows, we were able to employ the free cash flow valuation.


Sales Growth

We are currently in the middle of an economic contraction and severe reductions

in corporate profits are expected in the short term. The current turmoil in financial

markets is affecting consumer spending, business spending and accessability to credit

across all borrowers. It is typical to expect durable goods, large purchases that last over

five years, to be postponed until access to credit is restored and interest rates fall.

Although this is the reality for most firms operating in this segment, we feel Barnes

Group is partially recession resistant due to their backlog of aerospace orders and their

exclusive rights to repair certain GE airplane engines. In addition to a large backlog

representing the bulk of the following years’ sales, Barnes Group had relatively small

reductions in sales over the past recession of 2001. Since 2001, Barnes Group has been

shifting its product mix toward higher margin industries, namely, the aerospace

maintenance, repair, overhaul and precision machining segments.


$0.0$50.0

$100.0$150.0$200.0$250.0$300.0$350.0$400.0$450.0$500.0

2003 2004 2005 2006 2007

Aerospace Backlog

Backlog

$mil

$0.0 $100.0 $200.0 $300.0 $400.0 $500.0

2003

2004

2005

2006

2007

Aerospace Backlog

Sales

Backlog

$mil


Profitability

Since 2003, Barnes Group has been engaging heavily in Revenue Sharing

Programs related to the exclusive rights to repair several GE engine families. As a

result, their gross profit margin has been steadily increasing as their sales reflect the

higher-margin engine repair sales. The shift to higher margin products presented a

necessity to use discretion in estimating the extent of the increase in aerospace sales

and the impact this would have to our overall profitability. We decided to continue the

trend at a 50 basis points per year increase in gross profit as a percentage of sales until

reaching a terminal value of 40% (from 38%). This estimate was relatively conservative

and assumed a decrease in the growth rate of new aerospace contracts as the full

effect of the RSP programs is realized.

-20.00%

-15.00%

-10.00%

-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

1999 2000 2001 2002 2003

% Change Barnes / S & P 500

S&P Earnings Barnes Sales


Method of Comparables

The method of comparables is used to value a company that is willingly available

to the everyday investor to make choices. These processes and ratios decide value

based on the comparability to the industry average. The method of comparables does

not give you a precise price per share since it obtains the industry average using

companies that may not be consistent with the company to be valued. On this

comparison, a firm is either under or overvalued. The simplicity of these models is

deceptive for the reason that the models do not do an adequate job at analyzing the

value drivers of the business. We will use the method of comparables ratios and

compare Barnes’ share price as of the valuation. The following graph displays many

common measurable utilized by analysts.

Price 11/3 BPS EPSTTM Div TTM Div FWD G‐EPS EBITDA(m) Float(m) EBITDA/S FCF(m) FCF/S

B 13.96 13.262 2 0.6 0.64 11.59% 229.21 47.38 4.83769523 ‐110.27 ‐

2.3273533

AIT 19.94 12.168 2.16 0.6 0.6 8.04% 166.44 39.07 4.26004607 76.54 1.9590479

LDSH 17.40 16.264999 2.18 0 0 7.22% 59.4 15.88 3.74055416 ‐33.64 ‐

2.1183879

GWW 78.71 27.976 5.92 1.55 1.6 11.79% 908.44 63.55 14.2948859 258.12 4.0616837

TGI 44.01 44.651001 5.031 0.16 0.16 15.79% 198.2 16.12 12.2952854 20.67 1.2822581

AA 11.88 18.754999 2.113 0.68 0.68 28.95% 3970 800.32 4.96051579 ‐2210 ‐

2.7613954

FAST 41.26 7.552 1.83 0.52 0.54 15.81% 481.33 128.01 3.76009687 150.38 1.174752

P/E TTM P/E FWD P/B D/P TTM D/P FWD PEG P/EBITDA P/FCFs

B 6.98 7.1 1.0526316 4.30% 4.58% 0.6022433 2.885671655 ‐

5.9982298

AIT 9.2314815 8.89 1.6387245 3.01% 3.01% 1.1489087 4.680700553 10.178414

LDSH 7.9816514 5.81 1.0697818 0.00% 0.00% 1.1054919 4.651717172 ‐

8.2137931

GWW 13.295608 11.26 2.813483 1.97% 2.03% 1.1277021 5.506164964 19.378663

TGI 8.7477639 6.38 0.9856442 0.36% 0.36% 0.5540066 3.579420787 34.322264

AA 5.6223379 10.71 0.6334311 5.72% 5.72% 0.1942086 2.394912242 ‐

4.3021727


FAST 22.546448 16.83 5.4634534 1.26% 1.31% 1.4260878 10.97312156 35.122307

Average 11.237548 9.98 2.100753 2.05% 2.07% 0.9260676 5.297672879 14.41428

Assume 22.475097 19.96 27.860186 29.206457 30.873035 7.9902296 25.62852682 ‐

33.547123

Average

Price/Earnings Trailing

The price to earnings trailing is a frequently used ratio that computes earnings

per share of previous years and prices of upcoming years. Trailing Price to Earnings

