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Project analysis in chocolate confectionery industry: evidence from Macedonia

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 PROJECT ANALYSIS IN CHOCOLATE CONFECTIONERY
INDUSTRY: EVIDENCE FROM MACEDONIA

Dimche LAZAREVSKI1
Aleksandra KARADZA2
Daniela KARADZA3
Marija ANASTASOVSKA4

ABSTRACT
The aim of this paper is to construct a model for evaluation of a new established company
in the chocolate confectionery industry in emerging countries such as Macedonia. We begin with
distribution of a questionnaire to participants of a different age and profile across eight different
cities throughout Macedonia. Second, we analyze the industry profile so that we get reliable data
concerning the business climate and opportunities for opening a new chocolate factory. Then, we
use the one-year projected Income Statement and Cash Flow Statement to construct discounted free
cash flow model and calculate project’s Net Present Value and Internal Rate of Return.
Based on the forecasting variables and the financial projections, the project generates
positive NPV and high Internal Rate of Return despite the large investment needed for establishing
chocolate factory.

KEY WORDS: Project Analysis, Economic and Financial Analysis, Chocolate Confectionery
Industry, Emerging Markets, Macedonia

JEL: D61, L66, O22, R34,

1. INTRODUCTION

The aim of this paper is to perform project analysis for establishing a new company
in the chocolate confectionery industry in Macedonia. We will use Net Present Value
(NPV) and Internal Rate of Return as investment criteria for evaluation of the examined
project. For the purpose of this analysis, we prepare short business plan in order to give
more detail picture of all the variables needed when evaluating the project.
As a new business, company we examine will be competing in the food sector, i.e.
chocolate confectionery industry in Macedonia. According to our market analysis, the best

1
Assistant Professor, University American College Skopje, School of Business Economics
and Management, Skopje, Macedonia
2
MBA student, University American College Skopje, School of Business Economics and
Management, Skopje, Macedonia
3
MBA student, University American College Skopje, School of Business Economics and
Management, Skopje, Macedonia
4
MBA student, University American College Skopje, School of Business Economics and
Management, Skopje, Macedonia
place for establishing the factory is Macedonia’s capital city periphery, which is nearby to
both the capital of the country, as well as the major distribution centers. We predict that the
company will need 44 employees working in different company divisions: Production,
Packaging, Depot and Delivery department, along with one Financial and one Marketing
manager.
Company’s core business will consist of production and trade of a wide range of
delicious chocolate products, aimed for satisfying the needs of domestic middle-class and
business customers. The company will offer a diversified product portfolio, consisted of a
variety of chocolate bars with different tastes: milk, hazelnut, rise crisps, dried fruits and
chili. In the first couple of years of its establishment, the company will be working towards
creating a strong distribution network throughout the country.
Valuation process plays key role in determining investments and meeting financial
goals. As such, it is necessary in determining whether to invest in a particular company or
project, in determining the fair market value for selling the business, for planning of
mergers, acquisition or stock offering, for setting up and Employee Stock Ownership Plan
etc. (Lazarevski and Gilevska (2013)). Using already established discounted cash flow
valuation procedures, we will adjust our model to encounter the characteristics of
Macedonia as emerging market economy.
Emerging markets companies show a large volatility in returns as compared with
similar companies in a more stable, mature and developed environment. Pereiro (2002)
concludes that “Volatility means more risk; more risk means less business value in an
unpredictable arena” (p.36). Furthermore, according to Pereiro (2002) emerging markets
are such economies where conditions and regulations for stable operating of the money and
capital differ markedly from the familiar conditions of developed markets. Emerging
markets offer a wealth of opportunities to investors. On the other side, these markets
characterize with both risks and opportunities such that sound valuation analysis are
indispensable, thus providing a frontier where analysts could add a lot of value.

