Upload
others
View
3
Download
0
Embed Size (px)
Citation preview
Vol.6, No.4, October-December 2017
13
Abstract
The objective of this paper to find out the justified price multiples of HUL, ITC Ltd and
Nestle India using prices calculated on the basis of absolute valuation techniques like dividend
discount models and free cash flow models and comparing these with the current multiples of
these companies. The inputs were taken from the annual reports of the above companies for
understanding the outlook on the companies' business and the expected trends going forward.
Based on all these, the justified multiples using FCF and DDM were calculated and compared
with the current market multiples of the companies.
Keywords: Dividend Discount Models, Free Cash Flow Models, Current Multiples, HUL,
ITC and Nestle.
1.0 Introduction
The fast moving consumer goods (FMCG) segment is the fourth largest sector in the Indian
economy. The market size of FMCG in India is estimated to grow from US$ 30 billion in 2011 to US$
74 billion in 2018. According to the study conducted by AC Nielsen, 62 of the top 100 brands are
owned by MNCs, and the balance by Indian companies. Fifteen companies own these 62 brands, and
27 of these are owned by Hindustan UniLever.
2.0 Back Ground of the Companies
2.1 Hindustan Unilever Ltd
Hindustan Unilever Limited (HUL) is an Indian consumer goods company based in Mumbai,
Maharashtra. It is owned by Anglo-Dutch company, Unilever which owns a 67% controlling share in
HUL.
HUL was established in 1933 as Lever Brothers and, in 1956, became known as Hindustan
Lever Limited, as a result of a merger between Lever Brothers, Hindustan Vanaspati Mfg. Co. Ltd. and
* Assistant Professor Faculty of Management StudiesUniversity of DelhiDelhi 110007 Email id: [email protected]
** Assistant Professor Shaheed Sukhdev College of Business Studies University of Delhi Email: [email protected]
Comparison of Price Multiples using DDM, DCF and
Current Market Multiples of FMCG Companies
– Dr. AnjalaKalsie*
– Dr. Ashima Arora**
SUMEDHA Journal of Management
14
United Traders Ltd. It is headquartered in Mumbai, India and employs over 16,500 workers, whilst
also indirectly helping to facilitate the employment of over 65,000 people. The company was renamed
in June 2007 as "Hindustan Unilever Limited".
HUL's products include foods, beverages, cleaning agents and personal care products.
Financial position as of March 2014:
• Operating profit margin - 15.73%
• Net profit margin - 13.23%
• ROCE - 140.03
• Current ratio - 0.77
• Quick ratio - 0.46
• Debt to equity ratio - 0.01
2.2 ITC (Indian Tobacco Company)
ITC Limited or ITC is an Indian conglomerate headquartered in Kolkata, West Bengal. Established
in 1910 as the Imperial Tobacco Company of India Limited, the company was renamed as the Indian
Tobacco Company Limited in 1970 and further to I.T.C. Limited in 1974. The company completed
100 years in 2010 and as of 2012-13, had an annual turnover of US$8.31 billion and a market capitalisation
of US$45 billion. Its diversified business includes five segments: Fast Moving Consumer Goods (FMCG),
Hotels, Paperboards & Packaging, Agri Business & Information Technology.
Financial position as of March 2014:
• Operating profit margin - 36.95%
• Net profit margin - 24.5%
• ROCE - 47.54%
• Current ratio - 1.3
• Quick ratio - 0.7
• Debt to equity ratio - 0.01
2.3 Nestle India
Nestlé S.A. is a Swiss multinational food and beverage company headquartered in Vevey,
Switzerland. It is the largest food company in the world measured by revenues. Nestle India is a
subsidiary of Nestle S. A. of Switzerland. Nestle started its Indian journey in 1912 by entering the dairy
business.
Vol.6, No.4, October-December 2017
15
Nestle's product segments include milk products and nutrition, beverages, prepared dishes,
chocolates and confectioneries.
Financial position as of March 2014:
• Operating profit margin - 21.39%
• Net profit margin - 12.16%
• ROCE - 47.79%
• Current ratio - 0.65
• Quick ratio - 0.39
• Debt to equity ratio - 0.5
FMCG brands would need to focus on R&D and innovation as a means of growth. Companies
that continue to do well would be the ones that have a culture that promotes using customer insights
to create either the next generation of products or in some cases, new product categories.
3.0 Objective and Methodology Followed
The objective of this paper to find out the justified price multiples of HUL, ITC Ltd and Nestle
India using prices calculated on the basis of absolute valuation techniques like dividend discount
models and free cash flow models and comparing these with the current multiples of these companies.
As each of the above companies was into multiples business segments, the valuation was done
on a SOTP basis (sum of the parts basis) by forecasting the growth trends in each of the business
segments of the companies (based on the growth drivers and corporate actions) and summing them.
The absolute valuation method followed was based on its suitability to the companies' business model.
