Equity Valuvation of FMCG Sector- ITC Company

8/3/2019 Equity Valuvation of FMCG Sector- ITC Company

1/47

Equity Valuation ITC LTD.

Objective

The primary objective of equity research is to analyze the earnings persistence. Some key aspects

that affect the earnings persistence can be summarized as follows:

The stability of the equity under consideration

The predictability of the value of the given equity under the given circumstances

The variability of the given equity, given the various variance factors

VESIMSR Page 1


2/47


INTRODUCTION TO EQUITY

What is Equity?

In accounting and finance, equity is the residual claim or interest of the most junior class of

investors in assets, after all liabilities are paid.. In an accounting context, Shareholders' equity (or

stockholders' equity, shareholders' funds, shareholders' capital or similar terms) represents the

interest in assets of a company, spread among individual shareholders of common or preferred

stock.

At the start of a business, owners put some funding into the business to finance assets. This

creates liability on the business in the shape of capital as the business is a separate entity from itsowners. Businesses can be considered to be, for accounting purposes, sums of liabilities and

assets; this is the accounting equation.

This definition is helpful to understand the liquidation process in case of bankruptcy. At first, all

the secured creditors are paid against proceeds from assets. Afterward, a series of creditors,

ranked in priority sequence, have the next claim/right on the residual proceeds. Ownership equity

is the last or residual claim against assets, paid only after all other creditors are paid. In such

cases where even creditors could not get enough money to pay their bills, nothing is left over to

reimburse owners' equity. Thus owners' equity is reduced to zero. Ownership equity is also

known as risk capital.

What is Equity Shares?

Total equity capital of a company is divided into equal units of small denominations, each called

a share. For example, in a company the total equity capital of Rs 2,00,00,000 is divided into

20,00,000 units of Rs 10 each. Each such unit of Rs 10 is called a Share. Thus, the company then

is said to have 20, 00,000 equity shares of Rs 10 each. The holders of such shares are members of

the company and have voting rights.

VESIMSR Page 2


3/47


EQUITY INVESTMENT

Equity investments generally refers to the buying and holding of shares of stock on a stock

market by individuals and firms in anticipation of income from dividends and capital gain as the

value of the stock rises. It also sometimes refers to the acquisition of equity (ownership)

participation in a private (unlisted) company or a startup (a company being created or newly

created). When the investment is in infant companies, it is referred to as venture capital investing

and is generally understood to be higher risk than investment in listed going-concern situations.

How to invest in Equity Shares?

Investors can buy equity shares of a company from Security market that is from Primary market

(IPO) or Secondary market (stock markets).

The primary market provides the channel for sale of new securities. It provides opportunity to

issuers of securities, Government as well as corporate, to raise resources to meet their

requirements of investment.

Investors can buy shares of a company through IPO (Initial Public Offering) when it is first time

issued to the public. Once shares are issued to the public it is traded in the secondary market.

Stock exchange only acts as facilitator for trading of equity shares. Anyone who wishes to buy

shares of a company can buy it from an existing shareholder of a company.

Why should one invest in Equity in particular?

When you buy a share of a company you become a shareholder in that Company .Equities have

the potential to increase in value over time. It also provides your portfolio with the growth

necessary to reach your long term investment goals. Research studies have proved that the

equities have outperformed most other forms of investments in the long term.

Equities are considered the most challenging and the rewarding, when compared to other

investment options. Research studies have proved that investments in some shares with a longer

tenure of investment have yielded far superior returns than any other investment. However, this

VESIMSR Page 3


4/47


does not mean all equity investments would guarantee similar high returns. Equities are high risk

investments. One needs to study them carefully before investing.

It is important for investors to note that while equity shares give highest return as compared to

other investment avenues it also carries highest risk therefore it is important to find real value

or intrinsic value of the security before investing in it. The intrinsic value of a security being

higher than the securitys market value represents a time to buy. If the value of the security is

lower than its market price, investors should sell it.

To be able to value equity, we need to first understand how equity is to be analyzed using

fundamental analysis.

Overview of Indian Economy

VESIMSR Page 4


5/47


The overall growth of Gross Domestic Product (GDP) at factor cost at constant prices, as per

Advance Estimates, was 8.6 per cent in 2010-11 representing an increase from the revised growth

of 8.0 per cent during 2009-10, according to the Advance Estimate (AE) of Central Statistics

Office (CSO). Overall growth in the Index of Industrial Production (IIP) was 3.6 per cent during

February 2011. During April-February 2010-11, IIP growth was 7.8 per cent.

The six core industries (comprising crude oil, petroleum refinery products, coal, electricity,

cement and finished carbon steel) grew by 6.8 per cent in February 2011 as compared to the

growth of 4.2 per cent in February 2010. During April-February 2010-11, these sectors grew by

5.7 per cent as compared to 5.4 per cent during April-February 2009-10. In addition, exports, in

US dollar terms increased by 49.7 per cent and imports increased by 21.2 per cent, during

February 2011.

The domestic environment is conducive for growth and private final consumption expenditure is

projected to grow by a healthy 7.5 per cent and gross fixed capital formation by 14.6 per cent, the

Centre for Monitoring Indian Economy (CMIE) said in its latest monthly review of the countrys

economy. On the back of such facts, Indias GDP is projected to continue to grow at a brisk pace

of 8.8 per cent in 2011-12.

In FY 12, the agricultural and allied sector is projected to grow by 3.1 per cent, on top of the 5.1per cent growth estimated in 2010-11. The industrial sector, including construction, is projected

to grow by 9.4 per cent during 2011-12, as compared to 8.5 per cent estimated in 2010-11.

Growth in industrial production will be driven by a rise in consumption demand and investment

demand, said the review.

The Economic Scenario

VESIMSR Page 5


6/47


India is today rated as one of the most attractive investment destinations across the globe. The

UNCTAD World Investment Report (WIR) 2010, in its analysis of the global trends and

sustained growth of Foreign Direct Investment (FDI) inflows, has reported India to be the second

most attractive location for FDI for 2010-2012.

Moreover, India attracted FDI equity inflows of US$ 1,274 million in February 2011. The

cumulative amount of FDI equity inflows from April 2000 to February 2011 stood at US$ 193.7

billion, according to the data released by the Department of Industrial Policy and Promotion

(DIPP). The humungous increase in investment mirrors the foreign investors faith in the Indian

markets.

The services sector comprising financial and non-financial services attracted 21 per cent of the

total FDI equity inflow into India worth US$ 3,274 million during April-February 2011, while

telecommunications (including radio paging, cellular mobile and basic telephone services)

attracted the second largest amount of FDI worth US$ 1,410 million during the same period.

Automobile industry was the third highest sector attracting FDI worth US$ 1,320 million

followed by Housing and Real Estate industry which garnered FDI worth US$ 1,109 million

during the financial year April-February 2011.

Betting high on the Indian market, foreign institutional investors (FIIs)have purchased stocks anddebt securities worth US$ 222 billion in the financial year ending March 31, 2011, as per the data

available with the Securities and Exchange Board of India (SEBI).

As on April 29, 2011, India's foreign exchange reserves totalled US$ 313.51 billion, according to

the Reserve Bank of India's (RBI) Weekly Statistical Supplement.

India's merchandise export during March 2011 reached US$ 29.13 billion, up 43.8 per cent over

US$ 20.25 billion in the same month a year ago. With this, the countrys total exports in goodsfor 2010-11 reached US$ 245.29 billion, registering 37.5 per cent growth against US$ 178.75

billion in 2009-10, according to the foreign trade data released by the Ministry of Commerce and

Industry. The ministry has now set a target of achieving US$ 500-billion exports by 2013-14 by

strategizing the countrys foreign trade through diversification of products and markets and

technological enhancement.

VESIMSR Page 6


7/47


Foreign Tourist Arrivals (FTAs) during the Month of April 2011 was 417,000 as compared to

FTAs of 354,000 during the month of April 2010 and 348,000 in April 2009. There has been a

growth of 17.7 per cent in April 2011 over April 2010 as compared to a growth of 2 per cent

registered in April 2010 over April 2009. FTAs during the period January-April 2011 were 2.15

million with a growth of 12.3 per cent, as compared to the FTAs of 1.92 million with a growth of

8.9 per cent during January-April 2010 over the corresponding period of 2009.