Ratio is calculated by taking the current share price and dividing it by the past twelve

month’s earnings per share. By comparing price and earnings per share for a company,

one can analyze the markets’ stock valuation of a company and its shares relative to the

income the company is actually generating. (Wikipedia)

P/E TTM

B 6.98

AIT 9.231481

LDSH 7.981651

GWW 13.29561

TGI 8.747764

AA 5.622338

FAST 22.54645

Average 11.237548

Assume 22.475097

Average


After calculating an industry average P/E trailing ratio of 11.23, we can then

assume Barnes Group’s fair price. Since the P/E ratio is simply price divided by

earnings, we multiply the 11.23 by the firm’s EPS of 2. We compute the fair price of our

firm to be $22.47. This indicates that shares of company stock may be undervalued.

Price/Book

The Price to Book ratio is primarily used to compare a stock's market value to its

book value. The ratio is calculated by dividing the present closing price of the stock by

the most recent quarter's book value per share. The P/B ratio is of more interest to

value investors than growth investors because it compares the market’s valuation of a

firm to the value of that firm as shown on its financial statements. With these

circumstances, if the ratio is high, the market will be willing to pay a higher premium to

pay for the firm above its hard assets. A lower P/B ratio could mean that the stock is

undervalued and or it could mean that the stock may be a good investment opportunity.

On the other hand, it could unfortunately also mean that something is vitally wrong with

the company.

P/B

B 1.052632

AIT 1.638725

LDSH 1.069782

GWW 2.813483

TGI 0.985644

AA 0.633431

FAST 5.463453


Average 2.100753

Assume 27.860186

Average

To calculate the price to book ratio of each firm, we divided the book value of

equity by the number of shares outstanding. Then, after calculating an average, we

multiplied it by Barnes Group’s book value of equity per share. Using this comparable,

we estimated the firm’s price to be 27.86. This price is nearly twice that of the current

price, making the stock appear to be a bargain.

Price to Earnings Growth

The Price to Earnings Growth is a commonly used indicator of a stock's potential

value. The PEG is favored by many over the price/earnings ratio because it also

accounts for growth, especially if a stock earns a PEG of 1 because it is considered a

sign of good value. The ratio is calculated by taking the firm’s price/earnings ratio and

dividing that by the EPS (earnings per share) growth. Similar to all other ratios, there

are advantages and disadvantages with the use of this PEG ratio. An advantage,

primarily for investors, is that they possibly will favor PEG because it overtly places a

value on the anticipated growth in earnings of a firm. This ratio can present an idea of

whether a company’s high P/E ratio reflects an exceptionally high stock price or is an

indication of promising growth prospects for the firm. A major disadvantage when using

this ratio occurs when a firm is in need of measuring high growth. Large, well-


established firms for example, may propose dependable dividend income, but little

chance for expansion.

PEG

B 0.602243

AIT 1.148909

LDSH 1.105492

GWW 1.127702

TGI 0.554007

AA 0.194209

FAST 1.426088

Average 0.9260676 Assume Average 7.9902296

Based on PEG formulation, we found Barnes Group’s shares to be overpriced.

PEG analysis gave us a stock share price of $7.99, much below our current stock price

of $13.96. This is mainly due to the firm having low expected earnings growth.

Price over EBITDA

The Price over EBITDA (Earnings before Interest, Taxes, Depreciation, and

Amortization) is a ratio that takes a company’s current market capitalization rate and

divides that by the EBITDA. The EBITDA expression is an accounting concept that

conveys the gross profits of a company before the other factor of; depreciation,

amortization, and taxes are measured. The concept of EBITDA differs from cash flow


and working capital, and it is generally used to evaluate company stock. The current

market capitalization is found by taking the company’s number of shares outstanding

and multiplying that with the company’s price per share.

P/EBITDA

B 2.885672

AIT 4.680701

LDSH 4.651717

GWW 5.506165

TGI 3.579421

AA 2.394912

FAST 10.97312

Average 0.9260676 5.297672879

Assume 7.9902296 25.62852682

Average

To determine a price for Barnes Group using P/EBITDA, we had to first get the

market capitalization rates and P/EBITDA for companies used for comparison. Such

information could be found in company 10-K’s and through yahoo finance.

