Security Analysis 2

8/8/2019 Security Analysis 2

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Model Question PaperSecurity Analysis II (MSF2D2)

Section D : Case Study (50 Marks) This section consists of questions with serial number 1 - 5.

Answer all questions.

Marks are indicated against each question.

Do not spend more than 80 - 90 minutes on Section D.

Case Study*

1.Analyze the strengths, weaknesses, opportunities and threats of Surya Cigars Ltd. (SCL). ( 6marks)

2.a. The value of a companys assets and liabilities listed in the balance sheet at the current marketvalues can be estimated through asset based valuation. It also identifies omitted assets andassigns a market value to them. But there are some problems attached with this type ofvaluation model. Discuss these problems. ( 6marks)

b. Calculate Cash Earning Per Share (CEPS) of the Surya Cigars Ltd. (SCL) during the last fiveyears. Make comparative analysis of CEPS with EPS. ( 7marks)

3.Calculate the intrinsic value of the share of SCL as per the formula given below:

P0

= 0.15 PDDM

+ 0.85 PRegression

PRegression

= 441.15 + 21.35 DP + 22.05 GR 0.61 + 33.2 ROE

Where,DP = Average dividend Payout Ratio (%)GR = Average growth rate in earnings (%)ROE = Average Return on Equity (%)

PDDM

= Price as per the DDM

PRegression = Price as per regression equation

= Beta of SCL stock (relevant data appears in Annexure I to the case.)

It is assumed that for the next 5 years, SCL is maintaining its growth rate based on its average growthrate in earnings, after that it stabilizes at 13%. The risk free rate and market return are 8.5% and 18%respectively, which are expected to remain same in the future. (17marks)

4.With an increase in the world import requirements there is every possibility of rise in the exportpotential and Indian Tobacco industry is presented with significant opportunities to consolidate andstrengthen its position in the global market. Briefly discuss the various promotional activities that aretaken up by the Tobacco Board of India towards exports. ( 6marks)

5.Valuing a company which has an inconsistent schedule of earning, or with no earning at all, requires ajudicious balancing act on part of an analyst. In such instances, Price to Earning ratio for valuing acompany is not feasible. With respect to this, explain the importance of Price to Sales ratio as an

alternative for Price to Earning ratio for valuing a company. ( 8marks)

India is currently the worlds second largest producer of tobacco next to China and the fourth largestexporter of unmanufactured tobacco in the world. On an average, cigarettes account for about 85% oftobacco consumption globally. Despite being the second largest producer, India is only the ninthlargest exporter of tobacco and tobacco products in the world. Out of the total tobacco produced inIndia, only one-third is flue-cured tobacco suitable for cigarette manufacturing. Of the totalproduction of tobacco in the country, around 48% is in the form of chewing tobacco, 38% as bidis,and only 14% as cigarettes. Thus, bidis, snuff and chewing tobacco (such as gutka, khaini and zarda)form the bulk of India's total tobacco production. In the rest of the world, production of cigarettes is90% of total production of tobacco related products.

This unique tobacco consumption pattern is a combination of tradition and more importantly the tax


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imposed on cigarettes over the last 2 decades. Cigarette smokers pay almost 85% of the total taxrevenues generated from tobacco. Most of the tobacco produce is suitable for the manufacture ofchewing tobacco, bidis and other cheap tobacco products, which have no demand outside the country.In India, four major cigarette players dominate the market, out of these four major players, ITC with72% market share, Godfrey Phillips with 12% and VST and GTC with 8% share each.

Total tobacco production in India is about 700 million Kilograms annually. Rich and variedgeographic and agro-climatic conditions foster consistent availability of wide range of tobaccos.

Tobacco occupies a prime place in the Indian economy on account of its considerable contribution tothe agricultural, industrial and exports sectors. The industry in India is essentially capital intensive innature. The growth of this industry both in domestic and international market represents a big revenueopportunity for the economy. The industry continuously operates in a challenging economicenvironment, particularly with respect to taxation and regulations relating to communication andconsumption. The regulations, dictated by circumstances in more developed markets, together withprolonged punitive and discriminatory taxation have had the effect of being directed almostexclusively at cigarettes, thereby stifling cigarette consumption in India in comparison with otherforms of tobacco consumption. The burden of Tobacco tax has increasingly shifted to cigarette withthe removal of duty on raw Tobacco, resulting in increasing rates of duty compared to other Tobaccoproducts.

India's share in world cigarette production has remained at around 1.7% whereas India's exports ofaround 2.8 billion sticks of cigarette per year accounts for less than 1% of the world export ofcigarette. There is significant opportunity for cigarette industry to grow considerably and toconsolidate its position in international market due to some recent trends like withdrawal/reduction ofagricultural subsidy and escalating cost in the traditional cigarette exporting countries.

Regulatory Body

Market and marketing system play a dominant role in ensuring remunerative price for commercialcrop like Tobacco. The Tobacco Board was constituted under the Tobacco Act, 1975. The TobaccoBoard is responsible for regulating the cultivation, production, marketing and export of tobacco.There has been significant improvement in the marketing with establishment of Tobacco Board. Inthe area of exports, it helps in promotional activities such as, inviting officials and delegates fromaboard, providing recommendatory, advisory and other support services to the Trade and Industry etc.

Tobacco is a principal cash crop of national importance. Although the cultivation of tobacco isrestricted to 0.3% of the total cultivated area, it provides employment to large number of people.

Tobacco being a labour intensive crop provides employment to more than 60 lakhs people who areengaged in the farming, curing, redrying, packaging, grading, distribution, export and retailingactivities. On the other hand, it makes significant contribution to National Exchequer by way ofexcise revenue and foreign exchange earnings.

Although there is nation wide anti-tobacco campaign, the commercial importance of tobacco cannever be underestimated due to the revenue earning potentiality and employment generation capacityof the crop. Presently there is a call for substitution of tobacco with other crops, but the researchfindings show that there is no economically viable alternative crop which is as remunerative astobacco to the farmer. Presently of the total tobacco produce in India, only 50% is used in thedomestic market and of this domestic consumption of tobacco only 16% is used by cigarette industry.

The main source of raw materials for cigarettes is raw tobacco which is mainly found in the state of


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Andhra Pradesh. There is no scarcity in supply of raw tobacco since the net income earned by thefarmers from cultivating tobacco has been found to be much higher than the net income earned fromother crops.