India's GSM subscriber base grew by 2.61 per cent in March with the addition of 14.5 million

mobile phone users. The total number of GSM subscribers in the country crossed 560 million as

against 555 million in February, according to the data released by Cellular Operators Association

of India (COAI).

Further, the number of 3G subscriber connections in India is forecast to reach 400 million within

four years, representing almost 30 per cent of the country's total mobile connections, according to

a Wireless Intelligence study -- India 3G Rollout (forecasts and market shares 2011 - 2015). 3G

connections are set to grow three-fold between 2011 and 2015 as operators ramp-up rollout of

new 3G networks, according to the study.

The average assets under management of the mutual fund industry stood at US$ 157 billion in

February 2011 against US$ 154 billion in January, according to the data released by Associationof Mutual Funds in India (AMFI).

The Indian IT-BPO sector continues to be the fastest growing segment of the industry and is

estimated to have aggregated revenues of US$ 76 billion in FY2011 by growing 19 per cent over

the previous year, revealed software industry body NASSCOM. Further, NASSCOM predicts

that the Indian IT-BPO revenues may touch US$ 225 billion by 2020.

Indias auto market (domestic vehicle sales) grew at 26.17 per cent in 2010-11, according to theSociety of Indian Automobile Manufacturers (SIAM). Passenger cars grew by 29.73 per cent,

utility vehicles grew by 18.87 per cent and multi-purpose vehicles grew by 42.10 per cent during

the year 2010-11.

VESIMSR Page 7


8/47


Jewellery exports in the financial year 2010-11 surged to US$ 43,139.2 million as against

US$ 29,358.5 million in the previous year, according to the Gem and Jewellery Export

Promotion Council (GJEPC).

Passengers carried by domestic airlines during January-March 2011 were 14.3 million

registering a growth of 20.9 per cent, according to the Ministry of Civil Aviation.

The HSBC Market Business Activity Index, which measures business activity among

Indian services companies, based on a survey of 400 firms, stood at 58.1 in March 2011.

Agriculture

The growth of Indian agriculture and allied sector was a top agenda in Budget 2011-12 presented

by Finance Minister Pranab Mukherjee. He has estimated that the agriculture and allied sector

would grow by 6 per cent this fiscal, a projection which should ease government's worries on

food inflation of over 18 per cent.

In the Union Budget 2011-12, Finance Minister Pranab Mukherjee made the following

announcements for the agriculture sector:

Credit flow to farmers has been increased to US$ 105.81 billion and banks have been

asked to step up direct lending to farmers

Allocation under Rashtirya Krishi Vikasyojna (RKVY) increased to US$ 1.75 billion.

Banks have been consistently meeting the targets set for agricultural credit flow in the

past few years. For the year 2010-11, the target has been set at US$ 81.47 billion

US$ 66.83 million each allocated for vegetable initiative to achieve competitive prices, to

promote higher production of nutri-cereals, to promote animal based protein and for

Accelerated Fodder Development Program to benefit farmers in 25,000 villages

15 more mega food parks during 2011-12

National food security bill to be introduced this year.

Growth Potential Story

VESIMSR Page 8


9/47


The data centre services market in the country is estimated to grow at a compound annual

growth rate (CAGR) of 22.7 per cent between 2009 and 2011, to touch close to US$ 2.2

billion by the end of 2011, according to research firm IDC Indias report.

As per the Nasscom Strategic Review 2011, the Domestic BPO segment is expected to

grow by 16.9 per cent in 2010-11, to reach US$ 2.8 billion, driven by demand from voice

based services, in addition to adoption from emerging verticals, new customer segments,

and value based transformational outsourcing platforms.

The Q211 BMI India Retail Report forecasts that total retail sales will grow from US$

395.96 billion in 2011 to US$ 785.12 billion by 2015.

According to a McKinsey Global Institute (MGI) study titled 'Bird of Gold': The Rise of

India's Consumer Market, the total consumption in India is likely to quadruple making

India the fifth largest consumer market by 2025. Urban India will account for nearly 68

per cent of consumption growth while rural consumption will grow by 32 per cent by

2025.

India ranks first in the Nielsen Global Consumer Confidence survey released in January

2011. India is one of the fastest growing markets in the world and the current consumer

belief that recession would soon be a thing of the past has filled Indians with confidence,

said PiyushMathur, Managing Director, South Asia, The Nielsen Co. With 131 index

points, India ranked number one in the recent round of the survey, followed byPhilippines (120) and Norway (119).

Overview of Indian FMCG Sector

VESIMSR Page 9


10/47


The Indian FMCG sector is the fourth largest sector in the economy with a total market size in

excess of US$ 13.1 billion. It has a strong MNC presence and is characterized by a well

established distribution network, intense competition between the organized and unorganized

segments and low operational cost. Availability of key raw materials, cheaper labour costs and

presence across the entire value chain gives India a competitive advantage.

The FMCG market is set to treble from US$ 11.6 billion in 2003 to US$ 33.4 billion in 2015.

Penetration level as well as per capita consumption in most product categories like jams,

toothpaste, skin care, hair wash etc in India is low indicating the untapped market potential.

Burgeoning Indian population, particularly the middle class and the rural segments, presents an

opportunity to makers of branded products to convert consumers to branded products.

Growth is also likely to come from consumer 'upgrading' in the matured product categories. With

200 million people expected to shift to processed and packaged food by 2010, India needs around

US$ 28 billion of investment in the food-processing industry.

Automatic investment approval (including foreign technology agreements within specified

norms), up to 100 per cent foreign equity or 100 per cent for NRI and Overseas Corporate Bodies

(OCBs) investment, is allowed for most of the food processing sector.

Evolution Of FMCG Sector

India has always been a country with a big chunk of world population, be it the 1950s or the

twenty first century. In that sense, the FMCG market potential has always been very big.

However, from the 1950s to the 80s investments in the FMCG industry were very limited due

to low purchasing power and the governments favouring of the small-scale sector. Hindustan

Lever Limited (HLL) was probably the only MNC company that stuck around and had its

manufacturing base in India.

At the time, the focus of the organised players like HLL was largely urbane. There too, the

consumers had limited choices. However, Nirmas entry changed the whole Indian FMCG scene.

The company focused on the value for money plank and made FMCG products like detergents

VESIMSR Page 10


11/47


very affordable even to the lower strata of the society. Nirma became a great success story and

laid the roadmap for others to follow.

Private consumption expenditure trends

CAGR

(%)

Food, beverages,

tobacco

Personal

care

FY81 11.0% 13.4%

FY91 11.7% 11.9%

FY01 11.9% 14.8%

*CAGR over a decade

MNCs like HLL, which were sitting pretty till then, woke up to new market realities and noticed

the latent rural potential of India. The governments relaxation of norms also encouraged these

companies to go out for economies of scale in order to make FMCG products more affordable.

Consequently, today soaps and detergents have almost 90% penetration in India.

Post liberalisation not only saw higher number of domestic choices, but also imported products.

The lowering of the trade barriers encouraged MNCs to come and invest in India to cater to 1bn

Indians needs. Rising standards of living urban areas coupled with the purchasing power of rural

India saw companies introduce everything from a low-end detergent to a high-end sanitary

napkin. Their strategy has become two-pronged in the last decade. One, invest in expanding the

distribution reach far and wide across India to enable market expansion of FMCG products.

Secondly, upgrade existing consumers to value added premium products and increase usage of

existing product ranges.

So you could see all companies be it HLL, Godrej Consumer, Marico, Henkel, Reckitt Benckiser

and Colgate, trying to outdo each other in getting to the rural consumer first. Each of them has

seen a significant expansion in the retail reach in mid-sized towns and villages. Some who couldnot do it on their own, have piggy backed on other FMCG majors distribution network (P&G-

Marico). Consequently, companies that have taken to rural India like chalk to cheese have seen

their sales and profits expanding. For example, currently 50% of all HLL sales come from rural

India, and consequently, it is one the biggest beneficiaries of this (see table).