2. LITERATURE REVIEW

The emerging markets have become substantially important in shaping the global
economy, thereby attracting investors from the developed countries. Stoica (2002) finds
that the main attraction of emerging capital markets relies on the relatively high return
opportunities and their potential for future growth. In addition, he explains that in those
economies considered as emerging capital markets by their level of development, the
annual growth rate is high, currency controls are relaxed, there is frequent privatization, and
the internal and external debt is in restructuring.
According to IFC and World Bank Macedonia in 2012 was on the very high 22nd
place for ease of doing business, and 23th in 2013 out of 185 economies in the world, which
is better than most developed countries. Bruner et al. (2003) argues that emerging financial
markets offer interesting investment opportunities, particularly on a direct investment basis
and therefore deserve research attention in their own right.
A recent research paper on “Chocolate Confectionery: Industry Profile: Europe”
(MarketLine (2013), p.20) has indicated that, with the purpose of starting operations within
the chocolate confectionery market, relatively high levels of capital investments are needed
especially for the establishment of production facilities. It is so regarding to the fact that a
majority of chocolate confectionery products are subject to high volume production in order
to be profitable. Nevertheless, there also exists an opportunity for a small-scale entrance on
the market, which can best be achieved through implementing a production of high- value,
low-volume products in a craft process. Therefore, since a great deal of the already existing
brands on the market have created value, recognition, as well as consumers who may not be
willing to switch their consumption away from their preferred brand, there exists a
somewhat weakened threat for entrance of new companies on the chocolate confectionary
market.
According to Rajaram and Zhili (2009), the chocolate confectionery company will
have to operate at a lower margin, owing to the presence of competitors in this industry in
Macedonia, among which the biggest ones are: “Kraškomerc LLC Skopje”, “EVROPA-
Skopje” and “Swisslion LLC Skopje”.
According to the State Statistical Office of Macedonia, the manufacture of food
products constituted 11.47 % of the total industrial production in the country. Therefore, it
indicates that Macedonian’ food production industry has good prospects for growth and
development in the following years. According to “Research and Markets”, US chocolate
confectionery market had total revenues of $17,664.1 million in 2011.

3. METHODOLOGY AND DATA

For the purpose of preparing the business plan and making an analysis of the
opportunities and threats for entering the chocolate confectionery industry in Macedonia,
first we made the market research. For the market entry strategy, we have formulated a
questionnaire composed of 10 multiple-choice and open-ended questions. We distributed it
to both the retail (age 18-65) and business customer segments (age 21-69) located in the
cities of Skopje, Veles, Prilep, Ohrid, Bitola, Strumica, Gostivar and Kavadarci in order to
see whether potential customers would like to try out and later on start consuming new
chocolate products.
For the project analysis, we use the project Net Present Value formula, stated in
Brealey et al., (2009).

Where PV is the today’s value of future cash flows that the project will generate, and I is
the initial amount of money put in order to start the business.
PV calculation is:

Where FV is the expected future cash flow of the project on an annual basis, i.e. correspond
to cash flows in years: 1, 2, 3, etc., r is the discount rate used for discounting the future cash
flows each year and t is the number of periods.
 Project cash flow (PCF) contains three elements: (1) the Cash flow from Operations
(CFO), (2) the Cash flow from Investments in fixed assets (CFI), and (3) the Cash flow
from changes in working capital (CF∆WC). PCF calculation is:

The CFO represents the cash generated from the everyday business operations. CFO
calculation is:

Where NP is company’s net profit, A is the amortization and D is depreciation.

The CFI is the cash spent on purchasing, building and selling plant and equipment.
The CF∆WC represents cash spent on investments in inventories of raw materials or
unfinished goods, as well as on payment of unpaid customer bills. The Working Capital
(WC) is equal to the difference between the Current Assets and Current Liabilities.
For the discount rate r, we use the Weighted Average Cost of Capital (WACC) as
calculated by Lazarevski and Mrsik (2013) for Macedonian company ZK Pelagonija AD
Skopje that belongs in the food industry of 16.63%. The calculation is:

Where D is market value of debt, Tc is the corporate tax rate, V is the market value of the
company, Rd is the cost of debt, Е is the market value of equity and Re is the required rate
of return.
In calculation of WACC Lazarevski and Mrsik (2013) use their own created
modified CAPM formula:

Where, Re is the company required rate of return, RfL is the local risk free rate of return of
euro denominated sovereign bonds, Rc is the country risk premium, βLG is the local
company beta, RmG is the global market return, RfG is the global risk free rate, and Rv is the
relative company volatility.
According to Damodaran (2005) perpetuity’ growth rate should be less or equal to
the growth rate in the economy: nominal growth rate if the cost of capital is in nominal
terms or real growth rate if the cost of capital is in real terms. We determine the growth rate
according to the GDP real growth rate of the country of 3.36% (1998 – 2011 (Macedonian
State Statistical Office). We assumed the growth rate to be 3% for the first four years of
operations (2014-2017), 5% for the following three years (2018- 2020), and after 2021, 8%.
For the assumed long-term sustainable growth rate (after 2024), we assume 4%.
Concerning the financial projections, we prepare the quarterly multistep Income
Statement for the first year and based on these assumptions, we make the projections for the
following 10-year period. Each item on this financial statement we calculate as a
percentage from Total Revenues. We project the Initial Revenues at the level of €1,000,000
for the first year (1% market share in Macedonia). Cost of goods sold (COGS) we project
to be 34%, and Selling, General, and Administrative expenses (SG&A) 18% from the
revenues for the completely projected period. Depreciation and Amortization we project to
be 10% from Initial investment since we expect this equipment to last 10 years. Capital
expenditure except for the initial investments we projected to be 10% from revenues for the
completely projected period. The New Net Working Capital (the firm's ability to finance
additional sales without incurring additional debt) we calculate as a difference between
cumulative working capital of two consecutive years. Cumulative working capital we
calculate as sum of the inventories (as a percentage from expenditures) and receivables (as
a percentage from revenues). The Income tax rate applicable in Macedonia is 10%.
We also prepare projected Common-size Income Statement, where Initial investment
is consisted of purchase of land, building of the production plant, purchase of three
machines and five trucks. The completely initial investment amounts to €1.140.000
(€100.000 for 2000m2 of land, € 600.000 for the production plant, €400.000 for the
machines, and €40.000 for the purchase of trucks). We assume trucks and machines to have
an expected useful life of 10 years.