Production

Botanically, the tobacco plant belongs to the family solanacea and genus Nicotiana. The genusembraces over 60 species of which two alone are cultivated. India grows both the cultivated speciesviz. Nicotiana tabacum and Nicotiana rustica. The largest area is under Nicotiana tabacum which isgrown all over the country whereas Nicotina rustica is confined to North and North Eastern states i.e.

Uttar Pradesh, Bihar, West Bengal and Assam. About 5% to 6% of the total area under tobacco isaccounted for Nicotiana rustica varieties. The cultivation of Nicotiana tabacum has countrywidespread and this type alone accounts for more than 80% of the exchange earnings. Specific types andvarieties of tobacco have been developed for use in cigarette, bidi, cigar, cheroot, hookah, chewingand snuff whereas tabacum types are used for all purposes.

Types

Tobacco is consumed in two ways, either by smoking or chewing. While smoking the followingtobacco products are consumed: Cigarette, Cigar, Bidi (Hand rolled, leaf wrapped country cigarettes)and to chew the products are: Raw tobacco, Gutkha, Pan Parag etc. Due to diverse climatic conditionsevery type of tobacco is grown in India. Almost 90% of area is accounted for by Nicotine tobacemand 10% by Nicotina Restica. Only one third of the tobacco output in the country is Flue curedVirginia (FCV) variety, suitable for cigarette manufacturing.

Cigarette market in India is at present segmented on the basis of length and filter/nonfilter.

There are seven major categories of tobacco, Viz. Flue cured Virginia tobacco (FCV), Burley,Oriental, Bark flue cured, Sun cured, Light flue cured cigar and Dark flue cured.

Flue cured Virginia tobacco is mainly used for manufacture of cigarettes. Light air cured tobacco isused in the manufacture of bidis.

Marketing

There has been significant improvement in the marketing of FCV Tobacco with establishment of

Tobacco Board. The production and marketing of FCV Tobacco have been statutorily regulated bythe Tobacco Board. Excluding FCV Tobacco, the method of marketing of Tobacco in India differsfrom type to type and from State to State. In case of FCV Tobacco the Government of India and theTobacco Board are announcing Minimum Support Price (MSP) from year to year with the objectiveof protecting the interest of the growers of FCV Tobacco.

Current scenerio

The growth in the tobacco industry is greatly dependent on the policies of the government (bothexcise related and ban of public smoking). Higher duties result in higher prices of the product.Contraband cigarettes have become competitively priced as compared to domestic brands given thefrequent excise (price) hikes. It has started affecting volume growth of domestic companies as theconsumers are showing resistance to price hikes.

Exports

South & South East Asia emerged as the second most important destination for Indian tobaccos with ashare of 25% in total exports and had contributed significantly for increased exports of Indiantobaccos. Unmanufactured tobacco exports to South & South East Asia increased by about 35% inquantity terms and 32% in value terms over last years exports. This increase is mainly due to largeexports of tobacco to South Korea and Philippines, which emerged as the third major market forIndian tobaccos after Belgium and Russia. Exports to Indonesia and Vietnam increased by vastmargins, while exports to Singapore declined by 42% compared to last year. Indonesia emerged asone of the major markets for Indian tobacco in this region.

During 2007- 08, exports of unmanufactured tobacco to Western Europe increased by 20% inquantity terms and 19% in value terms on year on year basis. This is mainly on account of increasedexports of tobacco to Belgium (by 15% - mostly for re-export to Russia and other East European

Length Type Size of Market

Under 60mm Non-filter 4.8%60-70mm Non-filter 95.2%70-75mm Filter 19.3%75-85mm Filter 5.3%


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destinations), Germany (27%), Netherlands (61%) and France (37%) in this region. Exports to UK,Sweden, Austria and Denmark declined in quantity terms compared to last year. Western Europecontinued to be the most important destination for Indian tobaccos with 33% share in total exports.

Exports of unmanufactured tobacco to Eastern Europe declined marginally by about 1% in quantityterms. However, in value terms, the exports to Eastern Europe had increased by 7% on year on yearbasis because of general increase in export prices. The decline is on account of reduced exports toRussia by 16% in quantity terms and by about 8% in value terms. The main reason for the decline oftobacco exports to Russia and other CIS destinations is steep increase in the price of Indian tobacco.

Re-exports of Indian tobacco to Russia from Belgium will partly make up this short fall. Exports toUkraine, Kazakhstan and Romania increased, while Poland reduced its off take by 11% in quantityterms and 3% in value terms respectively. Exports to other important markets- Bulgaria and Belarusin this region also increased. As these markets are extremely price sensitive and import low cost / lowend tobaccos, there is significant decline in exports. Despite this, Eastern Europe continued to be thethird most important destination for Indian tobaccos with 18% share in total exports.

Research and Development

Research on Tobacco has been playing an important role in the development of Tobacco varieties inIndia. India grows different variety of Tobacco under different agro-climatic conditions. As such theproblem of improvement of different varieties of Tobacco in India are numerous and complicated.The main research work on Tobacco is being done at Central Tobacco Research Institute (CTRI) atRajahmundry and its Research Stations spread throughout India. Apart from conducting research fordevelopment of different varieties of Tobacco for maximising production, the CTRI, Rajahmundry

has been presently doing research for development of alternative crops to Tobacco. CTRI,Rajahmundry has also been entrusted with the research for development of alternative uses ofTobacco in view of anti-smoking campaign.

Earlier the Directorate of Tobacco Development was running two Non-Plan Schemes on bidi Tobaccoviz. (i) Seed and Seedlings Scheme and (ii) Farmers Training Scheme at Gujarat AgriculturalUniversity, Anand.

Surya Cigars Ltd.

The success of Surya Cigars Ltd. (SCL) is the result of the companys commitment to innovations,enhanced operational efficiencies and adoption of internationally acclaimed business processes.Driven to excel, innovate and win, the company intend to emerge as one of the most respectedCompany in the tobacco industry. SGL is the market leader in the Indian Cigarette Industry. Thecompanys market share in filter cigarettes is more than 70%. The company has got largest retail

networks in the country, consisting of over 2 million retailers Cigarette brands produced by SGL arevery famous and almost household name for smoking persons.