3.1 Methodology
3.1.1 Free Cash Flow model
In corporate finance, free cash flow to firm (FCFF) is a way of looking at a business's cash
flow to see what is available for distribution among all the securities holders of a business entity. This
may be useful to parties such as equity shareholders, debt capital holders, preferred shareholders,
convertible security holders, and so on when they want to see how much cash can be extracted from
a company without causing issues to its operations.
The free cash flow can be calculated in a number of different ways depending on objective and
what accounting information is available. A common definition is to take the earnings before interest
after taxes, add depreciation & amortization, and then subtract any changes in working capital and
capital expenditure. Depending on the objective, a number of refinements and adjustments may also be
made to try to eliminate distortions.
SUMEDHA Journal of Management
16
The free cash may be different from the net income for a particular accounting period, as the
free cash flow takes into account the expenditure of capital goods and the expenditure required in
working capital.Free cash flow measures the ease with which businesses can grow and pay dividends
to shareholders. Cash flows can be negative even for profitable business.
The free cash flow can be calculated as:
EBIT*(1-Tax rate) + Non-cash charges - Changes in working capital - Capital expenditure =
Free Cash Flow
According to the discounted cash flow valuation model, the intrinsic value of a company is the
present value of all future free cash flows, plus the cash proceeds from its eventual sale known as
terminal value. The presumption is that the cash flows are used to pay dividends to the shareholders.
Some investors prefer using free cash flow instead of net income to measure a company's
financial performance, because free cash flow is more difficult to manipulate than net income. The
problems with this presumption are itemized at cash flow and return of capital.
3.1.2 Free Cash Flow to equity model
In corporate finance, free cash flow to equity (FCFE) is a method which evaluates how much
cash can be distributed to the equity shareholders of the company as dividends or buybacks of stock-
after payment of all expenses, reinvestments, and debt repayments. Whereas dividends are the cash
flows actually paid to shareholders, the FCFE is the cash flow simply available to shareholders.The
FCFE is usually calculated as a part of DCF or LBO modelling and valuation. The FCFE is commonly
known as the levered free cash flow.
Assuming there is no preferred stock outstanding:
FCFE = FCFF + Net Borrowing - Interest*(1-t)
where
• FCFF is the free cash flow to firm;
• Net Borrowing is the difference between debt principals paid and raised;
• Interest*(1-t) is the firm's after-tax interest expense.
Arguably the best reason to like DCF is that it gives the closest value to an intrinsic stock value.
3.1.3 Dividend discount model
The dividend discount model (DDM) is a method of valuing a company's stock price based on
the theory that its stock is worth the sum of all of its future dividend payments, discounted back to
their present value. The equation most widely used is called the Gordon growth model. It is named
after Myron J. Gordon of the University of Toronto, who originally published it along with Eli Shapiro
in 1956 and made reference to it in 1959.
Vol.6, No.4, October-December 2017
17
The equation for DDM is as follows:
P = (D1/(r-g))
Where P is the current stock price. g is the constant growth rate in perpetuity expected for the dividends.
r is the constant cost of equity capital for the company. D1 is the value of the next year's dividends.
The maindrawback of this method is that it cannot provide a value for a company unless it pays
dividends. In today's market, the vast majority of companies do not pay a regular dividend. Many
companies instead choose to focus on growth and reinvest their profits into the company. According
to this model, the stocks of those companies would not be worth anything. However, in practice a lot
of these companies are very valuable and profitable.
Another drawback of this model is that one has to make many assumptions in order for the
formula to work. One has to predict whether a company will continue to pay the same dividend, or
whether it will continue paying dividends at all. If theses assumption goes wrong or does not work
formula becomes worthless.
3.1.4 Equity Valuation: The ComparableApproach
The basic essence of the comparable approach is that an equity's value should bear some
resemblance to other equities in a similar industry. For a stock, this can simply be determined by
comparing a firm to its key rivals, which are comparable in terms on net worth or sales revenue.
Discrepancies in the comparable values between similar firms could spell opportunity.
Common market multiples include the following: enterprise value to sales (EV/S), price to earnings
(P/E), enterprise multiple,price to book (P/B) and price to free cash flow (P/FCF). To get a better
indication of how a firm compares to rivals, analysts can also look at how its margin levels compare.
The concept behind relative valuation is that the value of a company is determined in relation to
how similar companies are priced in the market. A typical method to do a relative valuation on a
publicly listed company is a follows:
• Creating a list of comparable companies (comparable in terms of sales or rnetworth), often
industry peers, and obtain their market values.
• Converting these market values into comparable trading multiples, such as P/E, price-to-book,
enterprise-value-to-sales and EV/EBITDA multiples.
• Comparing the company's multiples with those of its peers to assess whether the firm is overvalued
or undervalued.
The main advantages of multiples are that they are relatively easy to use.Like any valuation tool,
relative valuation has its limitations. The biggest limitation is the assumption that the market has valued
the company correctly. To the degree that markets can be over or under valued in the aggregate,
SUMEDHA Journal of Management
18
relative valuation will fail.A carefully designed DCF, by contrast, should help investors to identify
companies that look inexpensive against expensive peers.