EV/EBITDA

The EV/ EBITDA, (exposure value)/ (Earnings before Interest, Taxes,

Depreciation, and Amortization), ratio is applied when valuing cash-based businesses

and is commonly used to value shares it is assumed that debt, such as bonds, that has

a provable market value is worth its market value. To efficiently calculate this ratio, first

calculate the enterprise value of the firm by taking the market value of equity plus the


book value of liabilities minus cash and investments. Then calculate the firm’s earnings

before interest, tax, depreciation and amortization with the yearly revenues. Lastly,

acquire the computed EV and divide by the EBITDA.

EV/EBITDA

B 5.1563442

AIT 4.8443432

LDSH 6.1943392

GWW 5.8349393

TGI 4.8695940

AA 4.3265339

FAST 10.0210393

Average 5.8875694

Assume 18.454.3235

Average

EV/EBITDA is a very unique method in gauging the fairness of a stock price. This

value takes into account a firm’s book value of liabilities minus cash and investments,

market value of equity, taxes, depreciation, and amortization. Thus, it is quite complex

yet can offer good insight into a firm’s current financial status. Based on utilizing

industry averages to turn around and create a fair value for Barnes Group of $18.45, we

deem the stock to be underpriced currently.

Price to Free Cash Flows

The Price to Free Cash Flows is a valuation that assesses a firm’s market price

to its level of yearly free cash flow. This valuation is calculated by identifying the


market capitalization of the firm and dividing that by the free cash flow. The price to free

cash flows is significant in measuring how well a company’s free cash flows can support

its equity value. Similar to the measure of price-to-cash flow, the price to FCF in reality

demonstrates a much stricter measure of free cash flow. This, in turn, reduces

operating cash flow by capital expenditures. In broad-spectrum, the higher this

measure, the more the firm is thought of to be expensive. It is also useful to evaluate

the company’s past levels of price-to-free-cash flow along with comparing the average

within its industry.

P/FCFs

B ‐5.99823

AIT 10.17841

LDSH ‐8.21379

GWW 19.37866

TGI 34.32226

AA ‐4.30217

FAST 35.12231

Average 14.41428

Assume ‐33.547123

Average

Although at times it presents itself as a very useful measureable, price to cash

flow does not give us an accurate reading on Barnes Group’s assumed price because

of the firms negative cash flows in the past year. With negative cash flows, we get a

negative stock price. Of course this cannot happen because corporations have limited


liability and shareholders are only risking the money they put forth into the firm. A

negative price would indicate more than that.

Dividends/P TTM

The dividends/price ttm ratio is calculated by taking a firm’s dividend per share

over the price per share. The dividend to price model is one that divides the industry’s

firms ‘dividends per share with their present market price, and then generates a mean

from them. The analyst will then divide the valuated company’s dividends per share.

This is an effective way to evaluate a company’s price per share amount.

D/P TTM

B 4.30%

AIT 3.01%

LDSH 0.00%

GWW 1.97%

TGI 0.36%

AA 5.72%

FAST 1.26%

Average 2.05%

Assume 29.206457

This is one of the most popular and easy to understand financial measurable.

However, firms that do not pay dividends do not add any quality information to this ratio

comparison and can distort findings. We disregard these non-dividend paying

companies in order to get a more accurate fair value stock price assessment. Of

course, if you prescribe by the Modigliani-Miller theorem (states dividend policy does

not affect shareholder value in the absence of taxes and bankruptcy while existing in an


efficient market), dividend ratios may not be great sources of stock value information.

With an industry average dividend payout of 2.05%, we calculated a fair share price of

$29.2064. This indicates the stock is current undervalued.

Conclusion

Although they are fun to observe and calculate, financial measurable should

never be trusted as the sole source of stock valuing. In the past, they have proven to

not accurately predict price movement of stocks and often have little merit at all. In fact,

none of the previous comparables are supported by financial theory, which indicates

their credibility. However, it should be noted that most of the measurable deemed

Barnes Group to be undervalued. Although analyst do look at these numbers, it must

again be stressed than they should not be taken as realistic financial observations on

the market, for have no supporting financial theory, are not consistent, and can not be

universally applied to all firms. Barnes Group in particular should not be judged by these

ratios because it delves into several different market segments and fellow competitors

are not identical in business practice. This challenge of industry classification provides

opportunity for distortions in price estimations.