4. RESULTS AND DISCUSSION OF THE MAIN FINDINGS

Based on the survey results, we can conclude that 65% of all 400 participants
declared that they would like to try out some new chocolate products made in Macedonia,
since they love consuming chocolates with high percentage of quality cocoa, enriched with
unique ingredients (dried fruits, rise crisps and chili). The remaining 35% of the
participants suggested not entering Macedonian chocolate industry, since they would not
like to switch their consumption away from the already existing products offered from
existing competitors. On the other hand, the children were eager to try out the chocolates
with rise crisps, i.e. the crunch chocolate, since they thought it would be fun to eat
something, which is crunchy. Furthermore, the participants in the survey have suggested
the production of those types of chocolates, which they could give as a gift to their loved
ones, family, friends and business partners for different occasions as: birthdays, proms,
graduation, weddings, new business deals, etc.
Based on the market analysis, we concluded that there are favorable economic
conditions prevailing in Macedonia for establishing a new chocolate confectionery
company. Inflation rate is favorable, which according to KPMG Macedonia averaged 3.3%
in 2012, government debt is only 34% from GDP, and the corporate tax rate is only 10%,
among the lowest figures in Europe. Governmental institutions’ support and efforts
regarding the paperwork needed for business registration in the Tax Revenue Service,
Agency for Real Estate Cadaster, Central Registry and the Business Community in
Macedonia, also goes ahead with this conclusion.
Company that is subject of this analysis should offer a diversified product portfolio,
consisted of chocolate bars produced with 40% quality cocoa powder with different flavors
(milk, hazelnut, rise crisps, dried fruits and chili). It should market and serve the products
to the middle-class consumers, (families with children from the age of 8-14, couples at the
age of 22-28) and the business customers. The company should strive to deliver value-
based chocolate confectionery products by placing a great emphasis on the quality of the
product itself, and its ability to satisfy the customer needs at an affordable price.
The manufacturing process should be set up in accordance with the international
confectionery standards, thus meeting the most stringent quality requirements. Company
should take special care about implementation of the food safety and quality standards of
the products by monitoring the raw materials used in the production process, the process
itself, the distribution channels and the end chocolate products sold on the market. The
company should be working towards implementation of the Food Safety Management
System ISO 22000:2005, consisting of: the Quality Management System, HACCP (Hazard
Analysis and Critical Control Point) system and the pre-conditioned programs for
controlling and reducing the food safety problems to an acceptable level (EVROPA Skopje
Official Website). This way the company will keep up with the latest trends regarding the
production of chocolate confectionery products, thereby ensuring a well-developed value
chain, safe and quality production, and continuous investment in knowledge, skills and new
technological developments.
The most important difference with existing competitors on the Macedonian market
is the usage of a high percentage of cocoa and specific ingredients in the production of
chocolates. The main companies operating on the Macedonian chocolate confectionary
market are “Kraškomerc LLC Skopje”, “EVROPA - Skopje”, “Swisslion LLC Skopje”,
“Nestlé Adriatik Macedonia” and “Kraft Foods” with its Milka brand. “Kraškomerc LLC
Skopje” represents a commercially dependent company through which “Kraš” - Croatia
sells its products on the Macedonian market since 1991. This company with its Dorina
brand has maintained the first market position (14% value share in 2011) and corporate
image, along with long-established tradition, 21 year-experience, and well established
customer relationships (Kraškomerc Skopje Official Website). “EVROPA - Skopje” is
holding a very strong position on the market, due to its long-term tradition of producing
chocolate confectionery products, since 1882 (127 years), implementation of “one shot”
technology for chocolate casting and heavy investments in computerization and equipment
of Western Europe (EVROPA Skopje Official Website). “Swisslion LLC Skopje” is being
an empire in the production of food with quality and health standards. It is implementing
the SL technology in its production processes, combined with highly automated technology
(Swisslion Skopje Official Website). “Kraft Foods” and its Milka brand managed to take
the second market position (2011) – 13 % market share, followed by “Nestlé Adriatik
Makedonija” with 9%, due to the increased product offering implemented and the
significant demand of its products (Kit Kat, Lion, Nesquik, Nestlé Gourmand and Nestlé
Snack) in volume terms (Euromonitor International).
According to the Macedonian State Statistical Office, in 2011 there have been a
total of 702 tons of filled chocolate blocks, slabs or bars with cream, liqueur or fruit paste;
excluding chocolate biscuits produced in the Manufacture of food products sector, followed
by a decline of 643 tons in 2012. In addition, produced were 359 tons of chocolate blocks,
slabs or bars with added cereal, fruit or nuts (excluding filled, chocolate biscuits) 2011,
dropping to 354 tons in 2012. This suggests that despite the negative trends regarding the
production of chocolate bars in Macedonia, there exists a positive environment for
establishing a domestic chocolate confectionery company. Macedonians, in general, want
to consume quality chocolate products, enriched with a high percentage of cocoa, at an
affordable price, thus being in accordance with their disposable income and preferences.
We establish the prices by making comparisons with existing competitors, and established
according to the value-based principle.
Company may face with barriers to entry on the Macedonian confectionery market
in terms of long-term competitors’ experience, and high investment costs. In order to
succeed company should consider the opportunity for expanding its business operations in
the Adriatic region after 5-10 years of presence on the Macedonian chocolate confectionery
market.
For chocolate products’ promotion, the company should focus on B 2 C (Business
to customers) marketing (billboard, TV and radio advertisements, as well as Internet and
social media advertising (Facebook, Twitter, MySpace, LinkedIn) in order to increase the
brand awareness and attract new customer segments).
Using the discount cash flow analysis and projected variables described in Data
part, we calculate project’s Net Present Value and Internal Rate of Return. Based on the
results, more detail presented in Table 1, with discount rate of 16.63% our project has
positive Net Present Value of more than €1.8 million. Projects’ Internal Rate of Return, that
equates NPV with zero, is 41.35 %.