Although DCF analysis certainly has its merits, it also has its own limitation. DCF valuations
can fluctuate wildly which depends upon the assumptions that one believes about how a company will
operate and how the market will respond to those assumptions.Inputs like- free cash flow forecasts,
discount rates and perpetuity growth rates - are not realistic, the fair value generated through DCF for
the company won't be accurate and it is of no use for assessing stock prices.
DCF works best when there is a high degree of confidence about future cash flows. But things
can get problematic when it's difficult to predict sales and cost trends with much certainty. While
forecasting cash flows a few years into the future is hard enough, pushing results into infinity -
terminal value (which is a necessary input) is nearly impossible.
4.0 Analysis and Interpretation
4.1 Hindustan Unilever Limited
HUL is into 5 business segments, as mentioned earlier, viz:
• Soaps and detergents
• Personal care products
• Processed foods
• Beverages
• Other business segments (Pureit, etc)
Split-up of HUL's standalone revenue amongst the 5 segments:
Vol.6, No.4, October-December 2017
19
Average EBIT margins across the segments
On a standalone basis, HUL's revenue for the financial year 2013-14 was INR 28,947.06 crores.
HUL's standalone revenues account for approx. 95% of its consolidated revenues (using the data for
the past 6-7 years). Hence, forecasts were made for the standalone figures and were converted to the
consolidated figures by using the conversion factor of 0.95.
Quarterly segment revenue growth trends (year-on-year basis):
HUL has a regular dividend payout policy with the payout ratio being close to 70% (average
figures) and these are reliably related to the earnings. Hence, dividend discount model is applicable for
calculating the HUL's stock price.
SUMEDHA Journal of Management
20
Tab
le 1
Pro
jecte
d P
/L A
cco
un
t F
igu
res
in c
rore
s
Vol.6, No.4, October-December 2017
21
Table 2
Margins Soaps &
Detergents Personal
care Processed foods Beverages
EBIT 13% 25% 6% 17%
Segments Revenue split up 2014 figures Forecasts Rationale
Soaps and detergents
48% 13,894.59 9%-14%
Expected to perform better owing to consumer spending, and mix improvements… pricing would also play a key role here
Personal care 30% 8,684.12 ~12%
Expecting a pick up in this segment owing to improved consumer spending
Processed foods 8% 2,315.76 8% slightly bearish here
Beverages 12% 3,473.65 10% expecting lipton to do better
Others 2% 578.94 9% A low base effect would translate into high growth…
Assumptions under DCF
1. Depreciation is 1% of topline
2. Tax rate is assumed to be 25%.
3. Standalone revenue is 95% of consololidation.
4. HUL cost of capital is 10%, cost of debt is zero as there is no debt. The cost of equity capital is 10%.
5. Working capital is assumed to be 1.5% of sales.
6. Capex assumed to be 1% of sales.
7. Total numbers of shares outstanding 216.33 cr
As per the figures available on Bloomberg, the cost of equity capital is 10% which is also the
cost of total capital, as HUL has a very low debt to equity ratio. Other than the dividend discount
model, the FCF (Free cash flow model) was also used to calculate the stock price of HUL. For
calculating the free cash flow, it was observed that HUL has negative working capital and this decrease
in working capital was found out to be around 1.5% of the sales of the company. This was the figure
used to calculate the working capital decrease for each of the segments. Similarly, the net capital
expenditure was found out to be around 1% of sales and this was used to calculate the net capex was
each of the segments. Depreciation was found out to be 1% of sales and tax rate was close to 25%.
SUMEDHA Journal of Management
22
HUL has a history of regular dividend payment which reflects the company earnings. Dividend
payout ratio is approximately 70%. This favours the use of DDM for arriving the values of multiplies.
Table 3 Forecasted Revenue Segmentwise
Forecasted revenues segment-wise
2014 2015 2016 2017 2018 2019 2020
Soaps and detergents 13,894.59 15,284.05 17,118.13 19,514.67 21,466.14 23,398.09 25,503.92 Personal care 8,684.12 9,726.21 11,087.88 12,751.06 14,281.19 15,566.50 16,967.48
Processed foods 2,315.76 2,547.34 2,853.02 3,252.45 3,707.79 4,041.49 4,364.81
Beverages 3,473.65 3,821.01 4,203.11 4,707.49 5,272.39 5,799.62 6,263.59
Others 578.94 631.05 687.84 749.75 817.22 890.77 970.94
Table 3 (a) FCFF Segmentwise
FCFF segment-wise 2014 2015 2016 2017 2018 2019 2020 Terminal
Soaps and detergent 1,702.09 1,872.30 2,096.97 2,390.55 2,629.60 2,866.27 3,124.23 65,608.83
Personal care 1,932.22 2,164.08 2,467.05 2,837.11 3,177.57 3,463.55 3,775.27 79,280.57
Processed foods 185.26 203.79 228.24 260.20 296.62 323.32 349.18 7,332.88
Beverages 564.47 620.91 683.01 764.97 856.76 942.44 1,017.83 21,374.51
Others 28.95 31.55 34.39 37.49 40.86 44.54 48.55 1,019.49
Total of PVs 4,892.63 5,008.79 5198.60 5260.27 5218.30 5163.00 98,566.34
Total of PV1,29,307.92 for FCFF . The firm value is rupees1,36,113.60 discounted at 10% of
cost of equity. As HUL has very low debt, firm value is as good as equity value.The value per share
HUL (using FCFE) is rupees 629.19 .