VESIMSR Page 11


12/47


CAGR growth in last 10 years

Sales Net profit

Cadbury 16.6% 53.0%

Colgate 9.9% 4.2%

HLL 19.1% 33.5%

Marico 12.3% 25.7%

Nestle 16.4% 25.3%

P&G Hygiene 9.0% 19.9%

Reckitt & Benckiser 13.3% 2.7%

There are others, like Nestle, which have till date catered mostly to urban India but have still seen

good growth in the last decade. The companys focus in the last decade has largely been on value

added products for the upper strata of society. However, in the last couple of years, even these

companies have looked to reach consumers at the slightly lower end.

One of the biggest changes to hit the FMCG industry was the sachet bug. In the last 3 years,

detergent companies, shampoo companies, hair oil companies, biscuit companies, chocolate

companies and a host of others, have introduced products in smaller package sizes, at lower price

points. This is the single big innovation to reach new users and expand market share for value

added products in urban India, and for general FMCG products like detergents, soaps and oral

care in rural India.

Another interesting phenomenon to have hit the FMCG industry is the mushrooming of regional

companies, which are posing a threat to bigger FMCG companies like HLL. For example, the rise

of Jyothi Laboratories, which has given sleepless nights to Reckitt Benckiser, the Ghari

detergent, that has slowly but surely built itself to take on Nirma and HLL in detergents, and

finally, the rise of Anchor in oral care, which has become synonymous with cat, which walks

away with spoils when two monkeys fight (HLL and Colgate). There are numerous other

examples of this.

What does all this mean for the future of FMCG industry in India? Undoubtedly, all this is good

for the consumers, who can now choose a variety of products, from a number of companies, at

different price points. But for the players who cater to the Indian consumer, the future brings a lot

VESIMSR Page 12


13/47


more competition. In this environment, only the innovators will survive. Focus will be the key to

profitability (ala HLL). From an investors point of view, Indian FMCG companies do offer long-

term growth opportunities given the low penetration and usage in most product categories. To

choose the best investment opportunities look at the shapers (i.e. innovators) that have been

constantly proactive to market needs and have built strong, efficient and intelligent distribution

channels. Management vision to growth is the key, as consumers going forward are likely to

become even more sophisticated in their demand.

Structural Analysis Of FMCG Industry

Typically, a consumer buys these goods at least once a month. The sector covers a wide gamut of

products such as detergents, toilet soaps, toothpaste, shampoos, creams, powders, food products,

confectioneries, beverages, and cigarettes. Typical characteristics of FMCG products are: -

The products often cater to 3 very distinct but usually wanted for aspects - necessity,

comfort, luxury. They meet the demands of the entire cross section of population. Price

and income elasticity of demand varies across products and consumers.

Individual items are of small value (small SKU's) although all FMCG products put

together account for a significant part of the consumer's budget.

The consumer spends little time on the purchase decision. He seldom ever looks at the

technical specifications. Brand loyalties or recommendations of reliable retailer/ dealer

drive purchase decisions

Limited inventory of these products (many of which are perishable) are kept by consumer

and prefers to purchase them frequently, as and when required.

Brand switching is often induced by heavy advertisement, recommendation of the retailer

or word of mouth.

Indian FMCG Sector Growth Drivers &

Category Trends

VESIMSR Page 13


14/47


The fourth largest sector in the Indian economy is all set for 16% growth during 2008-09, from a

base of Rs. 85470 crores as predicted by FICCI. Going forward, as anticipated by CRISIL,

FMCG sector will touch around Rs. 140000 crores by 2015 (33.4B$).

This post will through some pointers for growth in FMCG Sector and update with the

contemporary category trends.

Growth Drivers in FMCG Sector

1. Disposable Income: There is increase in disposable income, observed in both rural and urban

consumers, which is giving opportunity to many rural consumers to shift from traditional

unorganized unbranded products to branded FMCG products and urban fraternity to splurge on

value added and lifestyle products. The increasing salaries, along with rising trend of perks in the

corporate sector at regular intervals, have increased peoples spending power. As per some

research, there is a high correlation between Disposable per capita and HPC per capita.

2. Organized Retail: The emergence of organized retail have lead to more variety with ease in

browsing, opportunity to compare with different products in a category, one stop destination

(entertainment, food and shopping) etc, which is playing an important role in bringing boom in

the Indian FMCG market. Currently the modern trade is capturing 5% of the total retail space,

which will increase to 10% and 25% in 2010 and 2025 respectively. Also, as the credit card and

organized retail trend picks up, people wont think much while buying and buy more.

3. Distribution Depth - Rural Penetration: There are 5500 towns and 6.38 Lacs villages with

2.5Mln and 5Mln outlets respectively. Due to saturation and cut throat competition in urban

India, many FMCG companies are devising strategies for targeting rural consumers in a big way.

Many FMCG companies are focusing on increasing their distribution network to penetrate with a

step by step plan. This is the reason that FMCG urban market size has dropped from 50% to 29%

in last 5 years. The FMCG market size for semi-urban and rural segment was 19% and 52%respectively for the year 2006-07. As per FICCI, the FMCG market size for urban, semi-urban

and rural for year 2007-08 was expected to be 57%, 21% and 22%, which clearly shows that rural

market is the growth engine for FMCG growth. Though the urban markets are growing too, the

incremental addition in consumers households is much more in rural space as compared to urban

markets. The planned development of roads, ports, railways and airports, will increase FMCG

VESIMSR Page 14


15/47


penetration in the long term. 180 million rural and semi-urban peoples attention has already been

diverted towards FMCG products, according to latest estimates released by industry chamber,

Assocham in 2008. The estimated number of households using FMCG products in rural India has

grown from 131 million in 2004 to 140 million in 2007, according to market research company

IMRB. Over 70% sale of FMCG products is made to middle class households and over 50% of

middle class is in rural India.

4. Buying Pattern Shift: The crisis of declining FMCG markets during 2001-04 was driven by

new avenues of expenditure for growing consumer income such as consumer durables,

entertainment, mobiles, motorbikes etc. Now, as many consumers have already upgraded, their

income is being directed towards pampering themselves.

5. Favorable Indian Economy & Demographics: 45% people in India are under 20 years of

age. Per capita disposable income has increased from $550 to $600 in 2007 (9% increase). GDP

is growing at a CAGR between 8 to 9%.In the next five years, affluent and aspirers as a total will

supersede strivers and will be dominated by aspirers, as per NCAER.

FMCG Category Trends

VESIMSR Page 15


16/47


1. Underpenetrated Growth Categories: Within the Indian FMCG industry, there are few

categories that will grow more than 20% during 2008-2009, like shaving cream, skin/fairness

cream, shampoos, skin care & cosmetics, tooth powder. Some other growth categories will be

hair colour, skin care, anti-aging solution, deodorants and mens products. Most of these

categories are under penetrated and there is a huge scope for growth.

2. Penetrated Growth Categories: Even mainstream categories with high penetration levels

such as washing detergents, soaps and hair oils have shown strong underlying volume growth,

despite sharp inflation led price increases in FY08. This is partly related to the growth in

organised retail (3-5% of turnover for most FMCG players) that gives more visibility to national

brands with strong brand equity.

3.Response to demand: Anand Shah, an FMCG research analyst at Angel Broking, says most

FMCG companies are responding to the new demand by concentrating on developing a big theme

and building a portfolio around it. Nestle, for example, has identified 'health and wellness' as its

focus area, while Dabur is positioning itself around ayurvedic (a traditional Indian system of

healthcare), natural and herbal products. At the higher price end, companies are leveraging

health and wellness trends by focusing on providing 'experiential' and 'higher order' benefits

rather than purely functional ones.

4.Health Food Categories: FMCG majors are widening their health food portfolio to cash in on

the rich, urban, health conscious Indian. Sugar free Chywanprash, organic spices and multi grain

pastas and biscuits are few examples. Urban India is high on health and FMCG majors are

cashing in on the opportunity. Processed foods particularly juices that are based on the health

platform would see stronger growth. Also, with the Indian consumer becoming increasingly

health conscious, the demand for juices has witnessed rapid growth.