Intrinsic Valuation Models

Intrinsic valuation models discount the expected future cash flows to the present

value and discount them by the appropriate discount rate. In every scenario,

assumptions about future cash flows and growth trends must be made and therefore,

make this as much of an art as it is a science. We employed the discounted free cash


flow model, the discounted dividend model, the residual income model, the long-run

residual income model and the abnormal earnings growth model in order to compare

our results and come to a conclusion as to the intrinsic value of the firm.

Dividend Discount Model

0.00% 4.00% 8.00% 12.00% 16.00%

16.76% $6.79 $7.57 $9.07 $13.09 $59.42

18.73% $5.83 $6.34 $7.24 $9.20 $16.92

20.70% $5.08 $5.43 $6.00 $7.08 $10.03

22.67% $4.48 $4.72 $5.10 $5.75 $7.19

24.65% $3.99 $4.17 $4.42 $4.83 $5.63

26.63% $3.59 $3.72 $3.89 $4.16 $4.64

28.60% $3.26 $3.35 $3.47 $3.66 $3.97

The dividend discount model implies the only value a stock has is the present

value of all future dividend payments. We begin by forecasting sales growth and

assume a slightly decreasing dividend payout ratio until it bottoms out at 20%. Since we

have already forecasted future sales growth, we can imply net income, and thus,

dividends. The future dividends are then brought back to the present value by

multiplying them by 1/1+ke^t. We discount the future dividend payments by the cost of

equity because dividends are paid to shareholders only and the cost of equity is the

return required by shareholders. After we forecast net income as far as we can into the

future without making unreasonable assumptions, we create a perpetuity to account for

all the future dividend payments to infinity and reduce that terminal value to the present

value today. The final step is to sum the perpetuity to the forecasted dividend payments,

all discounted by the cost of equity, and arrive at a share price in today’s dollars.


DPS 0.5

5 0.62

0 0.66

0 0.72

6 0.81

7 0.92

3 1.04

8 1.18

9 1.34

9 1.53

2 1.73

8 1.973

PV Factor 0.81

5 0.665

0.542

0.442

0.360

0.293

0.239

0.195

0.159

0.130

29.581

PV YBY Dividends

0.505

0.439

0.393

0.361

0.332

0.307

0.284

0.263

0.244

0.225 3.834

Discounted Dividends Valuation

In order to account for the inevitable errors in our forecast, we illustrate different scenarios

through a sensitivity analysis, changing the cost of equity and the growth rate of the terminal

perpetuity. The sensitivity analysis showed that out of 35 combinations, 32 showed the stock

as being overvalued, two showed undervaluation and one was fairly valued. According to the

dividend discount model, Barnes Group is overvalued.

Free cash flow model

0% 1% 2% 3% 4%

10.22% $45.56 $49.40 $54.17 $60.26 $68.31

11.47% $37.08 $39.80 $43.10 $47.17 $52.33

12.72% $37.08 $32.36 $34.72 $37.55 $41.04

13.01% $29.01 $30.85 $33.03 $35.65 $38.85

13.30% $27.73 $29.46 $31.49 $33.91 $36.86

13.59% $26.50 $28.11 $30.00 $32.25 $34.96

15.18% $20.65 $21.78 $23.08 $24.60 $26.38

The free cash flow model attempts to value cash flows to the firm and discount them

based upon the weighted average cost of capital before tax. The values are discounted

before tax because tax is already paid on the free cash flows used in the valuation. This

model ignores the return specifically to shareholders and instead focuses primarily on

the cash flows to the firm in general. Although the values derived from this model show

the stock being highly undervalued, we disagree with this assessment. This particular


model ignores the riskiness of Barnes Groups future cash flows and instead uses the

weighted average cost of capital before tax to value the company. This model ignores

the idea that Barnes Group is currently in a transition and is unproven as to their new

business model. In essence, the model doesn’t take into account the risk of the various

outcomes and instead focuses primarily on the expected value of free cash flows. In our

analysis, we choose to ignore this valuation for the aforementioned reasons, and

instead would like to draw attention to the difference risk associated with debt-holders

and shareholders in a firm with high fixed assets that are more valuable to debt-holders

than the shareholders.