The growth rates for the different segments were estimated based on the historic quarterly
growth rates and the outlook on the business. Given that the FMCG sector in India is currently seeing
a slowdown, the growth rates estimated were a bit conservative for all the companies. The growth
rates are dependent on various factors like product mix, consumer spending, current price levels, etc.
The soaps and detergents segment of HUL was not witnessing robust growth lately and grew only by
6% y-o-y in 3QFY15. With the economy expected to do a better and possible increase in consumer
spending, this segment would be able to grow at least 9-10% yearly for the next 4-5 years. New
product launches would and price hikes would also help the growth. The personal care segment of
HUL did quite well in 2QFY15 and 1QFY15 with sales growth above 9% in both quarters. It did not do
as well in 3QFY15, managing just 6.5% growth. However, for the same reasons as with the soaps and
detergent segment, the segment can expected to clock close to 12% growth for the next 4-5 years.
The beverages segment is also expected to show 10%+ growth rate for the next 4-5 years while
processed foods might be able to grow by atleast 8%. Price hikes are expected in the processed foods
segment. The others segment which includes products like Pureit can grow at 9+% for the next 4-5
years.
Vol.6, No.4, October-December 2017
23
The terminal growth for all the above segments was assumed to be around 5% assuming that
the Indian economy would grow at this rate in the long run.
Table 4 Forecasted Revenue Segmentwise
DDM model segment wise 2014 2015 2016 2017 2018 2019 2020
Terminal value
Soaps and detergents 13894.59 15284.05 17118.13 19514.67 21466.14 23398.09 25503.92 - Personal care 8684.12 9726.21 11087.88 12751.06 14281.19 15566.50 16967.48 -
Processed foods 2315.76 2547.34 2853.02 3252.45 3707.79 4041.49 4364.81 -
Beverages 3473.65 3821.01 4203.11 4707.49 5272.39 5799.62 6263.59 - Others 578.94 631.05 687.84 749.75 817.22 890.77 970.94 - Total dividend PVs 22406.76 22877.27 23704.78 23952.90 23760.35 23501.58 278586.57 Sum of Total dividend PVs 440831.799
Per share value 2037.77
For calculating the stock price using the dividend discount models, the method similar to above
was followed, except that the earnings were multiplied with the factor of 75% which reflects the
dividend payout ratio. Adjustments were not made for the capex and working capital and the dividends
were discounted at the cost of equity capital of HUL (which is 10%).
The stock prices calculated by the methods discussed above were then divided by the past
years EPS, sales per share as well book value per share (HUL has 2163 million shares outstanding) to
get the respective ratios.
Table 5 Multiples
Multiples according to FCCF
P/E 26.43
P/S 4.47
P/B 41.53
Multiples according to DDM
P/E 85.60
P/S 14.47
P/B 134.52
Current market multiples
P/E 48.87
P/S 4.4
P/B 57.59
SUMEDHA Journal of Management
24
4.2 ITC Ltd
ITC Ltd is into 5 main business segments as mentioned earlier, viz:
• Cigarettes
• Non-cigarettes FMCG
• Hospitality
• Agri-business
• Paper and packaging
Split-up of ITC's standalone revenue amongst the 5 segments:
Average EBIT margins across the segments
Vol.6, No.4, October-December 2017
25
On a standalone basis, ITC's revenue for the financial year 2013-14 was INR 48175.8 crores.
ITC's standalone revenues account for approx. 95% of its consolidated revenues (using the data for
the past 6-7 years). Hence, forecasts were made for the standalone figures and were converted to the
consolidated figures by using the conversion factor of 0.95, (similar to HUL).
Quarterly segment revenue growth trends (year-on-year basis):
ITC has a regular dividend payout policy with the payout ratio being close to 60% (average
figures) and these are reliably related to the earnings. Hence, dividend discount model is applicable for
calculating the ITC's stock price.