5. Impact of inflation in 2008: Even if consumers don't switch to cheaper substitutes during

inflation, they normally switch from higher SKUs to lower SKUs of the same product. This is the

reason the companies have come up with smaller SKUs. In line with this trend, Henkel has

withdrawn its 500gm pack washing powder which was priced at Rs.46 and has replaced it with a

new 400gm pack that costs INR40. A couple of months back, Amul introduced 25gm packs of

butter. Not surprisingly, this pack is fetching more sales than 100gm and 500gm packs.

VESIMSR Page 16


17/47


In the first 10 months of 2007, there were 251 product launches, including 28 new brands,

compared with 191 for the same period of 2006. Snacks and foodstuffs remain the category

leaders, with recent launches of several health and beauty products, particularly in urban markets.

Impact Of Recession On Indian FMCG

Sector

VESIMSR Page 17


18/47


Recession report - Indian FMCG sector upbeat

India's fast moving consumer goods industry has so far been resilient to the slowdown in the

economy and a dip in consumer sentiment. If we go by the numbers for October 2008 and

estimates for November 2008, the growth only seems to have got better when compared to the

earlier months.

In October 2008, the soap and colors categories recorded a 22% and 27% value growth

respectively. The estimates for November2008 are also good, whereas in September 2008, the

growth was 12% to 13%.

As per report, consumers are holding on to their monies due to the uncertainties in the markets.

However, they are spending, but on small purchases. Hence, the volumes and growth in the

FMCG sector has not seen a dip.

FMCG sector Is growth, a major issue for the FMCG sector?

A scan of the industry would show up a few exceptions, which have grown year-on-year, though

the sector as whole seems to be under pressure. There could be several explanations for this:

FMCG is a typically defensive sector with a relatively inelastic demand. Neither the sector's

revenues dip when prices rise or incomes contract, nor they expand when prices fall or incomes

expand. There is also a time lag between the contraction/expansion of incomes and the impact on

FMCG revenues because of the `daily necessity' nature of these products; it takes time for

consumers to move away or into these products. However, within a given group of FMCG

products, there would be down and up trading; consumers moving from a low value for money

(VFM) products sold on imagery to high VFM products during a recession and do the reverse

during revival.

In the current economic revival too, these movements will happen in the FMCG sector but with a

time lag. There may be a visible impact in the coming quarters, especially in respect of

companies where there is a clear movement towards providing higher value added products.

VESIMSR Page 18


19/47


And, amid the hype of de-growth, many developments could have been missed out. The FMCG

sector has acquired many new consumers through better penetration using the smaller pack or the

low unit price strategy; volumes are yet to rise significantly, though.

But the real market growth could be a little better than what the research numbers show. For,

Direct/Multi-level marketing, store brands and imported products are not necessarily captured by

the market research agencies. And, the menace of unfair competition counterfeiters,

adulterators, etc., could be taking away 5-10 per cent of the industry's turnover. But, yes,

compared to the rest of the economy, the growth rates in the sector have not been dazzling.

FMCG to escape recession

Despite the global meltdown, Amway, Indias number one direct selling company is confident of

achieving a growth of over 25 per cent.

"I am not saying that our company is recession-proof but it is recession-resilient," the Amway

India Enterprises managing director and chief executive, Mr William Pinckney, said.

He was talking to a group of journalists from Kolkata during a factory-visit at Baddi in Himachal

Pradesh. Over 80 per cent of the Amway products sold in India are manufactured at the Baddi

factory. The state-of-art plant is spread over 110,000 square feet and employs 500 people.

Mr Pinckney claimed that FMCG unlike the automobile industry would not be badly affected by

the economic crisis. "People may stop or postpone purchasing a car but they will certainly not

stop purchasing a shampoo bottle or a shaving cream tube," he added.

He attributed what he described as "this year phenomenal growth" to a couple of factors:

introduction of energy drink and energy bar segments and the launching of great value products

such as coconut oil, Amla hair oil, dispensable razor and shaving cream.

Is the FMCG sector, losing its pricing power, because of intense competition?

One of the much-commented sidelights of economic liberalization in India is the "emergence" of

a large middle-class, and its ability to absorb many FMCG items. Such was the hype created

VESIMSR Page 19


20/47


about these factors that many players, not even in FMCG business, entered the sector with a

variety of products leading to intensified competition at various points, especially at the regional

levels.

With no entry barriers in terms of technology or investments the FMCG business seems an

easy sector to get in. There has been many a case of a new product reaching dizzy heights of

turnover in a short time, but falling by the wayside once the consumer realizes that the value

equation is not working out.

Although the role of the intermediary is important, especially as the influencer at the point of

purchase, the consumer will go for a product that he wants, not necessarily the one the trade

pushes.

Also, as the supply chain environment has improved with better infrastructure, mere availability

of products at retail outlets is not going to be enough; a value proposition is needed to break the

increasing clutter of products.

In some categories, such as toilet soaps, there has been little creativity and innovation, and

instead a misplaced insistence on `bribing' the consumers with freebies. In such cases, the

consumer have realised that the USP is just a better effective price an effective loss of pricing

power through a move away from branding into commoditisation.

Imagery and price premium is central to FMCG marketing propositions. However, that needs to

be backed by a clear value add. Taking the consumer for granted does not pay; companies that

"fleece" the consumer with unduly high margins may eventually be forced to compete with one

another in taking price cuts!

The writing on the wall is clear: The consumer, and not the competition, is the queen!

Is there scope for the FMCG sector to get re-rated on the bourses?

Unlike other sectors, FMCG, being a defensive play, would take time to bloom in a market boom.

The time lag would depend upon the magnitude and pace of the greater realisation of the

VESIMSR Page 20


21/47


potential of up-trading and movement of smarter companies up the value chain through

innovation.

There are some other relevant and recent factors, such as Unilever, the company with the largest

market capitalisation in the FMCG industry, losing considerable value on the bourses.

This has taken some sheen off the sector. Recent hype about price wars could dissuade investors

from getting into the warring MNCs as also into the affected Indian companies. Then there is the

delisting of such companies as Cadbury and Reckitt, which leaves few "good" options for

investors.

The trend is, therefore, likely to be in favour of companies that have not merely made brand

promises, but also kept them! Thus, while the entire sector may not get re-rated, there will surely

be some value picks.

FMCG firms chart new cost cutting plans

To tide over the high cost of inputs, the fast moving consumer goods (FMCG) companies are

designing new strategies. The firms have introduced new packs into the market which are costlier

when compared to the actual quantity they contain.

For instance, global beverages major Coca Cola introduced most of its major brands, including

Coca Cola, Diet Coke, Thumps Up and Mazaa, in new size of 350 ml. The company also

introduced the new Xpress 350 ml pack for its Sprite brand. The company already has 500 ml

bottles in the market priced at Rs 20. However, the recently introduced 350 ml pack, which cost

Rs 15, is helping companies to widen their profit margin by Re 1 on each bottle.

Henkel India Ltd recently introduced a 400 gram pack Henko detergent. The company till a few

months back was producing 500 gram Henko detergent packs priced at Rs 60. The new 400 gram

pack which cost Rs 50, helping it to widen its profit margin by Rs 2 on each packet. According to

Devashis Das, category manager, Henkel India Ltd, the company went for such measure to put a

check on de-growth during the period when the crude prices were ruling record-high.

VESIMSR Page 21


22/47


Besides increase in the profit margins, convenience is another reason why these companies are

going for such packs. Meeting the requirement of the consumers who are looking at single

consumption packs of 300 ml is not comparable with glass bottles which are not hygienic, an

industry analyst said.

According to leading provider of knowledge services, Evalueserve, the current easing off of

commodity prices will certainly give breathing space and there will be some improvement in

margins, in the immediate future. The latest Unctad Trade and Development Report 2008

predicts volatility of commodity prices, which indicates that they will have to battle pressures on

margins over the next few quarters.