As the second largest player in the Indian cigarette industry, the SCL own some of the most popularcigarette brands in the country like Igen, Stelar and North pole. Over the years SCL benchmarks ininnovation with revolutionary brands like Stellar, the first slim cigarette and Igen, the first euro normcigarette in India.

Brands

Igen Indias 1st Euro Norm cigarette holds the promise of an advanced cigarette quality andimmense style. This progressive brand, known for its innovation, has also introduced Indias 1st Kingsize 5s pack, a convenient and stylish pack format for the young adult of today.

Stelar The first slim cigarette launched in India. It has been specially engineered to deliver lownicotine without a compromise in taste and flavour. It is available in an elegant slim shaped 10s and

20s pack, aimed at the cognitive consumer who wants to be progressive and responsible in his habitsand lifestyle.

North Pole Launched in the year 1958 North Pole is the largest selling menthol cigarette in India.North Pole has recently the Golden Peacock commendation Award for innovation in packaging.

Their products are distributed over an extensive India wide network of more than 500 distributors and

800,000 retail outlets. With the Corporate Office in Delhi, the Company has offices all across India

in over 8 locations. Surya Cigars Ltd. empowers its entire people to think and act radically, stretchrelentlessly and generate path breaking ideas and strategies to propel the Company. This helps tocreate and build powerful brands with unmatched service and world class processes. Striving towardsits vision to become a leading tobacco player in India and beyond, Surya Cigars Ltd. has forayed into


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international markets with successful new business ventures.

Presently, Surya Cigars Ltd. is partnering with some of the top most players in the internationaltobacco industry in marketing their products and providing various professional and expert serviceswhich include contract manufacturing, consultancy services, cut tobacco and smoke analysis. Alreadypresent in the Middle East, West Africa, South East Africa and South East Asia, Surya Cigars Ltd.wishes to strengthen its position as an international player by entering new markets.

Today, Surya Cigars Ltd. can claim to be the first and only tobacco Company to organize the

fragmented cigar market in India and secure its position as the market leader in the cigar distribution.The success can be measured by the exclusive distribution agreements Surya Cigars Ltd. has withAltadis, USA who are the worlds largest cigar Company. The other groups are Villiger ofSwitzerland, Henri Wintermann from Holland and Cibahia from Brazil. The company is planning todiversify its business in various unrelated areas. It has an idea of diversification in hospitality andgarments industry.

Production

Andhra Pradesh, Gujarat and Karnataka account for the major portion (80%) of raw tobaccoproduction in India. These states produce FCV tobacco, bidi tobacco, natu tobacco, cigar tobacco,cheroot tobacco and snuff tobacco. Other states which manufacture tobaccos are Maharashtra, Orissa,Tamil Nadu, West Bengal, UP and Bihar. With a rich heritage of over 60 years in the industry, SCLhas incorporated the latest technology to deliver products of the finest quality in the market. Drivenby innovation and speed to market, the two manufacturing facilities in Ghaziabad (near Delhi) and

Andheri (Mumbai), are equipped with state-of-the-art equipment and incorporate best practices likeTQM, Haichi-Ban, 5S, Kaizen Teian etc.

SCL views its R&D capabilities as a vital component of its business strategy that provides a long termedge over its competition. Located along with the production facilities, the R&D extends itscompetencies and together they strive to implement the best in the market.

Empowerment and Accountability

Empowerment is an essential concomitant of SCL's first core principle of governance thatmanagement must have the freedom to drive the enterprise forward. SCL believes that empowermentis a process of actualizing the potential of its employees. Empowerment unleashes creativity andinnovation throughout the organization by truly vesting decision-making powers at the mostappropriate levels in the organizational hierarchy.

SCL believes that the Board of Directors is accountable to the shareholders, and the management is

accountable to the Board of Directors. They believe that empowerment, combined withaccountability, provide an impetus to performance and improve effectiveness, thereby enhancingshareholder value. The Government of India is regularizing the norms to fight against tobacco andbanning smoking in pubic places. It is a major concern for the company.

Environment and safety

SCL is known for its commitment to environment and safety. SCLs EHS (Environment Health andSafety) policy recognizes the twin needs of conservation and creation of productive resources .Theunit has won many awards and accolades in the area of Environment, such as ISO 14001, OSHAS18001, etc.

Each department of EHS conducts a monthly meeting to review the progress of the action plans andshare knowledge on developments in the field. The unit goes through stringent divisional audit andcorporate audit every year. There exists an established rating system covering the areas of Policy andorganization, Occupation Health & Hygiene, Equipment and Personal Safeguarding, Fire Preventionand Protection, Environment and Accident Recording and Investigation. The unit has progressivelyimproved in the ratings over last 5 years. The unit EHS team also conducts monthly departmentalaudits and hygiene inspection audits. Identified managers are sent for training programs conducted bycorporate branch of EHS.

SCL, Andheri factory, is committed to work towards continually reducing risk of injury, occupationalillness and environmental impact of its operation. As a part of this commitment SCL works towardsimproving workplace safety, quality of air emission, maximizing reuse of treated water andconservation of resources. The company complies with applicable legal and other requirementstowards health, safety and environment and strives towards elimination of incidences and preventionof pollution. SCL, in its role as a concerned corporate citizen, has committed itself towards


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responsibility towards the environment, and one of the key initiatives towards realizing thiscommitment has been a drive towards reducing energy costs.

Moreover, SCL recognizes that energy conservation efforts also deliver business value through theirsignificant impact on the bottom-line. SCL has made its contribution towards this initiative through asustained focus on the energy consumption of the unit.