Table 6 Consolidated Profit & Loss account
Particulars Mar '14 Mar '13 Mar '12 Mar '11 Mar '10
Sales Turnover 35,317.08 31,627.54 26,525.43 22,574.70 27,764.55
Excise Duty 0 0 0 0 8,214.66
Net Sales 35,317.08 31,627.54 26,525.43 22,574.70 19,549.89
Other Income 970.95 877.6 784.35 536.1 563.66
Stock Adjustments 112.74 256.84 85.74 272.72 -467.68
Total Income 36,400.77 32,761.98 27,395.52 23,383.52 19,645.87
Expenditure
Raw Materials 13,597.83 12,602.30 9,970.96 8,656.51 7,077.17
Power & Fuel Cost 644.96 579.98 476.74 446.64 410.37
Employee Cost 2,504.24 2,145.63 1,935.11 1,708.50 1,467.89
Other Manufacturing Expenses 0 0 0 0 422.31
SUMEDHA Journal of Management
26
Particulars Mar '14 Mar '13 Mar '12 Mar '11 Mar '10
Selling and Admin Expenses 0 0 0 0 2,278.56
Miscellaneous Expenses 5,630.90 5,382.13 5,018.58 4,366.98 1,142.93
Preoperative Exp Capitalised 0 0 0 0 -75.31
Total Expenses 22,377.93 20,710.04 17,401.39 15,178.63 12,723.92
Operating profits 13,051.89 11,174.34 9,209.78 7,668.79 6,358.29
PBDIT 14,022.84 12,051.94 9,994.13 8,204.89 6,921.95
Interest 6.37 87.18 80.5 70.93 73.54
PBDT 14,016.47 11,964.76 9,913.63 8,133.96 6,848.41
Depreciation 964.92 859.11 745.48 699.09 643.9
Other Written Off 0 0 0 0 0
Profit Before Tax 13,051.55 11,105.65 9,168.15 7,434.87 6,204.51
Extra-ordinary items 0 0 0 0 50.49
PBT (Post Extra-ord Items) 13,051.55 11,105.65 9,168.15 7,434.87 6,255.00
Tax 4,060.93 3,412.07 2,845.76 2,365.45 2,043.62
Reported Net Profit 8,990.62 7,693.58 6,322.39 5,069.42 4,210.78
Minority Interest 109.81 96.38 75.53 61.1 48.84
Share Of P/L Of Associates -10.57 -10.87 -11.28 -9.61 -6.24
Net P/L After Minority Interest
& Share Of Associates
8,891.38 7,608.07 6,258.14 5,017.93 4,118.29
Total Value Addition 8,780.10 8,107.74 7,430.43 6,522.12 5,646.75
Preference Dividend 0 0 0 0 0
Equity Dividend 4,771.91 4,148.46 3,518.29 3,443.47 3,818.18
Corporate Dividend Tax 822.77 705.97 571.68 559.57 635.1
Vol.6, No.4, October-December 2017
27
Table 7
Margins Cigarettes FMCG Hotels Agri Paper
EBIT 65% 6% 8% 10% 18%
Segments Revenue split up 2014 figures Forecasts Rationale
Cigarettes 43% 20715.594 8-10%
The impact of tax hikes will adversely affect volumes… however, ITC can pass on the increased cost to the customers to maintain the growth… expecting it to be around 10% in the near term
FMCG 22% 10598.676 11%+
For the same reasons as HUL, expecting good growth here… Cause of concern is the EBIT margins
Hotels 3% 1445.274 8%
Boost in the tourism industry and consumer spending might help this segment… at best, 8% growth… new resort opened might also help
Agri 18% 8671.644 10% Quite volatile…
Paper 14% 6744.612 8-10% recovery expected
Assumptions under DCF
1. Depreciation is 2% of topline
2. Tax rate is assumed to be 30%.
3. Standalone revenue is 95% of consololidation.
4. ITC cost of capital is 10%, cost of debt is zero as there is no debt. The cost of equity capital is
10%.
5. Working capital is assumed to be 3% of sales.
6. Capex assumed to be 6% of sales.
7. Total numbers of shares outstanding 7995.44 mn
ITC has a history of regular dividend payment which reflects the company earnings. Dividend
payout ratio is approximately 60%. This favours the use of DDM for arriving the values of multiplies.
SUMEDHA Journal of Management
28
Table 8 Forecasted revenues segment-wise
Forecasted revenues
segment-wise 2014 2015 2016 2017 2018 2019 2020
Cigarettes 20715.59 22580.00 24612.20 27073.42 29510.02 32165.927 35060.86
FMCG 10598.68 11764.53 13058.63 14886.84 16970.99 18668.093 20534.903 Hotels 1445.27 1546.44 1654.69 1770.52 1912.16 2065.14 2230.35
Agri 8671.64 9538.81 10492.69 11541.96 12696.15 13965.769 15362.346 Paper 6744.61 7351.63 8013.27 8734.47 9607.91 10568.706 11519.89
Per share value 493.19
Table 9 : FCFF segment-wise
FCFF segment-wise
2014 2015 2016 2017 2018 2019 2020 Terminal
Cigarettes 7975.50 8693.30 9475.70 10423.27 11361.36 12383.88 13498.43 267421.75 FMCG 339.16 376.46 417.88 476.38 543.07 597.38 657.12 13018.353
Hotels 52.03 55.67 59.57 63.74 68.84 74.34 80.29 1590.7016
Agri 433.58 476.94 524.63 577.10 634.81 698.29 768.12 15217.419 Paper 647.48 705.76 769.27 838.51 922.36 1014.60 1105.91 21909.527
Total of PVs 10308.13 10196.781 10174.995 10082.89573 9977.7827 9867.6651 177236.15 Firm value
(also equity value due to low debt)
253025.96
Per share value 316.48
As with the case of HUL, the growth rate in revenue of ITC's business segments depends on