The decision that most firms will have to make is how much of the increase in input costs can be

passed on to the consumer. In any case competitive pressures will limit the amount that can be

passed on directly, so companies will continue to adopt value-based measures in the current

scenario.

PROBLEM OF FMCG COMPANIES

Maintaining Profitable Growths

Freebies are threatening to lead to the commoditization of the industry.

Challenges before the Indian FMCG Sector

VESIMSR Page 22


23/47


Markets all over the world have been on a roll in 2003 and the Indian bourses are no exception

having gained almost 60% in 2003. During this period, while there are sectors that have

outperformed this benchmark index, there are also sectors that have underperformed. FMCG

registered gains of just 33% on the BSE FMCG Index last year.

At the macro level, Indian economy is poised to remained buoyant and grow at more than 7%.

The economic growth would impact large proportions of the population thus leading to more

money in the hands of the consumer. Changes in demographic composition of the population and

thus the market would also continue to impact the FMCG industry.

Recent survey conducted by a leading business weekly, approximately 47 per cent of India's 1 +

billion people were under the age of 20, and teenagers among them numbered about 160 million.

Together, they wielded INR 14000 Cr worth of discretionary income, and their families spent an

additional INR 18500 Cr on them every year. By 2015, Indians under 20 are estimated to make

up 55% of the population - and wield proportionately higher spending power. Means, companies

that are able to influence and excite such consumers would be those that win in the market place.

The Indian FMCG market has been divided for a long time between the organized sector and the

unorganized sector. While the latter has been crowded by a large number of local players,

competing on margins, the former has varied between a two-player-scenario to a multi-playerone.

Unlike the U.S. market for fast moving consumer goods (FMCG), which is dominated by a

handful of global players, India's Rs.460 billion FMCG market remains highly fragmented with

roughly half the market going to unbranded, unpackaged home made products. This presents a

tremendous opportunity for makers of branded products who can convert consumers to branded

products. However, successfully launching and growing market share around a branded product

in India presents tremendous challenges. Take distribution as an example. India is home to six

million retail outlets and super markets virtually do not exist. This makes logistics particularly for

new players extremely difficult. Other challenges of similar magnitude exist across the FMCG

supply chain. The fact is that FMCG is a structurally unattractive industry in which to participate.

Even so, the opportunity keeps FMCG makers trying.

VESIMSR Page 23


24/47


At the macro-level, over the long term, the efforts on the infrastructure front (roads, rails, power,

river linking) are likely to enhance the living standards across India. Till date, India's per capita

consumption of most FMCG products is much below world averages. This is the latent potential

that most FMCG companies are looking at. Even in the much-penetrated categories like

soaps/detergents companies are focusing on getting the consumer up the value chain. Going

forward, much of the battle will be fought on sophisticated distribution strengths.

Indian FMCG Industry Outlook 2013

The Rs.85,000 crore FMCG market in India is growing at a fast pace despite of the economic

downtrend. The increasing disposable income and improved standard of living in most tier II and

tire III cities are spearheading the FMCG growth across the nation. The changing profile and

mind set of the consumers has shifted the thought to Value for Money from Money for

Value.

Over the years companies like HUL, ITC and Dabur have improved performance with innovation

and strong distribution channels. Their key categories have strengthened their presence and

outperformed peers in the FMCG sector. On the contrary, Colgate Palmolive and Britannia

Industries are strong in single product category i.e. tooth pastes and Biscuits. In addition

companies have been successful in reviving their presence in the semi-urban and rural markets.

This report examines the growing market for FMCG market in India. This starts with an

overview of the Industry in India and goes on to explain how product and demographic

categories across the nation have added value to the Industry. The report examines the recent

development within the industry and tries to gauge the impact in shaping the landscape of the

FMCG market. It also contains a summary of the key players, including their product portfolio,

business operations, and strategies. The report concludes with an industry outlook section.Finally the report mandates with the outlook for the year 2013, considering the current events and

growing economy. The report concludes with a list of growth drivers, breaking them into demand

side, supply side and systematic drivers.

Key Findings:

VESIMSR Page 24


25/47


MNCs in India have a strong and competitive presence across the entire value chain of

FMCG.

The biggest opportunity for branded products lies in the middle class and the rural

segments of the Indian population for FMCG.

The foods category in FMCG is gaining popularity with a swing of launches by HUL,

ITC, Godrej, and others.

SWOT Analysis of FMCG Sector

STRENGTHS

Low operational costs

Presence of established distribution networks in both urban and rural areas

VESIMSR Page 25


26/47


Presence of well-known brands in FMCG sector

WEAKNESSES

Lower scope of investing in technology and achieving economies of scale,especially in small sectors

Low exports levels

"Me-too" products, which illegally mimic the labels of the established brands,

narrow the scope of FMCG products in rural and semi-urban market.

OPPORTUNITIES

Untapped rural market

Rising income levels i.e. increase in purchasing power of consumers

Large domestic market - a population of over one billion

Export potential 5. High consumer goods spending

THREATS

Removal of import restrictions resulting in replacing of domestic brands

Slowdown in rural demand.

Tax and regulatory structure

Top 10 FMCG Companies In India

VESIMSR Page 26


27/47


1. Hindustan Unilever Ltd.

2. ITC (Indian Tobacco Company)

3. Nestl India4. GCMMF (AMUL)

5. Dabur India

6. Asian Paints (India)

7. Cadbury India

8. Britannia Industries9. Procter & Gamble Hygiene and Health Care

10. Marico Industries

Overview of Indian Tobacco Company

(ITC)

History and Evolution

ITC was incorporated on August 24, 1910 under the name Imperial Tobacco Company of India

VESIMSR Page 27


28/47


Limited. As the Company's ownership progressively Indianised, the name of the Company was

changed from Imperial Tobacco Company of India Limited to India Tobacco Company

Limited in 1970 and then to I.T.C. Limited in 1974. In recognition of the Company's multi-

business portfolio encompassing a wide range of businesses - Cigarettes & Tobacco, Hotels,

Information Technology, Packaging, Paperboards & Specialty Papers, Agri-business, Foods,

Lifestyle Retailing, Education & Stationery and Personal Care - the full stops in the Company's

name were removed effective September 18, 2001. The Company now stands rechristened

'ITC Limited'.

The Companys beginnings were humble. A leased office on Radha Bazar Lane, Kolkata, was

the centre of the Company's existence. The Company celebrated its 16th birthday on August 24,

1926, by purchasing the plot of land situated at 37, Chowringhee, (now renamed J.L. Nehru

Road) Kolkata, for the sum of Rs 310,000. This decision of the Company was historic in more

ways than one. It was to mark the beginning of a long and eventful journey into India's future.

The Company's headquarter building, 'Virginia House', which came up on that plot of land two

years later, would go on to become one of Kolkata's most venerated landmarks.

Though the first six decades of the Company's existence were primarily devoted to the growth

and consolidation of the Cigarettes and Leaf Tobacco businesses, the Seventies witnessed thebeginnings of a corporate transformation that would usher in momentous changes in the life of

the Company.

ITC's Packaging & Printing Business was set up in 1925 as a strategic backward integration for

ITC's Cigarettes business. It is today India's most sophisticated packaging house.

In 1975 the Company launched its Hotels business with the acquisition of a hotel in Chennai

which was rechristened 'ITC-Welcomgroup Hotel Chola'. The objective of ITC's entry into the

hotels business was rooted in the concept of creating value for the nation. ITC chose the hotels

business for its potential to earn high levels of foreign exchange, create tourism infrastructure

and generate large scale direct and indirect employment. Since then ITC's Hotels business has

VESIMSR Page 28


29/47


grown to occupy a position of leadership, with over 100 owned and managed properties spread

across India.

In 1979, ITC entered the Paperboards business by promoting ITC Bhadrachalam PaperboardsLimited, which today has become the market leader in India. Bhadrachalam Paperboards

amalgamated with the Company effective March 13, 2002 and became a Division of the

Company, Bhadrachalam Paperboards Division. In November 2002, this division merged with

the Company's Tribeni Tissues Division to form the Paperboards & Specialty Papers Division.