Profit and Loss Account of SCL as on

Balance sheet of SCL as on

Rs. in crores

March 08 March 07 March 06 March 05 March 04

Income

Net sales 888.04 773.36 671.76 687.33 623.85

Expenses

Material Consumed 311.27 279.78 224.09 235.55 203.76

ManufacturingExpenses

50.98 42.89 38.50 38.01 33.34

Personnel Expenses 80.74 66.36 59.69 56.92 41.98

Selling Expenses 171.13 142.46 138.12 125.70 133.08

AdministrativeExpenses

127.58 117.94 112.68 136.11 138.58

Cost Of Sales 741.70 649.43 573.08 592.29 550.74

Operating Profit 146.34 123.93 98.68 95.04 73.11

Other RecurringIncome

15.20 10.42 10.32 11.59 14.00

PBDIT 161.54 134.35 109.00 106.63 87.12

Financial Expenses 3.68 2.92 2.78 5.72 5.68

Depreciation 19.77 19.07 18.37 16.55 9.95

PBT 138.09 112.36 87.85 84.36 71.49

Tax Charges 57.51 47.12 39.57 36.36 24.31

PAT 80.58 65.24 48.28 48.00 47.18

Equity Dividend 26.00 26.00 23.40 22.88 19.76

Rs. in croresMarch 08 March 07 March 06 March 05 March 04

SOURCES OF FUNDS

Equity Share Capital(shares of Rs.10 each)

10.40 10.40 10.40 10.40 10.40

Reserves & Surplus 487.20 405.39 347.70 314.25 276.74

Loan Funds

Secured Loans 103.38 60.73 74.39 60.36 8.60

Unsecured Loans 0.00 0.00 0.00 1.88 12.09

Total 600.98 476.52 432.49 386.89 307.83

USES OF FUNDS

Fixed Assets

Gross Block 260.25 231.09 223.40 201.28 137.21Less : Revaluation Reserve 2.36 2.36 2.36 2.36 2.36

Less : AccumulatedDepreciation

128.36 112.49 96.24 78.55 63.13

Net Block 129.53 116.24 124.80 120.37 71.72

Capital Work-in-progress 21.47 7.95 2.67 6.47 13.23

Investments 329.57 246.27 211.01 199.16 144.73

Net Current Assets

Current Assets, Loans &Advances

363.93 261.26 251.42 234.82 220.38

Less : Current Liabilities & 243.52 155.20 157.41 173.93 142.23


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Annexure - IShare price of SCL and Nifty Values

END OF SECTION D

Provisions

Total Net Current Assets 120.41 106.06 94.01 60.89 78.15

Total 600.98 476.52 432.49 386.89 307.83

End of Month

Share price of SCL

(Rs.)

Nifty

ValuesJanuary 2008 174.65 5274.30

February 2008 154.50 5322.55

March 2008 187.05 4971.12

April 2008 189.05 5739.55

May 2008 188.55 4701.11

June 2008 186.00 3176.95

July 2008 218.00 5162.20

August 2008 219.90 4517.55

September 2008 204.20 5400.25

October 2008 99.80 5187.00

November 2008 295.20 5982.55

December 2008 182.60 3855.12

Security Analysis II (MSF2D2)

Section E : Caselets (50 Marks)This section consists of questions with serial number 6 - 11.

Answer all questions.

Marks are indicated against each question.

Do not spend more than 80 - 90 minutes on Section E.

Caselet 1

Read the caselet carefully and answer the following questions:

6. Foreign Direct Investment (FDI) plays an important role in the long-term economicdevelopment of a country. Briefly discuss the various advantages that FDI enjoyed inIndia. ( 8marks)

7. The FDI is not an unmixed blessing. Elucidate the various problems that may arise fromFDI inflow into India. ( 8marks)

Globalization entails the opening of our own economy towards the world economywhere the barriers and restrictions of trade are eliminated and the governments areencouraging private investment. The rapid growth of Asian economy is the result ofglobalization where Foreign Direct Investment (FDI) is playing an important role. Thedeveloping countries, particularly in Asia have removed restrictions and implementedpolicies to attract FDI inflows to benefit from the investments and potential spillovereffects. The governments of various countries are taking appropriate steps to encourageFDI that will maximize the significance for their economies. FDI has enough potential togenerate employment, enhance exports and contribute to the long-term economic


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development.

FDI, according to IMF, is defined as "the investment that is made to acquire a lastinginterest in an enterprise operating in an economy other than that of the investor. Theinvestor's purpose being to have an effective will in the management of the enterprise".

FDI plays a pivotal role in the development of Indian economy. It is an integral part ofthe global economic system. Significance of FDI can be enjoyed to full extent throughvarious national policies and international investment architecture. Both the factors

contribute enormously to the maximum FDI inflows into India, which stimulates theeconomic development of the country. Attracting FDI has become an integral part of theeconomic development strategies for India. The FDI ensures production and generatesvaried employment opportunities in the developing countries, which is a major steptowards the economic growth of the country. The FDI has been a booming factor thathas bolstered the economic life of India, but, on the other hand, it is also being blamedfor ousting domestic inflows. The FDI is also claimed to have lowered a few regulatorystandards in terms of investment patterns. The effects of FDI are by and largetransformative. The incorporation of a range of well-composed and relevant policies willboost the profit ratio from FDI.

The FDI is not an unmixed blessing. The Governments of Less Developed Countries(LDCs) have to be very careful while deciding the magnitude, pattern and conditions ofprivate foreign investment that includes financial Instability, net job loss etc.Raising theinflows of FDI substantially was considered one of the key objectives of industrial andtrade reforms. The reforms were accompanied by a rapid increase in inflows of FDI intothe Indian economy.

It can be concluded that the first and second generation reforms have created aconducive environment for foreign investments in India. Market-oriented policies areboosting economic activity, all-round development and economic growth rate. As theIndian economy gears up for competition in the international market, overseas investorsclearly see the potential for attractive returns from investments in India, which is alsoevident from the already-achieved FDI success stories.

END OFCASELET 1

Caselet 2


8. Uncertainty about long-run value of securities for investors can lead to disturbances inthe markets. Discuss the various factors contributing to market instability. ( 9 marks)

9. For surviving from future market crashes, a strategic perspective on investing isnecessary. Briefly discuss the various strategies the investors should adopt towardsmanaging the market instability. ( 9 marks)The stock markets exhibit tendencies that make the `stability issue' more and morecomplicated. The sudden booms and bursts, the intensity of market sentiments, theskyrocketing expectations from the markets, the impacts of the flow of FII, governmentpolicy and global market impacts can either jeopardize the scenario or catapult thefortunes of many investors. One of the most abominable developments is the marketcrash or market instability. Such a market slide can be detrimental to the interests of

investors, needless to mention the potential damage to economy as well as the market'sreputation.

The market crash is usually perceived as detrimental and is held in negative light by themajority of investors. Instead, a positive perspective can be more enriching even duringcrisis, when it offers immense opportunity to buy the stocks with optimal potential fairvalue in long-term strategic investment, as the market will eventually bounce back andsuch buyers will reap long-term results.