Table 1
Discounted Free Cash Flow Model

Discounted Free Cash Flow Model

2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023
Total revenue 1.000.000 1.030.000 1.060.900 1.092.727 1.125.509 1.181.784 1.240.873 1.302.917 1.407.151 1.519.723 1.641.300
Cost of Goods Sold 340.000 350.200 360.706 371.527 382.673 401.807 421.897 442.992 478.431 516.706 558.042
Gross profit 660.000 679.800 700.194 721.200 742.836 779.978 818.976 859.925 928.719 1.003.017 1.083.258
SG&A 180.000 185.400 190.962 196.691 202.592 212.721 223.357 234.525 253.287 273.550 295.434
EBITDA 480.000 494.400 509.232 524.509 540.244 567.256 595.619 625.400 675.432 729.467 787.824
Deprec. and Amort. 114.000 114.000 114.000 114.000 114.000 114.000 114.000 114.000 114.000 114.000 114.000
EBIT 366.000 380.400 395.232 410.509 426.244 453.256 481.619 511.400 561.432 615.467 673.824
State Income Taxes 36.600 38.040 39.523 41.051 42.624 45.326 48.162 51.140 56.143 61.547 67.382
NOPAT 329.400 342.360 355.709 369.458 383.620 407.931 433.457 460.260 505.289 553.920 606.442
Add back Depr.&Amort. 114.000 114.000 114.000 114.000 114.000 114.000 114.000 114.000 114.000 114.000 114.000
Subtract Capital Exp. -1.140.000 -103.000 -106.090 -109.273 -112.551 -118.178 -124.087 -130.292 -140.715 -151.972 -164.130
Subtract New Net WC -222.530 -6.676 -6.876 -7.082 -8.443 -12.580 -13.209 -15.863 -23.461 -25.338 -27.365
Free Cash Flow -919.130 346.684 356.743 367.103 376.626 391.172 410.161 428.105 455.113 490.610 528.947
Terminal value 4.119.967
PV at 16.63% -919.130 297.251 262.261 231.397 203.549 181.266 162.964 145.841 132.934 122.869 998.272
NPV 1.819.474
(Source: Author’s own creation and calculation)

5. CONCLUSIONS AND RECOMMENDATIONS

Based on the survey results, country, industry and company analysis, and performed
economic and financial analysis, we can conclude that establishment of a chocolate
confectionery company in Macedonia and produce unique, quality chocolates with
differentiable taste, is a profitable opportunity. Using the forecasted variables and projected
one year Income Statement and Cash Flow Statement, we determine positive Net Present
Value of the project of above €1.8 million using the discounted free cash flow analysis.
Internal Rate of Return is 41.29 %, which makes this opportunity a highly profitable one.
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