factors like consumer spending, product mix, current price levels etc. Given that around 43% of the
company's revenue comes from cigarettes, and that the volumes in the cigarettes business are decreasing
due to tax hikes and price hikes being passed onto customers, ITC's earnings would definitely be
impacted. ITC is looking to increase its revenue from the non-cigarette FMCG business and is looking
at an ambitious figure of 1 lakh crore by 2030 in this segment. However, that said, ITC's margins are
below 5% in this segment but for the purpose of valuation, it has been assumed that ITC is able to
improve its EBIT margins by cutting costs and increasing prices. In fact, in Q3 of FY15, the non-
cigarette FMCG business registered a 11.4% growth in sales. Given the recovery expected in the
economy and the improving consumer sentiment, coupled with product launches expected and capex
investments made for the non-cigarette FMCG segment, ITC is expected to post a modest 8-9%
growth in the cigarettes segment over the next 4-5 years while posting a robust 12+% growth in the
non-cigarette FMCG segment over the same period. The improving economy might see higher levels
of spending and hence a revival is expected in the hospitality and tourism industry, propelled by higher
expected occupancy rates. Also, one of ITC's hotels, a premium luxury resort near Gurgaon started
operations in Q3FY15. Hence, a growth rate of at least 9% is expected in the hospitality segment over
the next 4-5 years. The agri and paper business are also expected to do well in the next 4-5 years,
Vol.6, No.4, October-December 2017
29
posting around 10-11% growth. Going by the trends, ITC's working capital investments and capital
expenditures are expected to be around 3% and 6% respectively of the turnover for each of the
segments, though the capex in the case of non-cigarette FMCG business is expected to be higher,
owing to ITC's ambitious 1 lac crore turnover target by 2030.
As with HUL, the terminal growth for all the above segments was assumed to be around 5%
assuming that the Indian economy would grow at this rate in the long run.
Table 10DDM model segment wise
DDM model segment wise
2014 2015 2016 2017 2018 2019 2020
Cigarettes 20715.59 22580.00 24612.20 27073.42 29510.02 32165.927 35060.86
FMCG 10598.68 11764.53 13058.63 14886.84 16970.99 18668.093 20534.903
Hotels 1445.27 1546.44 1654.69 1770.52 1912.16 2065.14 2230.35
Agri 8671.64 9538.81 10492.69 11541.96 12696.15 13965.769 15362.346
Paper 6744.61 7351.63 8013.27 8734.47 9607.91 10568.706 11519.89
Total dividend PVs
31668.84 31458.65 31566.69 31610.20 31389.10 31131.49
Terminal value 205499.85
Sum of total dividends PV and TV 205499.85
Value per share 493.19
For calculating the stock price using the dividend discount models, the method similar to above
was followed, except that the earnings were multiplied with the factor of 60% which reflects the
dividend payout ratio. Adjustments were not made for the capex and working capital and the dividends
were discounted at the cost of equity capital of ITC (which is 10.3%).
The stock prices calculated by the methods discussed above were then divided by the past
years EPS, sales per share as well book value per share (ITC has 7995 million shares outstanding) to
get the respective ratios.
Table 11 Multiples
Multiples according to DCFE
P/E 27.36 P/S 4.99
P/B 9.64 Multiples according to DDM
P/E 42.64
P/S 7.78 P/B 15.02
Current market multiples P/E 28.69
P/S 7.4 P/B 9.9
SUMEDHA Journal of Management
30
4.3 Nestle India Ltd
Nestle India is into 4 business segments viz:
• Milk products and nutrition
• Beverages
• Prepared dishes
• Chocolates and confectioneries
Split-up of Nestle's revenues amongst the 4 segments:
Nestle's EBIT margins (all the segments together) are around 19%. As data was not specifically
available for the margins for each of the segments, it was assumed that the EBIT margins across all the
segments are 19%.
Nestle India does not have any subsidiaries and hence the standalone figures would be the firm
figures as well.
Vol.6, No.4, October-December 2017
31
Yearly segment revenue trends:
Nestle India revenue growth (%):
As can be seen from the above graph, Nestle'stopline growth has declined over the years, and
the drop has been all the more steep in the past year. Even in FY 14, the topline growth in Q1, Q2 and
Q3 were pretty tepid (single digit growth).