Residual income model

-0.1 -0.2 -0.3 -0.4 -0.5 -0.6

16.76% $18.30 $18.22 $18.17 $18.14 $18.12 $18.10

18.73% $15.46 $15.60 $15.69 $15.74 $15.78 $15.81

20.70% $13.19 $13.46 $13.63 $13.74 $13.82 $13.88

22.67% $11.35 $11.69 $11.91 $12.05 $12.16 $12.24

24.65% $9.85 $10.22 $10.46 $10.62 $10.74 $10.83

26.63% $8.62 $9.00 $9.24 $9.41 $9.54 $9.64

28.60% $7.61 $7.97 $8.22 $8.39 $8.52 $8.62

The residual income model values the firm based upon the return it should

produce given the book value of equity and the actual forecasted returns. This model

assumes that a firm cannot outperform, or underperform their cost of equity in the long-

run. Instead of incorporating a perpetuity and grows out to infinity, this model assumes

the cost of equity will eventually equal the net income produced by the book value of

equity. Although this model doesn’t have a perpetuity that grows to infinity, it does


however incorporate a perpetuity with the growth value in the numerator.

Our analysis revealed that out of 42 possible scenarios, 28 showed the stock as

overvalued while 12 showed the stock being undervalued and two were within our range

of fair value. This indicates the stock is currently overvalued at a price of $13.96.

Recommendation

Our analysis indicates the stock of Barnes Group is overvalued at a price of $13.96.

Appendices

Sales Manipulation Diagnostics Tables

Net Sales/Accounts Receivable 2003 2004 2005 2006 2007Barnes Group 7.478 7.159 7.084 6.603 6.811 Alcoa 7.489 7.829 7.825 8.844 10.071Ladish 6.062 5.001 5.182 5.341 5.645Triumph Group 4.975 5.381 5.146 5.470 5.535Grainger 10.806 10.501 10.656 10.384 10.650 Fastenal Co. 7.727 7.621 8.299 8.635 8.724AIT 7.950 8.491 8.210 8.099 8.524


Net Sales/Inventory 2003 2004 2005 2006 2007Barnes Group 8.115 8.094 6.922 6.331 5.832Alcoa 8.520 7.910 7.578 7.984 9.245Ladish 4.104 4.028 3.414 3.460 3.593 Triumph Group 2.942 3.169 3.224 3.103 3.183Grainger 7.058 7.208 6.985 7.112 6.782Fastenal Co. 4.272 4.030 4.213 3.968 4.086AIT 9.505 9.782 9.976 10.076 9.916

Net Sales/Cash from Sales 2003 2004 2005 2006 2007Barnes Group 1.025 1.020 1.015 1.029 1.014Alcoa 1.015 1.005 1.013 1.003 0.988 Ladish 0.986 1.061 1.038 1.050 1.015Triumph Group 1.026 1.008 1.027 1.029 1.030Grainger 1.002 1.010 1.007 1.008 1.006Fastenal co. 1.024 1.028 1.014 1.015 1.013AIT 1.011 1.007 1.016 1.009 0.998

Expense Manipulation Diagnostics Tables

Asset Turnover 2003 2004 2005 2006 2007Barnes Group 1.072 1.072 1.102 0.943 0.935Alcoa 0.678 0.720 0.776 0.817 0.792 Ladish 0.831 0.934 0.901 1.124 1.113Triumph Group 0.650 0.734 0.780 0.777 0.814Grainger 1.778 1.797 1.778 1.932 2.074Fastenal Co. 1.527 1.608 1.712 1.741 1.773AIT 2.542 2.488 2.601 3 2.616


CFFO/OI 2003 2004 2005 2006 2007Barnes Group 1.155 0.969 0.835 0.977 0.790Alcoa 1.456 0.998 0.867 0.748 0.693 Ladish 5.229 0.290 0.311 ‐0.007 0.760 Triumph Group 1.247 1.944 0.720 0.510 0.405 Grainger 1.018 0.925 0.833 0.756 0.699Fastenal Co. 0.671 0 0.455 0.306 0.605AIT 1 0.921 0.604 0.525 0.722

CFFO/NOA 2003 2004 2005 2006 2007Barnes Group 0.390 0.326 0.461 0.545 0.522Alcoa 0.212 0.193 0.151 0.230 0.241 Ladish 0.070 0.027 0.075 ‐0.003 0.276Triumph Group 0.184 0.278 0.170 0.157 0.158Grainger 0.538 0.534 0.561 0.551 0.534Fastenal Co. 0.534 0.297 0.543 0.371 0.824AIT 0.559 1.134 0.987 1.046 1.697

Total Accruals/Change in Sales 2003 2004 2005 2006 2007Barnes Group 0.253 0.200 0.111 0.257 0.106Alcoa 1.202 0.450 0.165 0.076 1.482Ladish ‐0.004 ‐0.052 ‐0.108 ‐0.281 0.135Triumph Group 0.639 0.668 0.000 ‐0.004 ‐0.082Grainger 7.230 0.312 0.181 0.149 0.091Fastenal Co. 0.073 ‐0.302 ‐0.158 ‐0.354 ‐0.019AIT 0.221 0.128 ‐0.013 ‐0.133 0.197

