Dawson Lumber Company Limited

Objective

National Bank of Canada (“NBC” or “the Bank”) is tasked with the decision to review Dawson Lumber Company Limited’s (“Dawson”) request for an increase in its line of credit up to the amount of $10.8mm. Dawson intends to finance inventory and receivables with the line of credit. NBC must remain cognizant of the competitive landscape of the lumber industry and assess whether a focus on the retail segment is beneficial to Dawson’s strategic plan. Given that Dawson is one of the region’s largest borrowers, NBC must be careful in how it manages this relationship. The Bank cannot afford to turn away NBC’s business. However, extending Dawson additional credit may increase Dawson’s default risk and jeopardize the potential for NBC to retrieve the $4.2mm term loan it is already owed.

Industry Analysis

Canadian Lumber Industry Analysis

The Canadian lumber industry can be seen as very unattractive at best. Expected oversupply of Canadian lumber, increased competition in the industry, and greater buyer power, have put downward pressure on prices, adversely affecting the profitability of producers.

With an increase in the number of many small and medium lumber producers, competing to sell a commoditized product, the industry has become very fragmented. The combination of these factors and the slow industry growth in recent years has led to a high degree of rivalry among producers, resulting in a fall in lumber prices. As lumber producers were forced to compete on price, buyers reaped the benefits. The high level of buyers’ information and their low switching cost has added to their high negotiation power relative to the producers. Restrictive governmental actions along with the high power of buyers, and high degree of rivalry have made the industry unattractive. Additionally, due to the large initial investment in fixed assets with high specialization required for this industry, lumber firms are locked in and cannot easily exit the industry, further intensifying competition.

Canadian Retail Hardware and Home Improvement Industry Analysis

This industry, although more attractive than the lumber industry, has its own inherent flaws . The Canadian retail hardware and home improvement industry can be characterized by high degree of rivalry, mainly due to a large number of players competing over products of low differentiation and incurring high fixed costs. Furthermore, due to low switching costs, high information, and price sensitivity, buyers are not loyal and have high bargaining power relative to retailers. Additionally, the medium threat and power of large new entrants and suppliers adds to the industry’s unattractiveness.

Company Overview

Dawson was founded in the 1870’s and has remained a private business since inception. Located in Ontario, Canada, its operations have been focused on three regions: Ottawa, primarily an urban market, Cornwall, a rural market, and Kingston, partially a resort and partially an urban market.

During the last 3 years Dawson’s net sales have increased considerably (21% in 1997; and 38% in 1998) putting great pressure on the way the company finances its working capital (“WK”). This situation is intensified by seasonal sales, typical of the construction industry. In September of 1998, Dawson pursued a strategy of forward integrating into the retail segment of the lumber value chain expanding operations into the hardware retail segment in order to stabilize current operations .

Financial Analysis of the Company’s Projections

In Dawson’s request to increase its current credit line from $5mm to $10.8mm NBC was presented with projections for the coming year. Sales are projected to increase by 65% to $54mm, 4.2% higher than NBC’s estimation maintaining Dawson’s current business model. While Dawson’s relationships with its contractors have allowed for accurate sales predictions, in the past it has significantly underestimated its sales and capital expenditures required for its retail segment. NBC understands that the retail market represents an opportunity for growth and a chance at diversification from the seasonal lumber industry; however it feels that Dawson has neglected to consider the changing competitive landscape. An expected decline in lumber prices would suggest a reduction in forecasted lumber sales beyond 1999. Increased competition from large chains also poses a threat to Dawson’s retail sales projections and margins.

In light of the industry outlook for both sectors, Dawson’s capital expenditure projection of $1.1mm (1.9% and 2.4% of expected sales from lumber and retail, respectively) appears to be low, considering