The stock markets have a general tendency to experience myriad booms and bursts; astock market may take off and rise rapidly over a period of time. Market crash is adecline in the indices and deterioration in the value of stocks and securities on amonumental scale. On an optimistic note, a crash is an excellent time to buy stock with


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promising future returns. During the period of crash, holding on to stocks without sellingis considered to be good; the panic selling by other investors causes the market prices todrop below fair value and one should be able to pick up some lucrative bargains. As theprice falls, buyers will pour in and buy, thus eventually leading the market to regain itsvalid position. This is how the market mechanisms operate.

The securities markets provide liquidity by facilitating trading and helping investors tosell their securities to other investors for cash. A security market should ideally absorbliquidity-driven sales without any change in security price. The price in an ideal security

market changes only as per the new information about the future cash flows, whetherpositive returns or uncertainty of returns. As far as liquidity sales and purchases are notrelated at all, they tend to off set one another with very less effect on price. The largerand more concentrated the market, the better the pooling, the less the market price isaffected by liquidity trading. This will result in occasional imbalance of desired liquiditysales and purchases. In dealer market, the market-makers absorb liquidity imbalances bytrading for their own account. In the auction markets, the specialized traders jump in tobuy and sell rapidly, so sometimes the mechanism which provides the market withliquidity can be swamped by the rush of selling which results in a crash. Themechanisms which provide liquidity to the market are not in a position to handle such agreat rush of selling. The major cause is volume. The market-makers provide liquidityby buying up securities when there is an excess of sell orders and for this they needcredit to finance the purchases, which is not easily available in abundance.

Uncertainty about long-run value of securities for investors can lead to disturbances inthe markets. The investors need to understand and educate themselves about themechanisms of the market and how the long-term value of a security can be a wiserinvestment rather than speculating for short-term instant benefits. The factorsresponsible for market crash includes Influence of noise traders, Influence of qualitycycles etc.

For surviving from future market crashes, a strategic perspective on investing isnecessary. A well-planned and long-term value-based investment by investors is the key,rather than prompt, short-term gains. One of the survival strategies include that theinvestors should constantly track their portfolio, the non-performing shares andsecurities should be replaced with better performers.

The markets and the investors have witnessed good times and bad times in history. Theseries of market crashes have, in one way, weakened the stock markets and, in another,

strengthened to undertake the challenges and avail opportunities for better future. Theoptimism for future growth in both developed as well as emerging markets shall set newpathways to fortune hopefully avoiding the pitfalls on both micro and macro levels. Thecompliances and regulations shall pave a safer haven for the stock markets to evolve.

END OFCASELET 2

Caselet 3


10. PE is essential to fuel the economy and nurture the budding entrepreneurs/technocrats.Discuss why companies should go for private equity. ( 8 marks)

11. The critical aspect either in VC or PE is exit route, because the exit route can decide thefate of both the investee and the investor. Discuss the various exit routes available forPrivate Equity investors. ( 8 marks)

Venture capital (VC) has been catering to the financial needs of the budding technocratsand entrepreneurs all over the world for the growth and betterment of the economy. Inthe recent past, the same has also turned into a new shape as Private Equity (PE).

Private Equity (PE) is the ownership of shares or other equity or equity-like interests incompanies that do not trade publicly on a stock exchange, or over-the-counter, amonginvestment dealers. As there is no instantaneous market for trading, these investmentsare appropriate only for patient investors with a long-term view. PE opportunities aregenerally more appropriate for large institutional investors with the time and resources


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END OF CASELET 3

END OF SECTION E

END OF QUESTION PAPER

to evaluate the potential risks and returns, and the patience to wait for 10 years or longerto maximize investment returns, because the investments often involve the acquisition ofa controlling interest or significant influence, costing several millions of dollars.

PE is essential to fuel the economy and nurture the budding entrepreneurs/technocrats.Not only that, PE can even work very well in making India excel in the totalentrepreneurship that can contribute a lot for its development. The main reasons for theneed of PE includes bringing required expertise in multiple functions.

There are basically three types of PE investments. Venture capital, Buyout and

Acquisition financing and Expansion or Merchant Banking capital. Venture capitalprincipally meant for early-stage companies that are still developing their products orservices, but have the prospect of generating revenue in a few years; and later-stagefirms generating revenue with the expectation of profits within a year or two. Buyoutand acquisition financing usually accompanied by a new business plan, and occasionallywith new management, to improve a company's financial performance. Expansion ormerchant banking capital is for established companies looking to enter new markets orto achieve a larger scale of operations.

PE fund managers raise money from investors with the aim of investing it in a long-termportfolio of potentially high growth private companies. The criterion for choosing suchcompanies depends on the following factors such as superior business or idea, qualityand depth of management, modern and robust corporate governance, appropriate way toinvest in the company, and strategy for exiting the investment. PE strategies vary widely

with a focus on fund maturity as it is not a fancy proposition for promoters for variousreasons such as fear of losing the confidentiality and control over the company, highcost option, and participation of outsiders. Hence, there are so many steps involved inthe PE process.

The Indian PE market has been getting more active day by day. During the last year orso, almost all the major global VC and PE firms have either established an on-groundpresence in India or raised significant India-dedicated funds. Several key sectors of theIndian economy, viz., IT, BPO, telecom, pharma/healthcare, financial services, retail andautomotive components that are investment targets, are experiencing even higher growththan the said levels of growth rate. The other reasons for the growth is the well-positioned economy that can utilize the opportunities of globalization and increase anappetite for innovation and entrepreneurship.

The critical aspect either in VC or PE is exit route, because the exit route can decide the

fate of both the investee and investor. There are different exit routes, namely listing ofshares, offer for sale, sale to strategic investors, etc.

Thus PE is known as investing in securities through a negotiated process. The majorityof PE investments are in unquoted companies. The PE investment is typically atransformational, value-added, active investment strategy. It calls for a specialized skillset. Hence, the PE has become the means of financing the new and innovative projectsand to boost the entrepreneurial spirit all over the world. There is a need for PE moldedas a great weapon that works a lot in the development process of entrepreneurs in thecountry, which can lead the country to acquire the development status.


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Suggested AnswersSecurity Analysis II (MSF2D2)

Section D : Case Study

1. Strength :

SGL is the market leader in the Indian Cigarette Industry. Cigarette brands produced by SGL are veryfamous and almost household name for smoking persons. SGL manufactures cigarettes for all kinds ofcustomers and caters the need for all people. The companys market share in filter cigarettes is more than70%. The company has got largest retail networks in the country, consisting of over 2 million retailers.Through this huge retail network the company can reach all types of customers in metros or rural village inthe country. The management of SGL is very strong and people at the helm of main affairs are considered tobe pioneers in the Indian Corporate world.