ITC's paperboards' technology, productivity, quality and manufacturing processes are

comparable to the best in the world. It has also made an immense contribution to the

development of Sarapaka, an economically backward area in the state of Andhra Pradesh. It is

directly involved in education, environmental protection and community development. In 2004,

ITC acquired the paperboard manufacturing facility of BILT Industrial Packaging Co. Ltd

(BIPCO), near Coimbatore, Tamil Nadu. The Kovai Unit allows ITC to improve customer

service with reduced lead time and a wider product range.

In 1985, ITC set up Surya Tobacco Co. in Nepal as an Indo-Nepal and British joint venture.

Since inception, its shares have been held by ITC, British American Tobacco and various

independent shareholders in Nepal. In August 2002, Surya Tobacco became a subsidiary of ITCLimited and its name was changed to Surya Nepal Private Limited (Surya Nepal).

In 1990, ITC acquired Tribeni Tissues Limited, a Specialty paper manufacturing company and a

major supplier of tissue paper to the cigarette industry. The merged entity was named the Tribeni

Tissues Division (TTD). To harness strategic and operational synergies, TTD was merged with

the Bhadrachalam Paperboards Division to form the Paperboards & Specialty Papers Division

in November 2002.

Also in 1990, leveraging its agri-sourcing competency, ITC set up the Agri Business Division

for export of agri-commodities. The Division is today one of India's largest exporters. ITC's

unique and now widely acknowledged e-Choupal initiative began in 2000 with soya farmers in

Madhya Pradesh. Now it extends to 10 states covering over 4 million farmers. ITC's first rural

mall, christened 'Choupal Saagar' was inaugurated in August 2004 at Sehore. On the rural retail

VESIMSR Page 29


30/47


front, 24 'Choupal Saagars' are now operational in the 3 states of Madhya Pradesh, Maharashtra

and Uttar Pradesh.

ITCProfile

ITC is one of India's foremost private sector companies with a market capitalization of over US $

33 billion and a turnover of US $ 7 billion. ITC is rated among the World's Best Big Companies,

Asia's 'Fab 50' and the World's Most Reputable Companies by Forbes magazine, among India's

Most Respected Companies by Business World and among India's Most Valuable Companies by

Business Today. ITC ranks among India's `10 Most Valuable (Company) Brands', in a study

conducted by Brand Finance and published by the Economic Times. ITC also ranks among Asia's

50 best performing companies compiled by Business Week.

ITC has a diversified presence in Cigarettes, Hotels, Paperboards & Specialty Papers, Packaging,

Agri-Business, Packaged Foods & Confectionery, Information Technology, Branded Apparel,

Personal Care, Stationery, Safety Matches and other FMCG products. While ITC is an

outstanding market leader in its traditional businesses of Cigarettes, Hotels, Paperboards,

Packaging and Agri-Exports, it is rapidly gaining market share even in its nascent businesses of

Packaged Foods & Confectionery, Branded Apparel, Personal Care and Stationery.

As one of India's most valuable and respected corporations, ITC is widely perceived to be

dedicatedly nation-oriented. Chairman Y C Deveshwar calls this source of inspiration "a

commitment beyond the market". In his own words: "ITC believes that its aspiration to create

enduring value for the nation provides the motive force to sustain growing shareholder value.

ITC practices this philosophy by not only driving each of its businesses towards international

competitiveness but by also consciously contributing to enhancing the competitiveness of the

larger value chain of which it is a part."

ITC's diversified status originates from its corporate strategy aimed at creating multiple drivers of

growth anchored on its time-tested core competencies: unmatched distribution reach, superior

brand-building capabilities, effective supply chain management and acknowledged service skills

VESIMSR Page 30


31/47


in hoteliering. Over time, the strategic forays into new businesses are expected to garner a

significant share of these emerging high-growth markets in India.

ITC's Agri-Business is one of India's largest exporters of agricultural products. ITC is one of the

country's biggest foreign exchange earners (US $ 3.2 billion in the last decade). The Company's

'e-Choupal' initiative is enabling Indian agriculture significantly enhance its competitiveness by

empowering Indian farmers through the power of the Internet. This transformational strategy,

which has already become the subject matter of a case study at Harvard Business School, is

expected to progressively create for ITC a huge rural distribution infrastructure, significantly

enhancing the Company's marketing reach.

ITC's wholly owned Information Technology subsidiary, ITC Infotech India Ltd, provides IT

services and solutions to leading global customers. ITC Infotech has carved a niche for itself by

addressing customer challenges through innovative IT solutions.

ITC's production facilities and hotels have won numerous national and international awards for

quality, productivity, safety and environment management systems. ITC was the first company in

India to voluntarily seek a corporate governance rating.

ITC employs over 24,000 people at more than 60 locations across India. The Company

continuously endeavors to enhance its wealth generating capabilities in a globalizing

environment to consistently reward more than 4,05,000 shareholders, fulfill the aspirations of its

stakeholders and meet societal expectations. This over-arching vision of the company is

expressively captured in its corporate positioning statement: "ENDURING VALUE. FOR THE

NATION. FOR THE SHAREHOLDER."

The ITC Way

ITC is a board-managed professional company, committed to creating enduring value for the

shareholder and for the nation. It has a rich organizational culture rooted in its core values of

VESIMSR Page 31


32/47


respect for people and belief in empowerment. Its philosophy of all-round value creation is

backed by strong corporate governance policies and systems.

ITCs corporate strategies are :

Create multiple drivers of growth by developing a portfolio of world class businesses that

best matches organizational capability with opportunities in domestic and export markets.

Continue to focus on the chosen portfolio of FMCG, Hotels, Paper, Paperboards &

Packaging, Agri Business and Information Technology.

Benchmark the health of each business comprehensively across the criteria of Market

Standing, Profitability and Internal Vitality.

Ensure that each of its businesses is world class and internationally competitive.

Enhance the competitive power of the portfolio through synergies derived by blending the

diverse skills and capabilities residing in ITCs various businesses.

Create distributed leadership within the organization by nurturing talented and focused

top management teams for each of the businesses.

Continuously strengthen and refine Corporate Governance processes and systems to

catalyse the entrepreneurial energies of management by striking the golden balance

between executive freedom and the need for effective control and accountability.

ITC Vision , Mission and Core Values

Vision

VESIMSR Page 32


33/47


Sustain ITC's position as one of India's most valuable corporations through world class

performance, creating growing value for the Indian economy and the Companys stakeholders.

Mission

To enhance the wealth generating capability of the enterprise in a globalizing environment,

delivering superior and sustainable stakeholder value.

Core Values:

ITC's Core Values are aimed at developing a customer-focused, high-performance organisation

which creates value for all its stakeholders:

Trusteeship

As professional managers, we are conscious that ITC has been given to us in "trust" by all our

stakeholders. We will actualize stakeholder value and interest on a long term sustainable basis.

Customer Focus

We are always customer focused and will deliver what the customer needs in terms of value,

quality and satisfaction.

Respect For People

We are result oriented, setting high performance standards for ourselves as individuals and teams.

We will simultaneously respect and value people and uphold humanness and human dignity.

We acknowledge that every individual brings different perspectives and capabilities to the team

and that a strong team is founded on a variety of perspectives.

We want individuals to dream, value differences, create and experiment in pursuit of

opportunities and achieve leadership through teamwork.

Excellence

VESIMSR Page 33


34/47


We do what is right, do it well and win. We will strive for excellence in whatever we do.

Innovation

We will constantly pursue newer and better processes, products, services and managementpractices.

Nation Orientation

We are aware of our responsibility to generate economic value for the Nation. In pursuit of our

goals, we will make no compromise in complying with applicable laws and regulations at all

levels.