Liquidity Tables

Current Ratio 2003 2004 2005 2006 2007Barnes Group 1.62 1.50 1.47 1.56 1.51Alcoa 1.33 1.19 1.19 1.26 1.13Ladish 2.56 2.23 1.86 3.06 2.75Triumph Group 3.10 2.47 2.58 2.69 2.92Grainger 2.31 2.65 2.75 2.64 2.18Fastenal Co. 7.45 7.56 7.09 7.39 6.39AIT 2.93 2.90 2.96 2.56 3.08


Industry 3.28 3.17 3.07 3.27 3.07

Quick Asset Ratio 2003 2004 2005 2006 2007Barnes Group 1.05 0.95 0.85 0.89 0.80Alcoa 0.83 0.72 0.72 0.74 0.66Ladish 1.33 1.11 0.91 1.28 1.17Triumph Group 1.40 0.98 1.06 1.06 1.20Grainger 1.38 1.59 1.66 1.47 1.03Fastenal Co. 3.63 3.24 3.14 3.00 2.73AIT 1.87 1.94 1.95 1.70 2.01Industry 1.74 1.60 1.58 1.54 1.47

Working Capital Turnover 2003 2004 2005 2006 2007Barnes Group 7.45 8.92 9.12 7.58 8.13Alcoa 12.99 19.65 18.40 16.19 33.42Ladish 3.25 3.68 3.75 2.98 3.25Triumph Group 2.39 3.22 3.10 2.99 2.85Grainger 5.04 4.62 4.35 5.09 6.59Fastenal Co. 2.53 2.65 2.73 2.73 2.78AIT 5.20 4.97 5.14 5.51 5.11Industry 5.23 6.46 6.24 5.92 9.00

A/R Turnover 2003 2004 2005 2006 2007Barnes Group 7.48 7.16 7.08 6.60 6.81Alcoa 8.53 8.57 8.97 9.72 11.82Ladish 6.06 5.00 5.18 5.34 5.64Triumph Group 4.98 5.38 5.15 5.47 5.53Grainger 10.81 10.50 10.66 10.38 10.65Fastenal co. 7.73 7.62 8.30 8.65 8.72AIT 7.95 8.49 8.30 8.10 8.52Industry 7.67 7.60 7.76 7.94 8.48

Days Sales Outstanding 2003 2004 2005 2006 2007Barnes Group 48.81 50.98 51.53 55.28 53.59Alcoa 42.79 42.57 40.69 37.57 30.89Ladish 60.21 72.98 70.44 68.34 64.66Triump Group 73.37 67.83 70.93 66.72 65.95Grainger 33.78 34.76 34.25 35.15 34.27Fastenal Co. 47.24 47.89 43.98 42.18 41.84AIT 45.91 42.99 43.98 45.07 42.82


Industry 50.55 51.50 50.71 49.17 46.74

Inventory Turnover 2003 2004 205 2006 2007Barnes Group 5.25 5.33 4.43 4.01 3.62Alcoa 6.79 6.27 6.15 6.13 7.29Ladish 3.88 3.68 2.95 2.83 3.01Triumph Group 2.20 2.38 2.39 2.24 2.27Grainger 4.58 4.49 4.25 4.27 4.03Fastenal Co. 2.17 2.00 2.12 1.98 2.01AIT 6.99 7.19 7.28 7.33 7.21Industry 4.43 4.34 4.19 4.13 4.30

Days Supply Inventory 2003 2004 2005 2006 2007Barnes Group 69.46 68.53 82.39 91.06 100.93Alcoa 53.76 58.17 59.39 59.56 50.07Ladish 94.14 99.19 123.59 128.95 121.30Triumph Group 166.20 153.16 153.03 162.86 160.54Grainger 79.68 81.35 85.82 85.55 90.55Fastenal Co. 168.04 182.65 172.45 184.60 181.59AIT 52.25 50.76 50.15 49.77 50.60Industry 102.34 104.21 107.40 111.88 109.11

Cash to Cash Cycle 2003 2004 2005 2006 2007Barnes Group 118.28 119.51 133.91 146.34 154.51Alcoa 96.55 100.74 100.07 97.13 80.95Ladish 154.35 172.17 194.03 197.29 185.96Triumph Group 239.57 220.98 223.96 229.58 226.48Grainger 113.46 116.11 120.07 120.70 124.83Fastenal Co. 215.27 230.54 216.44 226.78 223.43AIT 98.16 93.75 94.13 94.83 93.41Industry 152.89 155.72 158.12 161.05 155.85