Weakness

The companys main weakness can be found in the vigorous diversification started by the company in almostall fields. If any of the new ventures do not succeed the companys profitable business will have to bear thelosses. This will definitely create a big dent in its strong financial base. Diversification in various unrelatedbusiness may prove to be harmful to the companys strong brand value in its core business.

Opportunities

Export market of cigarettes is an important opportunity to the company where SGL can tap lucrativeinternational market.

Threats

Growing health concerns and banning of several tobacco products and banning smoking in the public placescan be viewed as threat to the company. Recently, the share of cigarettes in the total consumption has beendeclining in India and has gone down to 14% as against an average of 86% in the rest of the World. Thislower consumption of cigarettes in India is posing a threat to the company. Even entry of premiuminternational brands is a threat to the companys core business.

2. a. Asset based valuation estimates a firms value by identifying the value of its assets. But there are someproblems using this model for valuation. They are as under

Assets listed on the balance sheet may not be traded often, so market values may not be readilyavailable.

Market values, if available, might not be efficient measures of intrinsic value if markets for theassets are imperfect.

Market values, if available, may not represent the value in the particular use to which the asset isput in the firm. One might establish either the current replacement price for an asset or its currentselling price (its liquidation value), but neither of these may be indicative of its value in aparticular going concern. A building used in computer manufacturing may not have the samevalue when used for warehousing groceries.

The omitted assets must be identified for their market value to be determined. Assets such asbrand asset, knowledge asset, managerial asset etc. are the assets missing from the balance sheet.These are all intangible assets and valuing them is very difficult task.

Even if the individual assets can be valued, the sum of the market values of all identified assetsmay not (and probably will not) be equal to the value of the assets in total. Assets are used jointly.Indeed, entrepreneurs create firms to combine assets in a unique way to generate value. The valueof the synergy asset is indefinable.

Asset based valuation is a complex way of valuation and also an expensive tool.

b. Cash earning per share =

PAT+Depreciation

No.of stocks outstanding

2008 2007 2006 2005 2004

CEPS


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CEPS give a better idea of the cash available for use within a company. From the above result it is very

evident that cash earning per share of the company has increased in 2006. Earning per share has marginallyincreased in 2006. This signifies that the fixed assets are gradually increased along with depreciation. Theaverage growth rate in CEPS is 15.35% where as for EPS it is 15.24%. This shows that the company ismaintaining a sound financial position on its assets.

(80.58 19.77)

1.04

+ (65.24 19.07)

1.04

+ (48.28 18.37)

1.04

+ (48.00 16.55)

1.04

+ (47.18 9.95)

1.04

+

= 96.49 = 81.08 = 64.09 = 62.07 = 54.93

EPS80.58

1.04

65.24

1.04

48.28

1.04

48.00

1.04

47.18

1.04

= 77.48 = 62.73 = 46.42 = 46.15 = 45.37

3.

= = = 11.49%

= = = 0.42%

= = = 761.79(%)2

Covxy = = = 534.83 (%)2

Beta = = 0.70

Dividend Payout Ratio (%)

Average Dividend Payout Ratio =

= 42.06%.Growth Rate in Earnings

Shareprice of

SCL(Rs.)

NiftyValues

Returnfrom SCL

(%)(y)

Returnfrom

Nifty (%)(x)

(Y )Y(X

)X(X- )2X

(Y ) (X

)

Y

X

174.65 5274.30

154.50 5322.55 -11.54 0.91 -23.03 0.49 0.24 -11.39

187.05 4971.12 21.07 -6.60 9.57 -7.02 49.32 -67.23

189.05 5739.55 1.07 15.46 -10.43 15.04 226.13 -156.77

188.55 4701.11 -0.26 -18.09 -11.76 -18.51 342.74 217.70186.00 3176.95 -1.35 -32.42 -12.85 -32.84 1078.58 421.92

218.00 5162.20 17.20 62.49 5.71 62.07 3852.53 354.39

219.90 4517.55 0.87 -12.49 -10.62 -12.91 166.62 137.13

204.20 5400.25 -7.14 19.54 -18.63 19.12 365.53 -356.27

99.80 5187.00 -51.13 -3.95 -62.62 -4.37 19.09 273.61

295.20 5982.55 195.79 15.34 184.30 14.92 222.52 2749.15

182.60 3855.12 -38.14 -35.56 -49.64 -35.98 1294.63 1786.03

Total 126.44 4.62 7617.94 5348.27

Y n

Y 126.44

11

X n

X 4.62

11

2x 1n

)XX( 2

7617.94

10

(X X) (Y Y)

n 1

5348.27

10

534.83

761.79

Year Dividend Payout Ratio

2008 25.00/77.48 = 0.3232007 25.00/62.73 = 0.399

2006 22.50/46.42 = 0.485

2005 22.00/46.15 = 0.477

2004 19.00/45.37 = 0.419

0.323 0.399 0.485 0.477 0.419

5

+ + + +

Year Earnings Growth %


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Average Growth Rate =

= 15.24%.ROE (Return on Equity)

Average ROE =

= 15.32%

PRegression

= 441.15 + 21.35 DP + 22.05 GR 0.61 + 33.2 ROE

= 441.15 + (21.35 0.4206) + (22.05 0.1524) (0.61 0.70) + (33.2 0.1532)= 441.15 + 8.98 + 3.36 0.43 + 5.09

= 458.15

Price as per DDM

DPS for the year 2008 is: 25.00

The required rate of return

Re = Rf+ (Rm Rf) i

= 8.5 + (18 8.5) 0.70

= 15.15%.