SUMEDHA Journal of Management
32
Table 12 Standalone Profit & Loss account
Particulars Dec '13 Dec '12 Dec '11 Dec '10 Dec '09
Sales Turnover 9,101.05 8,614.15 7,682.22 6,382.78 5,232.59
Excise Duty 0 287.6 191.4 122.57 90.69
Net Sales 9,101.05 8,326.55 7,490.82 6,260.21 5,141.90
Other Income 96.9 31.03 12.35 27.25 14.26
Stock Adjustments -105.32 100 56.93 83.67 6.3
Total Income 9,092.63 8,457.58 7,560.10 6,371.13 5,162.46
Expenditure
Raw Materials 4,059.29 3,909.06 3,671.64 3,168.18 2,478.94
Power & Fuel Cost 385.38 370.89 295.81 219.2 158.87
Employee Cost 741.5 663.38 546.46 433.44 432.38
Other Manufacturing Expenses 0 115.07 120.49 110.91 94.05
Selling and Admin Expenses 0 0 1,200.14 1,026.88 839.22
Miscellaneous Expenses 1,861.98 1,542.81 159.07 130.66 115.98
Preoperative Exp Capitalised 0 0 0 0 0
Total Expenses 7,048.15 6,601.21 5,993.61 5,089.27 4,119.44
Operating profits 1,947.58 1,825.34 1,554.14 1,254.61 1,028.76
PBDIT 2,044.48 1,856.37 1,566.49 1,281.86 1,043.02
Interest 36.51 26.6 9.06 1.07 1.4
PBDT 2,007.97 1,829.77 1,557.43 1,280.79 1,041.62
Depreciation 329.95 277.15 153.33 127.75 111.27
Other Written Off 0 0 0 0 0
Profit Before Tax 1,678.02 1,552.62 1,404.10 1,153.04 930.35
Extra-ordinary items 0 0 0 0 0
PBT (Post Extra-ord Items) 1,678.02 1,552.62 1,404.10 1,153.04 930.35
Tax 560.89 484.69 426.38 326.45 261.97
Reported Net Profit 1,117.13 1,067.93 961.55 818.66 655
Total Value Addition 2,988.86 2,692.15 2,321.97 1,921.08 1,640.50
Preference Dividend 0 0 0 0 0
Equity Dividend 467.62 467.62 467.62 467.62 467.62
Corporate Dividend Tax 79.47 75.86 75.39 77.2 79.47
*Nestle financial year from Jan to Dec
*Based on the dividend payment history, DDM wont work for Nestle India
DPS is constant, not DPR
Vol.6, No.4, October-December 2017
33
Table 13
Margins Milk
Products/Nutrition Beverages
Prepared dishes
Choc and confectioneries
EBIT 19% 19% 19% 19%
Segments Revenue split up 2014 figures Forecasts Rationale
Milk Products /Nutrition 43% 40333.57 10%
consumer spending, etc
Beverages 15% 14069.85 11%-14% this might continue doing well
Prepared dishes 28% 26263.72 12% same as first
Choc and confectioneries 14% 13131.86 8%-9%
combination of consumer spending, mix and price hikes
Assumptions under DCF:
1. Depreciation is 2.5% of topline
2. Tax rate is assumed to be 30%.
3. Cost of capital is 10%, cost of debt is zero as there is no debt. The cost of equity capital is 10%.
4. Working capital is assumed to be 4% of sales.
5. Capex assumed to be 4% of sales.
6. Total numbers of shares outstanding 96.42 mn
The dividend discount model is not applicable to Nestle as the dividend payout ratios have varied
quite a lot over the years, from 83.52% in 2009 to 41.85% in 2013.
Table 14Forecasted revenues segment-wise
Forecasted revenues
segment-wise 2014 2015 2016 2017 2018 2019 2020
Milk Products/Nutrition 40333.57 44366.93 48803.62 53195.95 57983.58 62042.4312 66385.40139
Beverages 14069.85 15476.84 17024.52 18726.97 20599.67 22659.6341 24925.59754
Prepared dishes 26263.72 28890.09 31779.10 35592.59 40575.56 45444.6232 49989.0855
Choc and confectioneries 13131.86 14445.05 15745.10 17004.71 18365.08 19834.2916 21421.03491
SUMEDHA Journal of Management
34
Table 15 FCFF segment-wise
FCFF segment-wise 2014 2015 2016 2017 2018 2019 2020 Terminal
Milk Products/Nutrition 1915.84 2107.43 2318.17 2526.81 2754.22 2947.02 3153.31 66219.44 Beverages 1167.80 1284.58 1413.04 1554.34 1709.77 1880.75 2068.82 43445.32 Prepared dishes 2048.57 2253.43 2478.77 2776.22 3164.89 3544.68 3899.15 81882.12 Choc and confectioneries 1089.94 1198.94 1306.84 1411.39 1524.30 1646.25 1777.95 37336.86 Total of PVs
6844.37 6833.47 6833.69 6876.93 6842.90 6767.56 129198.90
DCFF/DCFE 170197.82 Per share value 1765.17
Despite the milk products and nutrition segment not doing well in FY 13 and 14, growth can be
expected due to new product launches and price increases, to compensate for the low volume growth
in this segment. The growth can be expected to be around 9-10% over the next 4-5 years. The
beverages segment can be expected to do well, clocking around 10-11% growth over the next 4-5
years. The chocolates and confectioneries segment faces stiff competition from Cadbury and Britannia.
However, recent product launches like premium chocolate alpino and kit kat senses helped to some
extent but overall, the growth in this segment has been moderate. A growth of around 8-9% over the
next 4-5 years is expected. The prepared dishes segment is doing reasonably well thanks to Maggi and
related products and can be expected to grow at around 12% over the next 4-5 years. Maggi has
however been facing stiff competition from Top Ramen and ITC's Yippee noodles lately. Price hikes
can be expected in this segment. The investments in working capital and capital expenditures were
each found to be around 4% of the revenues. Also, Nestle India has 96.42 mn shares outstanding.