Profitability Ratio Tables

Gross Profit Margin 2003 2004 2005 2006 2007Barnes Group 35.25% 34.19% 35.99% 36.69% 37.99%Alcoa 20.30% 20.68% 18.89% 23.24% 21.14%


Ladish 5.52% 8.65% 13.50% 18.19% 16.25%Triumph Group 25.36% 24.81% 26.01% 27.78% 28.56%Grainger 35.10% 37.76% 39.11% 40.01% 40.57%Fastenal Co. 49.16% 50.41% 49.77% 50.17% 50.81%AIT 26.51% 26.49% 27.04% 27.21% 27.25%Industry 26.99% 28.13% 29.05% 31.10% 30.76%

Operating Expense Ratio 2003 2004 2005 2006 2007Barnes Group 0.2941 0.2857 0.2813 0.2740 0.2740Alcoa 0.6022 0.0547 0.0517 0.0462 0.0479Ladish 0.0485 0.0494 0.0457 0.0493 0.0393Triumph Group 0.1470 0.1552 0.1442 0.1440 0.1384Grainger 0.2681 0.2906 0.2972 0.3019 0.3012Fastenal Co. 0.3554 0.3363 0.3215 0.3248 0.3256AIT 0.2312 0.2137 0.2095 0.2051 0.1993Industry 0.2754 0.1833 0.1783 0.1785 0.1753

Operating Profit Margin 2003 2004 2005 2006 2007Barnes Group 5.84% 5.62% 7.87% 9.29% 10.59%Alcoa 14.28% 15.21% 13.72% 18.63% 16.35%Ladish 0.67% 3.72% 8.94% 13.26% 12.32%Triumph Group 60.19% 4.86% 7.38% 9.50% 10.97%Grainger 8.30% 8.70% 9.39% 9.83% 10.45%Fastenal Co. 13.58% 16.73% 17.58% 17.68% 18.26%AIT 3.39% 5.12% 6.08% 6.70% 7.31%Industry 0.1674 0.0906 0.1052 0.1260 0.1261

Net Profit Margin 2003 2004 2005 2006 2007Barnes Group 3.71% 3.36% 5.49% 5.86% 7.04%Alcoa 4.36% 5.58% 4.71% 7.40% 8.34%Ladish 0.01% 1.80% 5.14% 7.71% 7.60%Triumph Group 3.00% 1.66% 4.54% 4.93% 5.84%Grainger 4.86% 5.68% 6.27% 6.52% 6.55%


Fastenal Co. 8.45% 10.58% 10.95% 11.00% 11.28%AIT 2.07% 3.22% 3.80% 4.27% 4.57%Industry 3.79% 4.75% 5.90% 6.97% 7.36%

Asset Turnover 2003 2004 2005 2006 2007Barnes Group 1.3618 1.1973 1.1873 1.2598 1.0771Alcoa 0.7214 0.7404 0.8022 0.9016 0.8269Ladish 0.7968 0.9634 1.1945 1.2475 1.2922Triumph Group 0.7039 0.7357 0.8109 0.9794 0.9365Grainger 1.9147 1.9240 1.9671 1.8931 2.1070Fastenal Co. 1.7798 1.9009 1.9778 2.0329 1.9844AIT 2.7412 2.8769 2.7541 2.7565 2.6879Industry 1.4430 1.5235 1.5844 1.6352 1.6391

Return on Assets 2003 2004 2005 2006 2007Barnes Group 5.06% 4.02% 6.52% 7.39% 7.58%Alcoa 3.15% 4.13% 3.78% 6.67% 6.90%Ladish 0.01% 1.73% 6.14% 9.62% 9.83%Triumph Group 2.11% 1.22% 3.68% 4.83% 5.47%Grainger 9.31% 10.93% 12.33% 12.33% 13.79%Fastenal Co. 15.05% 20.10% 21.66% 22.36% 22.39%AIT 5.69% 9.27% 10.48% 11.77% 12.28%Industry 5.89% 7.90% 9.68% 11.26% 11.78% Return on Equity 2003 2004 2005 2006 2007Barnes Group 15.86% 10.38% 17.70% 18.69% 19.50%Alcoa 9.45% 10.85% 9.27% 16.81% 17.52%Ladish 0.02% 3.22% 11.20% 24.25% 21.15%Triumph Group 3.68% 2.22% 6.55% 8.35% 10.72%Grainger 13.61% 15.55% 16.75% 16.75% 19.29%Fastenal Co. 16.83% 22.71% 24.37% 25.40% 25.23%AIT 10.22% 16.30% 18.38% 20.74% 21.17%Industry 8.97% 11.81% 14.42% 18.72% 19.18%

