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
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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
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Equity Valuation ITC LTD.
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 its
owners. 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.
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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
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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 security’s 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.
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Overview of Indian Economy
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
country’s economy. On the back of such facts, India’s 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 5.1
per 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.
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The Economic Scenario
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 and
debt 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 country’s total exports in goods
for 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
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strategizing the country’s foreign trade through diversification of products and markets and
technological enhancement.
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 Association
of 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.
India’s auto market (domestic vehicle sales) grew at 26.17 per cent in 2010-11, according to the
Society of Indian Automobile Manufacturers (SIAM). Passenger cars grew by 29.73 per cent,
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utility vehicles grew by 18.87 per cent and multi-purpose vehicles grew by 42.10 per cent during
the year 2010-11.
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 Programme to benefit farmers in 25,000 villages
15 more mega food parks during 2011-12
National food security bill to be introduced this year.
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Growth Potential Story
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 India’s 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 by
Philippines (120) and Norway (119).
Overview of Birla Sun Life InsuranceVESIMSR Page 9
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Company Profile
Established in 2000, Birla Sun Life Insurance Company Limited (BSLI) is a joint venture
between the Aditya Birla Group, a well known and trusted name globally amongst Indian
conglomerates and Sun Life Financial Inc, leading international financial services organization
from Canada. The local knowledge of the Aditya Birla Group combined with the domain
expertise of Sun Life Financial Inc., offers a formidable protection for its customers' future. With
an experience of over 10 years, BSLI has contributed significantly to the growth and
development of the life insurance industry in India and currently ranks amongst the top 6 private
life insurance companies in the world.
Known for its innovation and creating industry benchmarks, BSLI has several firsts to its
credit. It was the first Indian Insurance Company to introduce "Free Look Period" and the same
was made mandatory by IRDA for all other life insurance companies. Additionally, BSLI
pioneered the launch of Unit Linked Life Insurance plans amongst the private players in India.
To establish credibility and further transparency, BSLI also enjoys the prestige to be the
originator of practice to disclose portfolio on monthly basis. These category development
initiatives have helped BSLI be closer to its policy holders' expectations, which gets further
accentuated by the complete bouquet of insurance products (viz. pure term plan, life stage
products, health plan and retirement plan) that the company offers.
Add to this, the extensive reach through its network of 600 branches and 1, 47,900
empanelled advisors. This impressive combination of domain expertise, product range, reach and
ears on ground, helped BSLI cover more than 2.4 million lives since it commenced operations
and establish a customer base spread across more than 1500 towns and cities in India. To ensure
that our customers have an impeccable experience, BSLI has ensured that it has lowest
outstanding claims ratio of 0.00% for FY 2010-11. Additionally, BSLI has the best Turn Around
Time according to LOMA on all claims Parameters. Such services are well supported by sound
financials that the Company has. The AUM of BSLI stood at 19725 crs as on April 30, 2011,
while the company has a robust capital base of Rs. 2450 crs.
Vision
To be a leader and role model in a broad based and integrated financial services business.
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Mission
To help people mitigate risks of life, accident, health, and money at all stages and under all
circumstances
Enhance the financial future of our customers including enterprises.
Values
Integrity
Commitment
Passion
Seamlessness
Speed
About Aditya Birla Group A US $30 billion corporation, the Aditya Birla Group is in the
league of Fortune 500 worldwide. It is anchored by an extraordinary force of 130,000
employees, belonging to 40 different nationalities. The group operates in 27 countries across six
continents – truly India's first multinational corporation.
Aditya Birla Group through Aditya Birla Financial Services Group (ABFSG), has a strong
presence across various financial services verticals that include life insurance, fund management,
distribution & wealth management, security based lending, insurance broking, private equity and
retail broking The seven companies representing Aditya Birla Financial Services Group are Birla
Sun Life Insurance Company Ltd., Birla Sun Life Asset Management Company Ltd., Aditya
Birla Finance Ltd., Aditya Birla Capital Advisors Pvt. Ltd., Aditya Birla Money Ltd., Aditya
Birla Money Mart Ltd, and Aditya Birla Insurance Brokers Ltd. In FY 2009-10, ABFSG
reported consolidated revenue from these businesses at Rs. 5871 Cr., registering a growth of
43%.
About Sun Life Financial Sun Life Financial is a leading international financial services
organization providing a diverse range of protection and wealth accumulation products and
services to individuals and corporate customers. Chartered in 1865, Sun Life Financial and its
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partners today have operations in key markets worldwide, including Canada, the United States,
the United Kingdom, Ireland, Hong Kong, the Philippines, Japan, Indonesia, India, China and
Bermuda. As of March 31, 2011, the Sun Life Financial group of companies had total assets
under management of $469 billion.
Overview of Indian FMCG Sector
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The Indian FMCG sector is the fourth largest sector in the economy with a total market size in
excess of US$ 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 1950’s or the
twenty first century. In that sense, the FMCG market potential has always been very big.
However, from the 1950’s to the 80’s investments in the FMCG industry were very limited due
to low purchasing power and the government’s 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, Nirma’s entry changed the whole Indian FMCG scene.
The company focused on the ‘value for money’ plank and made FMCG products like detergents
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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
MNC’s like HLL, which were sitting pretty till then, woke up to new market realities and noticed
the latent rural potential of India. The government’s 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 MNC’s 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 could
not do it on their own, have piggy backed on other FMCG major’s distribution network (P&G-
Marico). Consequently, companies that have taken to rural India like chalk to cheese have seen
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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).
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 company’s 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,
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
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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 46,259.7MV of debt 214.4MV of Equity 46,045.3No of shares 773.8Intrinsic value of share 59.5Share price as on 2nd Aug 2011 200.2Comment 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 of 4% 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.
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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 &