As with HUL and ITC, the terminal growth has been assumed to be 5% while Nestle India's cost
of capital is 10%.
Table 16 Multiples
Multiples according to DCFE
P/E 15.24
P/S 1.81
P/B 7.19
Current market multiples
P/E 59.4
P/S 5.4
P/B 29.66
Based on the analysis, table 17 shows the multiples obtained for the three companies.
Table 17
Company Using DCFE Using DDM Current multiples
P/E P/S P/B P/E P/S P/B P/E P/S P/B
HUL 26.43 4.47 41.53 88.63 14.47 134.52 48.87 4.4 57.59
ITC 27.36 4.99 9.64 42.64 7.78 15.02 28.69 7.4 9.9
Nestle India 15.24 1.81 7.19 NA NA NA 59.4 5.4 29.66
Vol.6, No.4, October-December 2017
35
5.0 Conclusion
As seen above, the value of the multiples calculated using the DCF method is lesser than the
current market multiples. The same is not the case with using the DDM method, which yields higher
figures than the current multiples.
One of the main reasons for the lower multiples using the DCF method include the conservative
revenue growth forecasts. Given that the FMCG sector in India is currently facing a slowdown and
the volume growth in the FMCG sector is on the lower side, the current multiples of the companies are
quite expensive and corrections can be expected in their prices. Hence, the recommendation here
would be a sell verdict until these stock prices reduce to their justified prices.
Given that the FMCG sector in India is overpriced with price multiples on the higher side, the
justified price multiples play a very important role in giving an idea of the fair price.
References
1. Baurens, S. (2010, November 7). Valuation of Metals and Mining Companies. Retrieved 2015, from
Basinvest: http://www.basinvest.ch/upload/pdf/Valuation_of_Metals_and_Mining_ Companies.pdf
2. Damodaran, A. (2001, July 12). Discounted Cash Flow Valuation: Basics. Retrieved June 2015, from
Stern, New York Education: http://people.stern.nyu.edu/adamodar/pdfiles/eqnotes/basics.pdf
3.Damodaran, A. (2006, November). Valuation Approaches and Metrics: A Survey of the Theory and
Evidence. Retrieved 2015, from Stern School of Business, NYU: http://people.stern.nyu.edu/adamodar/
pdfiles/papers/valuesurvey.pdf
3. Fernandez, P. (2003, August). 75 Common and Uncommon Errors in Company Valuation. Working
Paper No. 515.
4. Hindustan Unilever Limited. (Numerous Years). Annual Reports of HUL. Retrieved June 2015, from
Hindustan Unilever Limited: http://www.hul.co.in/investorrelations/AnnualReports/
5. ITC Limited. (Numerous Years). ITC Limited. Retrieved May 2015, from ITC Portal: http://
www.itc.com.hk/en/financial_inform/annual_reports.asp?rpt
6. Kalsie, A. (2014). Valuation of a Troubled Firm: A Case Study on Jet Airways. Manthan: Journal of
Commerce and Management, 1(2), 110-131.
7. Kalsie, A., & Arora, A. (2015, April- June). Valuation Tools: Analysis of Dividend Discount Models and
Price Multiple, Real Valuation. International Journal of Business and Administration Research Review,
1(10), 156-162.
8. Kumah, E., Damgaard, J., & Elkjaer, T. (2009, November). Valuation of Unlisted Direct Investment
Equity. IMF Working Paper WP/09/242.
9. Nestle India Limited. (Numerous Years). Nestle. Retrieved July 2015, from Annual Reports, Nestle
India: https://www.nestle.in/investors/stockandfinancials/annualreports
10. Fernandez, P. (2003, August). 75 Common and Uncommon Errors in Company Valuation. Working
Paper No. 515.
SUMEDHA Journal of Management
36
11. Hindustan Unilever Limited. (Numerous Years). Annual Reports of HUL. Retrieved June 2015, from
Hindustan Unilever Limited: http://www.hul.co.in/investorrelations/AnnualReports/
12. ITC Limited. (Numerous Years). ITC Limited. Retrieved May 2015, from ITC Portal: http://
www.itc.com.hk/en/financial_inform/annual_reports.asp?rpt
13. Kalsie, A. (2014). Valuation of a Troubled Firm: A Case Study on Jet Airways. Manthan: Journal of
Commerce and Management, 1(2), 110-131.
14. Kalsie, A., & Arora, A. (2015, April- June). Valuation Tools: Analysis of Dividend Discount Models and
Price Multiple, Real Valuation. International Journal of Business and Administration Research Review,
1(10), 156-162.
15. Kumah, E., Damgaard, J., & Elkjaer, T. (2009, November). Valuation of Unlisted Direct Investment
Equity. IMF Working Paper WP/09/242.
16 Nestle India Limited. (Numerous Years). Nestle. Retrieved July 2015, from Annual Reports, Nestle
India: https://www.nestle.in/investors/stockandfinancials/annualreports