Growth Rates/Z-Score Tables Internal Growth Rate 2003 2004 2005 2006 2007


Barnes Group 2.43% 1.80% 4.38% 4.93% 5.41%Alcoa 1.41% 2.48% 2.17% 5.13% 5.32%Ladish 0.01% 1.73% 6.14% 9.62% 9.83%Triumph Group 2.11% 1.22% 3.68% 4.63% 5.26%Grainger 6.53% 8.19% 9.33% 9.11% 10.05%Fastenal Co. 12.20% 15.46% 15.55% 15.59% 16.03%AIT 4.03% 7.14% 7.89% 8.90% 8.98%Industry 4.38% 6.04% 7.46% 8.83% 9.25%

Sustainable Growth Rate 2003 2004 2005 2006 2007Barnes Group 7.62% 4.65% 11.94% 12.48% 13.90%Alcoa 4.25% 6.51% 5.33% 12.92% 13.53%Ladish 0.02% 3.22% 11.20% 24.25% 21.15%Triumph Group 3.68% 2.22% 6.55% 8.00% 10.30%Grainger 9.61% 11.71% 12.77% 12.49% 14.22%Fastenal Co. 13.64% 17.46% 17.51% 17.70% 18.07%AIT 7.24% 12.55% 13.84% 15.68% 15.47%Industry 6.41% 8.94% 11.20% 15.17% 15.46%

Z‐Scores 2003 2004 2005 2006 2007

Barnes Group 3.6484 3.1031 3.5811 2.5878 2.2805

Grainger 7.2050 8.8885 8.7199 8.4576 8.8581

Triump 2.3161 2.4453 2.5644 2.5904 2.9756

Alcoa 2.2911 2.2244 1.5189 2.4659 2.4074

Capital Structure Ratio Tables

Debt to Equity 2004 2005 2006 2007

Barnes 1.72 1.51 1.57 2.50

GWW 0.42 0.36 0.40 0.47

Triumph 0.82 0.78 0.73 0.96


Ladish 0.36 0.38 0.35 0.27

AIT 0.76 0.75 0.76 0.72

Alcoa 1.35 1.52 1.54 1.42

Fastenal 0.13 0.14 0.13 0.15

Times Interest Earned 2004 2005 2006 2007

Barnes 7.96 7.40 2.85 2.7

GWW 2.82 45.60 95.15 102.15

Triumph 5.83 13.31 23.20 5.72

Ladish 4.54 3.23 ‐0.02 4.91

AIT 0 0 0 0

Alcoa 4.20 29.40 2.02 2.35

Fastenal 0 0 0 0

Debt Service Margin 2004 2005 2006 2007

Barnes 3.63 4.35 4.94 6.06

GWW 265.76 286.92 314.10 230.27

Triump 4.89 4.44 4.47 5.98

Ladish

AIT 3.10 2.79 21.48 24.08

Alcoa 8.16 6.70 9.94 12.20

Fastenal 0.00 0.00 0.00 0.00

Weighted Average Cost of Debt

Current liabilities Debt Interest Rate Weight WACD

Notes Payable 7,322 2.74 0.83% 0.00

Accounts Payable 187,136 2.74 21.14% 0.58

Accrued Liabilities 107,202 2.74 12.11% 0.33


Current portion of Long Term Debt 42,660 2.74 4.82% 0.00

Total Current Liabilities 344,320

Long term Debt 384,482 5.91 43.43% 0.03

Other Liabilities 156,586 2.74 17.69% 0.00

Total Liabilities 885,388 100% 0.94


References

1. Wikipedia.org 2. Sec.gov 3. Investopedia.com 4. Barnes Group 10K 5. Ladish 10K 6. AIT 10K 7. Grainger 10K 8. Alcoa 10K 9. Fastenal 10K 10. Triumph 10K 11. Aia.aerospace.org (Aerospace Industries Association) 12. aia-aerospace.org/ 13. Dr. Moore’s Notes Finance 3321 14. Yahoo Finance 15. Wall Street Journal 16. Mymrp.com 17. BIZWIZ.COM

Documents

Barnes Group Equity and Valuation Analysismmoore.ba.ttu.edu/ValuationReports/Fall2008/BarnesGroup-Fall2008.pdf · Balance Sheet ..... 116 Income Statement ..... 117 ... firm’s worth