P5

= = 2670.48

Value at the end of year 5 = 2670.48 PVIF(15.15%, 5)

= 1319.08

Price as per DDM = 1319.08 + 125.30 = 1444.38

P0 = 0.15 PDDM + 0.85 PRegression

= 0.15 1444.38 + 0.85 459.00

= Rs.606.08

2008 23.512007 35.132006 0.582005 1.742004 -

23.51 35.13 0.58 1.74

4

+ + +

Year ROE (%)

2008 16.192007 15.692006 13.482005 14.792004 16.43

16.19 15.69 13.48 14.79 16.43

5

+ + + +

Year DPS PVIF@ 15.15% PV (DPS)

2009 25.00 (1.1524) = 28.81 0.8684 25.022010 28.81 (1.1524) = 33.20 0.7542 25.04

2011 33.20 (1.1524) = 38.26 0.6550 25.06

2012 38.26 (1.1524) = 44.09 0.5688 25.08

2013 44.09 (1.1524) = 50.81 0.4939 25.10

125.30

50.81(1.13)

0.1515 0.13

4. Tobacco Board undertakes the following Export Promotion Activities:

Inviting official and business delegations from abroad. Organizing visits of official and tradedelegations abroad.

Participation in International Trade Fairs and Exclusive world tobacco exhibitions & symposiumsabroad.


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Publicity by undertaking an extensive advertisement campaign in the international media to promoteIndian tobacco

Dissemination of Information and various enquiries received from overseas customers to the exporters

Providing recommendatory, advisory and other support services to the Trade and Industry.

Problem solving in Government Agencies and Organizations - RBI, Import/Export Procedures;problems with Importers through Indian Missions abroad.

Provision of inputs to the Central Government on policy matters relating to export of tobacco and

tobacco products.

5. Valuing a company with inconsistent schedule of earning, or worse, with no earning at all requires a delicatebalancing act on part of the analysts. At these instances, traditional methods of valuations befall tohelplessness. Thats where the price/sales ratio comes in. Just like its more popular alternative the P/E ratio,PSR (Price-to-Sales Ratio) is useful to value any company. Price-to-Sales Ratio for a company can becalculated by dividing the market capitalization of a company by its total revenue for the last four quarters.As compared to PE ratio, Price-to-Sales Ratio is a more reliable measure because, unlike earnings, revenuefor a company is difficult to manipulate. Besides earnings is a complex figure which may include inflowsfrom non-recurring events also. Therefore, analysts look to both the PE ratio and PS ratio of companiesbefore taking any investment decision. PS ratio is useful while valuing companies even with no earnings atall. PS ratio comes handy to value companies in todays dynamic set-up where mergers and divestitures are apart of the daily routine. For examples, need for economy of scale has driven companies in telecom sectorfor sometime. Owing to write-offs related to merger, several such companies report negative earnings soon

after the process. However, strategically and fundamentally, the company may well be on its way to a brightfuture. This can be verified by analyzing the Price-to-Sales Ratio, which may be growing immediately afterthe merger, thus presenting a more realistic presentation of the prospect for the company.

Like any other ratio, a high or low PS ratio connotes different interpretations for an analyst. High or low PSratio depends on the profit margin of the company. Thus, PS ratio for a steel manufacturer may vary from thePS ratio for a chip maker.

Price-to-Sales Ratio may also vary consequent to the capital structure of the company. A company with a lotof debt component in its balance sheet may have to allocate more resources for servicing the interest burden,and thus might see erosion in its profits. Another problem with PSR is that sales figure does not contain anyinformation about the debt burden of the company. Thus, it may so happen that some companies may haveno profits but only huge debt and could be on the verge of bankruptcy. Due to all these, it is advisable tocompare both the PE ratio and PS ratio for the company on a historical basis for a reliable analysis.Mathematically, relationship between these two ratios can be established Ratio x (Profit Margin).


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Security Analysis II (MSF2D2)

Section E: Caselets

Caselet 1

6. The various advantages FDI enjoyed in India are:

Enhancement of Export Potential

By raising the level of efficiency and the standards of product quality, FDI makes a positive

impact on the host country's export competitiveness. It provides the host country a betteraccess to foreign markets due to international linkages.

Economic Growth

This is one of the major sectors, which is enormously benefited from FDI. A remarkableinflow of FDI in various industrial units in India has boosted the economic life of thecountry.

Employment Generation

The FDI has also ensured a number of employment opportunities by aiding the setting up ofindustrial units in various corners of India. The training obtained by the employees in thereceipt of FDI also contributes to human capital formation.

Consumer Benefits

The consumers of the host country benefit through better variety of products at competitiveprices due to the inflow of FDI.

Trade Benefits

The FDI has opened a wide spectrum of opportunities in the trading of goods and services inIndia both in terms of import and export production. It provides the much needed foreignexchange which helps bridge the balance of trade deficit which otherwise would add to theexternal debt of the country.

Technology Diffusion and Knowledge Transfer

The FDI apparently helps in the outsourcing of knowledge from India, especially in theInformation Technology Sector. It helps in developing the know-how process in India interms of enhancing the technological advancement in India.

Benefits to the Government

Profits generated by FDI contribute to the corporate tax revenues in the host country. TheFDI is non-volatile and non-debt creating and hence avoids debt servicing (i.e., interest

payments). The macroeconomic effects of FDI is connected with issues of domestic capitalformation, balance of payments and taking advantage of external markets for achievingfaster growth. The microeconomic effects are connected with cost reduction, improvementin the quality of the product, making changes in industrial structure and global inter-firmlinkages.

Linkages and Spillover to Domestic Firms

Various foreign firms are now occupying a position in the Indian market through jointventures and collaboration concerns. The maximum amount of the profits gained by theforeign firms through these joint ventures is spent on the Indian market.

7. The problems that may arise FDI inflow into India are:

Impact on Domestic Savings and Investment

When foreign investment is competitive with home investment, the profits in domesticindustries fall, leading to a fall in domestic saving. Foreign corporations may formmonopolies in the domestic market and drive out small firms. When FDI enters in the formof mergers and acquisitions, taking excessive control over decision-making andmanagement, it may not take into account the needs of domestic economy. Repatriation ofprofits can lead to withdrawal of capital from the host country.

Worsen Balance of Payment

The FDI can have a negative impact on the balance of payments situation of the hostcountry through an increase in import of inputs and through remittances of royalties anddividends abroad by the subsidiaries.

Inappropriate Technology

Developing countries might not have the ability to absorb high technology imparted by


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Caselet 2

foreign firms. For example, domestic conditions such as poor infrastructure, low levels ofeducation, rigid labor laws and other regulations are other obstacles facing the Indianeconomy. Some foreign corporations can bring in technology that is not appropriate to suitthe conditions of the host developing country.

Environmental Cost

Foreign investors can take the advantage of weak environmental regulations in developingcountries, by using technologies that are cheap but harmful to the environment.