SWOT Analysis Of ITC Ltd

Strengths

Strong Financial Performance

Products Portfolio

Distribution Network

VESIMSR Page 34


35/47


Environmental Friendly

Research & Development

Socially Responsibility

Brand Equity

Weakness

Dependency on the tobacco business

Not present in many important sectors

Local Company

Opportunities

Leveraging its brand equity

Right size at the right time

Synergies across businesses and leveraging domain expertise for growth in other sectors

The unique reach and distribution network of E-choupal

Threats

Competition

Pressure groups and Government Policy

Wide income disparities

Growth Drivers Of ITC LTD

VESIMSR Page 35


36/47


Growth Drivers

We believe the growth opportunity in all of ITCs businesses remains exciting; ITC has made

aggressive investment plans to sustain the 17.2% PAT CAGR it has seen in the last 10 years.

Investment in its paper and hotel businesses should be largely funded by its own cash flows. Buy,

target price Rs229. Cigarette business outlook intact despite recent tax hikes. Recent VAT

increases in three states Rajasthan (20% to 40%), Gujarat (13.5% to 20%) and J&K (12.5% to

20%) have not materially increased ITCs weighted average VAT incidence, which we estimate

at around 15.5% because these states are not significant contributors to ITCs overall cigarette

volume. In terms of cigarette sales, ITCs key states are Tamil Nadu, Karnataka, Maharashtra and

West Bengal Tamil Nadu and West Bengal will announce new budgets in a few months after

state government elections. The current VAT duty structure will migrate into a GST (Goods &

Services Tax) structure next year, which we expect to be governed centrally and consist of a

uniform tax levy.

ITC preparing for sustained growth in all businesses

Despite the launch of new brands such as Marlboro, ITCs cigarette business continues to

dominate the domestic market, based on a combination of attractive price points and new product

offerings. The companys paper manufacturing division plans to increase its 0.5mmt pa capacity

by 0.1mmt within 12-18 months and to add an incremental 0.2mmt pa of greenfield capacity to

its existing facility in Andhra Pradesh. Meanwhile, the hotel division is working to increase its

number of five-star rooms from 3,000 to 4,000 via the launch of the Grand Chola property in

Chennai by end-FY12 and the Kolkata expansion by end-FY13. ITC is also working to launch

new hotels in Hyderabad, Ahmadabad, Gurgaon and Delhi. We raise our estimates by 1-4% and

our TP to Rs229 We raise our three-stage DCF-based target price to Rs229 as we nudge up our

earningsestimates and increase our capex forecast. We see little risk to ITCs growth due to itsstrong competitive position and growth potential in its key business areas of cigarettes, paper and

hotels.

Growth drivers intact

VESIMSR Page 36


37/47


ITCs diversified growth strategy has delivered an overall PAT CAGR of 17.2% for the past

10 years vs its cigarette businesss EBIT CAGR of 13% in the same period. Thus, its noncigarette

businesses have driven growth, and we see this trend continuing. ITCs non-cigarette business

including paper, agribusiness and hotels have delivered an overall PAT CAGR of 17.2% over

the last 10 years, much higher than its core cigarette businesss 13% EBIT CAGR for the same

period. In our view, the companys most significant achievement in the last 10 years has been the

turnaround of its hotel business. While its division other MCGbusinesses is currently losing

money due to the initial gestation period for many of the businesses, we believe the division has

the potential to contribute to overall profitability in the next 5-10 years.

Hotel and paper businesses funding their own growth

While the paper and hotel businesses used cash generated by the cigarette business to fund

their initial investments, both have generated enough cash flow to fund their own growth for the

past seven years. Going forward, we expect both to fund the majority of their capex via internal

cash generation.

VESIMSR Page 37


38/47


Financial Analysis

Profit & loss A/C of ITC LTD

in Rs. Cr. Mar '07 Mar '08 Mar '09 Mar '10 Mar '11

Income 12 mths 12 mths 12 mths 12 mths 12 mths

Sales Turnover 19,519.99 21,467.38 23,247.84 26,399.63 30,633.57

Excise Duty 7206.16 7435.18 8262.03 7832.18 9512.74

Net Sales 12,313.83 14,032.20 14,985.81 18,567.45 21,120.83

y-o-y growth 13.95% 6.80% 23.90% 13.75%

Other Income 276.22 516.5 426.21 545.05 775.76

Stock Adjustments 322.96 32.46 630.3 -447.54 308.42Total Income 12,913.01 14,581.16 16,042.32 18,664.96 22,205.01

Expenditure

Raw Materials 5807.48 6307.79 6864.96 7140.69 8601.13

Power & Fuel Cost 253 309.9 394.12 387.34 421.68

Employee Cost 630.15 745.00 903.37 1,014.87 1,178.46

Other Manufacturing Expenses 65.32 73.52 402.88 413.79 560.57

Selling and Admin Expenses 1,299.17 1,609.33 1,684.41 2,093.87 2,408.03

Miscellaneous Expenses 601.28 682.72 516.9 1,008.91 1,120.89

Preoperative Exp Capitalized -42.52 -112.75 -72.55 -71.88 -60.54

Total Expenses 8,613.88 9,615.51 10,694.09 11,987.59 14,230.22

3,699.95 4,416.69 4,291.72 6,579.86 6,890.61

Operating Profit 4,022.91 4,449.15 4,922.02 6,132.32 7,199.03

4,299.13 4,965.65 5,348.23 6,677.37 7,974.79

PBDIT 4,299.13 4,965.65 5,348.23 6,677.37 7,974.79

Interest 16.04 24.61 47.65 90.28 78.11

PBDT 4,283.09 4,941.04 5,300.58 6,587.09 7,896.68

Depreciation 362.92 438.46 549.41 608.71 655.99

Other Written Off 0 0 0 0 0

Profit Before Tax 3,920.17 4,502.58 4,751.17 5,978.38 7,240.69

Extra-ordinary items 61.94 117.41 81.52 48.65 35.21

PBT (Post Extra-ord Items) 3,982.11 4,619.99 4,832.69 6,027.03 7,275.90

Tax 1263.07 1480.97 1565.13 1965.43 2,287.69

Reported Net Profit 2,699.97 3,120.10 3,263.59 4,061.00 4,987.61

VESIMSR Page 38


39/47


Total Value Addition 2,806.40 3,307.72 3,829.13 4,846.90 5,629.09

Preference Dividend 0 0 0 0 0

Equity Dividend 1166.29 1319.01 1396.53 3818.18 3443.47

Corporate Dividend Tax 198.21 224.17 237.34 634.15 558.62

Per share data (annualised)

Shares in issue (lakhs) 37,622.23 37,686.10 37,744.00 38,181.77 77,381.44Earning Per Share (Rs) 7.18 8.28 8.65 10.64 6.45

Equity Dividend (%) 310 350 370 1000 445

Book Value (Rs) 27.59 31.85 36.24 36.69 20.55

Balance Sheet Of ITC LTD

In Rs Cr. Mar '07 Mar '08 9-Mar Mar '10 Mar '11

12 mths 12 mths 12 mths 12 mths 12 mths

Sources Of Funds

Total Share Capital 376.22 376.86 377.44 381.82 773.81

Equity Share Capital 376.22 376.86 377.44 381.82 773.81

Share Application Money 0 0 0 0 0

Preference Share Capital 0 0 0 0 0Reserves 10,003.78 11,624.69 13,302.55 13,628.17 15,126.12

Revaluation Reserves 57.08 56.12 55.09 54.39 53.34

Net worth 10,437.08 12,057.67 13,735.08 14,064.38 15,953.27

Secured Loans 60.78 5.57 11.63 0 1.94

Unsecured Loans 140.10 208.86 165.92 107.71 97.26

Total Debt 200.88 214.43 177.55 107.71 99.20

Total Liabilities 10,637.96 12,272.10 13,912.63 14,172.09 16,052.47

VESIMSR Page 39


40/47


Application Of Funds

Gross Block 7,134.31 8,959.70 10,558.65 11,967.86 12,765.82

Less: Accum. Depreciation 2,389.54 2,790.87 3,286.74 3,825.46 4,420.75

Net Block 4,744.77 6,168.83 7,271.91 8,142.40 8,345.07

Capital Work in Progress 1,130.20 1,126.82 1,214.06 1,008.99 1,333.40Investments 3067.77 2934.55 2,837.75 5,726.87 5,554.66