Net Job LossJob creation might only take place in already well-developed urban sectors where the levelsof education, training and infrastructure are high. Small-scale and rural areas have a lowcapacity to attract FDI and as a result are left out.

Financial Instability

Given the capacities and constraints of developing countries, free capital movements makethem more vulnerable to both external and internal shocks. The dependency of developingcountries on foreign finance to cover their current account deficit also makes them morefinancially fragile.

Increase in Income Inequalities

Foreign firms reinforce dualistic socio-economic structure and increase income inequalities.They create a small number of highly paid modern sector executives. They divert resourcesaway from priority sectors to the manufacture of sophisticated products for the consumptionof local elite. As they are located in urban areas, they create imbalance between rural andurban opportunities, accelerating the flow of rural people to urban areas.

8. Factors contributing to market instability are:

Influence of uncertainty and risk: The first contributing factor to market instability is theuncertainty about the long-run value and the risks associated with it. There is no particularstandardized value or rule of thumb and opinions differ from one investor to another. Someinvestors are optimistic about and favor a long-term positioning while others are skeptical orpessimistic and always favor a short-term positioning. The market eventually favors theoptimistic investor in comparison to the pessimistic, as a result of which the prices rise.

Influence of noise traders: The volatility is aggravated by noise traders who care little

about long-term value. They are spontaneous and are always betting so that the rising trendshould continue, without giving due logical consideration to fundamental analysis. There isalways a rush of such people when the market rises. Their buying helps prices to increasemore and more, giving them capital gains for achieving their expectations and spurringmore buying. This phenomenon of rapid rise in prices followed by peak and then a suddencrash is known as a bubble. This is detrimental to the stability and sustenance of growth inmarkets.

Influence of limits on short-selling: Optimal short-selling can be seen in a positive as wellas in optimistic perspective. But there is a thin line which when crossed can potentiallycontribute to a crash as the investors become illogical and oversell. This creates imbalanceand instability.

Influence of quality cycles: It relates to the quality inherent in the investments themselves.The investors with tendencies of greed and hunger are always seeking new and innovative

investment avenues. To cater to the need of investors, the markets start offering more ofnew and creative investment avenues but only at the cost of deteriorated quality in order tocater to quantity. Thus investors face a risk of uncertainty toward future gain.

Increasing importance of institutional investors and foreign investors: The institutionalinvestors, who trade in large volumes, are agile, reactive and better informed than individualinvestors, and their reactions have far-reaching impacts. So, there exists a bargaining powerin their hands. The institutional investors are also gaining importance in securities markets.Instead of holding stocks for themselves, they do their dealings through intermediaries as apreferred channel. They do not cease to influence stock markets for their volume of trading.

Besides the above discussed issues, sometimes international political issues can alsoinfluence the markets. Experts believe that when international cooperation influences


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Caselet 3

national policies, the new economic order of a global economy becomes fragile and equitymarkets tend to decline. Thus, the intensity of factors determines the quantum of marketslide.

9. The various strategies the investors should adopt towards managing the market instabilityare:

Investors must avoid leveraging their investments to avoid the much-dreaded debttrap.

Investors must look into the diversification of portfolio with strategic implications.Diversification should be done not necessarily for the heck of it but with a well-designed objective. On the cross-border trading front, diversification can also be donein developed as well as emerging markets, besides a number of industrial sectors..

The investors should pay more attention to company's fundamentals and consistentprofitability rather than the stock prices.

The investors should constantly track their portfolio, the non-performing shares andsecurities should be replaced with better performers.

Logical choice of value over price should be made.

Financial literacy tops the list. In contrast to the international financial markets,

financial literacy among the Indian investors is comparatively low. Avoid extremely volatile or high risk companies as well as very small industries with

high debt burdens ranging over a long term.

The large cap shares may not always be as lucrative as certain mid cap shares, thechoice should be made logically.

Invest in fundamentally sound companies; the opportunity should be available whenthere is massive selling due to investor sentiment, overreaction by market players onsome news and issues, followed by experts' negative remarks.

The well-regulated intermediaries can play a constructive role in the stability ofmarkets. The investors (less financially literate) must channel through theintermediaries for best results.

Avoid short-selling up to risky proportions.

Market instruments should be opted for on the basis of risk-return trade-offs andcompatibility should be there between what an instrument is offering and what aninvestor is expecting.

Short-selling should be optimally restricted and if the investors are financially literatethere can be a balance between market optimism and restricted short-selling. This maycurb the volatility to some extent.

Investors can better prepare themselves for value creation and profitability on thestock markets. Hopefully, the investors' strategies and market forces are incoherenceand lead to better market mechanisms and wiser choices, for the economies andindividuals to make fortune by exercising right choices. The investors should evolvewith the evolution in stock markets.

10. PE firms often work in conjunction with other providers of finance and may be able tohelp put a total funding package together for the business.

PE firms also bring in required expertise in multiple functions.

The placement with reputed investor will further enhance the brand image of thecompany.

PE helps achieve ambitions of a company and provides a stable base for strategicdecision-making.

PE firms will seek to increase a company's value to its owners, without taking day-to-day management control.

PE firms usually provide higher valuations in normal stock market conditions and


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lower valuations when stock market is booming.

Investors can also help company in improving and developing its business andstrategies.

11. The various exit routes are

Listing of shares: The listing of shares subsequently after public offer is a well-linked route for exit as it enables free transfer of securities in the open market.

Offer for sale: The PE investor may get out of the transition by offering his holding

to any other interested investor.

Sale to strategic investors: The PE holder, if not restricted by the covenants of theagreement, may sell his stake to any acquirer, who is interested in taking over themanagement of the company.

Tag along rights: It is a contractual obligation used to protect minority shareholders.Basically, if majority shareholders sell their stake, then the minority shareholders havethe right to join the transaction and sell their minority stake in the company.

Management buy-out: The managers and/or executives of a company can purchasecontrolling interest in a company from exiting shareholders.

Auction of shares: The PE investors may sell their stake in an open markettransaction by way of auction.

Buyback by promoters: The holding of outsider investor is being purchased by

promoters through buy back complying with the provisions of the Companies Act,1956.

Merger with listed companies: The most popular way of exiting is merger oramalgamation of investee company with any other listed company, enabling theshareholders to freely transfer the shares in the open market.

Documents

Security Analysis 2