Inventories 3354.03 4050.52 4599.72 4549.07 5267.53

Sundry Debtors 636.69 736.93 668.67 858.80 907.62

Cash and Bank Balance 103.54 153.34 68.73 120.16 98.77

Total Current Assets 4,094.26 4,940.79 5,337.12 5,528.03 6,273.92

Loans and Advances 1,390.19 1,949.29 2,150.21 1,929.16 2,173.89

Fixed Deposits 796.62 416.91 963.66 1,006.12 2144.47

Total CA, Loans & Advances 6,281.07 7,306.99 8,450.99 8,463.31 10,592.28

Deferred Credit 0 0 0 0 0

Current Liabilities 3,113.01 3,619.76 4,121.59 4,619.54 5,668.10Provisions 1472.84 1,645.33 1,740.49 4549.94 4104.84

Total CL & Provisions 4,585.85 5,265.09 5,862.08 9,169.48 9,772.94

Net Current Assets 1,695.22 2,041.90 2,588.91 -706.17 819.34

Miscellaneous Expenses 0 0 0 0 0

TotalAssets 10,637.96 12,272.10 13,912.63 14,172.09 16,052.47

Contingent Liabilities 129.56 308.08 261.36 258.73 251.78

Book Value (Rs) 27.59 31.85 36.24 36.69 20.55

VESIMSR Page 40


41/47


Valuation

For Valuation purpose DCF valuation method has been used since it is easier to use for the firms

whose

1. Cash Flows are currently positive

2. Can be estimated with some reliability for future periods

3. Where a proxy risk that can be used to obtain the discount rates is available.

FCFF Calculations

FCFF = EBIT (1 Tax Rate) +Depreciation Capital Expenditure Increase In Non Cash

Working Capital

In Rs Cr. Mar '07 Mar '08 Mar '09 Mar '10 Mar '11

12 mths 12 mths 12 mths12

mths12

mths

Profit Before Tax 3,920.2 4,502.6 4,751.2 5,978.4 7,240.7

Interest 16.0 24.6 47.7 90.3 78.1

EBIT 3,936.2 4,527.2 4,798.8 6,068.7 7,318.8

Tax rate 32% 32% 32% 33% 31%

Depriciation 362.9 438.5 549.4 608.7 656.0

CAPEX 794.6 886.7 754.13 1,247.9 1,087.8

Woriking Capital (C.A. -C.L.)

1,695.2 2,041.9 2,588.9 -706.2 819.3

Change in Working Capital 346.7 547.0 -3,295.1 1,525.5

FCFF 2,256.0 2,281.1 2,492.9 6,745.5 3,060.3

VESIMSR Page 41


42/47


Retention Ratio (b) 0.49 0.48 0.49 -0.12 0.17

ROE (NI/Equity) 25.9% 25.9% 23.8% 28.9% 31.3%

Growth (b*ROE) 12.6% 12.4% 11.6% -3.5% 5.3%

FCFF ForecastingLooking at the historical growth rate we assume cash flows to grow at 10%.

Growth rate in FCFF tillFY-20

Mar '11 Mar '12 Mar '13 Mar '14Mar'15

10% 12mths 12mths 12mths 12mths 12mths

Yrs 1.0 2.0 3.0

FCFF3,060.

33,366.

33,702.

94,073.

24,480.

5

Discounted Cashflows 2,953.1 2,849.7 2,750.0 2,653.7

VESIMSR Page 42


43/47


PV 23,144.7

Calculations

VESIMSR Page 43

Mar '16 Mar '17 Mar '18 Mar '19Mar'20

12mths

12mths

12mths

12mths

12mths

5.0 6.0 7.0 8.0 9.0

4,928.6

5,421.4

5,963.6

6,559.9

7,215.9

2,560.8 2,471.1 2,384.6 2,301.1 2,220.6

Growth rate in FCFF tillFY-20

10%

Yrs

FCFFDiscounted Cashflows


44/47


In Rs Cr. Mar '07 Mar '08 Mar '09 Mar '10 Mar '11

12 mths 12 mths 12 mths 12 mths 12 mths

Total debt 200.88 214.43 177.55 107.71

Interest paid 16.04 24.61 47.65 90.28 78.11

Interest rate (I) 7.98% 11.85% 24.31% 63.30% 75.50%

Total Equity 10,437.08

12,057.67

13,735.08

14,064.38

15,953.27

Wd 1.89% 1.75% 1.28% 0.76% 0.62%

We 98.11% 98.25% 98.72% 99.24% 99.38%

Kd = I (1-t) 5.59% 8.30% 17.02% 44.31% 52.85%

Risk free rate (Rf) 8% 8% 8% 8% 8%

Market Risk Premium ( Rm -Rf )

6% 6% 6% 6% 6%

Beta 0.99 0.99 0.99 0.99 0.99

Ke = Rf + e( Rm - Rf ) 13.94% 13.94% 13.94% 13.94% 13.94%

WACC = Wd * Kd + We *Ke

13.78% 13.84% 13.98% 14.17% 14.18%

Average WACC 13.99%

Terminal Value Calculations

VESIMSR Page 44


45/47


FCFF in FY 21 7,504.6

Stable long term growth (G) 4%

Terminal value (FCFF21/(WACC-G) 75,114.5

Discounted Terminal value 23,115.0

PV of the firm = PV of Cash flows (FY12 to FY20) + PV of Terminal Value

= 23,144.7+ 23,115.0

= 46,259.7 crore.

Valuation of the stock

Total Value of the Firm 46,259.7

MV of debt 214.4

MV of Equity 46,045.3

No of shares 773.8

Intrinsic value of share 59.5

Share price as on 2nd Aug 2011 200.2

Comment Overvalued

Comment

Using the DCF methodology, we value of the core business of ITC LTD. at Rs.59.5 per share,

assuming 10% growth in FCFF over FY12 to FY20, terminal growth rate of4% and WACC of

13.99%.

The stock is currently trading at Rs.200.2 which indicates that the stock is overvalued and

recommendation for investors is to SELL the share.

VESIMSR Page 45


46/47


Conclusion

The method used in this valuation is Discounted cash flow analysis (DCF) as this method is

easier to use for the firms whose:

Cash flows are currently positive

Can be estimated with some reliability for future periods

Where a proxy for risk that can be used to obtain discount rates is available.

As per the DCF analysis of equity valuation of ITC LTD, the intrinsic value of the firm is 59.5

whereas the market price as on 3nd AUGUST 2011 is 200.2 .Hence the share is

OVERVALUED.

RECOMENDATION:

THE SHARE OF THE COMPANY IS OVERVALUED AS IT IS NOT GIVING THE

SAME RETURN AS EXPECTED.SO, IT IS RECOMENDED TO SELL THE SHARES &

INVEST IN SOME OTHER SHARES.

VESIMSR Page 46


47/47


Bibliography

TEXTBOOKS:

FINANCIAL MANAGEMENT BY KHAN & JAIN -EDITION 5- SECTION 9.28- PAGE 35-DCF VALUATION

REFERENCES:

http://www.adityabirlamoney.com/

http://www.ibef.org/artdisplay.aspx?cat_id=444&art_id=7933

http://www.itcportal.com/

http://www.moneycontrol.com/financials/itc/balance-sheet/ITC

http://www.moneycontrol.com/financials/itc/profit-loss/ITC

http://www.bseindia.com

http://www.nseindia.com
http://www.adityabirlamoney.com/http://www.ibef.org/artdisplay.aspx?cat_id=444&art_id=7933http://www.itcportal.com/http://www.moneycontrol.com/financials/itc/balance-sheet/ITChttp://www.moneycontrol.com/financials/itc/profit-loss/ITChttp://www.bseindia.com/http://www.nseindia.com/http://www.adityabirlamoney.com/http://www.ibef.org/artdisplay.aspx?cat_id=444&art_id=7933http://www.itcportal.com/http://www.moneycontrol.com/financials/itc/balance-sheet/ITChttp://www.moneycontrol.com/financials/itc/profit-loss/ITChttp://www.bseindia.com/http://www.nseindia.com/

Documents

Equity Valuvation of FMCG Sector- ITC Company