comparison of price multiples using ddm, dcf and current

Vol.6, No.4, October-December 2017

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Abstract

The objective of this paper to find out the justified price multiples of HUL, ITC Ltd and

Nestle India using prices calculated on the basis of absolute valuation techniques like dividend

discount models and free cash flow models and comparing these with the current multiples of

these companies. The inputs were taken from the annual reports of the above companies for

understanding the outlook on the companies' business and the expected trends going forward.

Based on all these, the justified multiples using FCF and DDM were calculated and compared

with the current market multiples of the companies.

Keywords: Dividend Discount Models, Free Cash Flow Models, Current Multiples, HUL,

ITC and Nestle.

1.0 Introduction

The fast moving consumer goods (FMCG) segment is the fourth largest sector in the Indian

economy. The market size of FMCG in India is estimated to grow from US$ 30 billion in 2011 to US$

74 billion in 2018. According to the study conducted by AC Nielsen, 62 of the top 100 brands are

owned by MNCs, and the balance by Indian companies. Fifteen companies own these 62 brands, and

27 of these are owned by Hindustan UniLever.

2.0 Back Ground of the Companies

2.1 Hindustan Unilever Ltd

Hindustan Unilever Limited (HUL) is an Indian consumer goods company based in Mumbai,

Maharashtra. It is owned by Anglo-Dutch company, Unilever which owns a 67% controlling share in

HUL.

HUL was established in 1933 as Lever Brothers and, in 1956, became known as Hindustan

Lever Limited, as a result of a merger between Lever Brothers, Hindustan Vanaspati Mfg. Co. Ltd. and

* Assistant Professor Faculty of Management StudiesUniversity of DelhiDelhi 110007 Email id: [email protected]

** Assistant Professor Shaheed Sukhdev College of Business Studies University of Delhi Email: [email protected]

Comparison of Price Multiples using DDM, DCF and

Current Market Multiples of FMCG Companies

– Dr. AnjalaKalsie*

– Dr. Ashima Arora**

SUMEDHA Journal of Management

14

United Traders Ltd. It is headquartered in Mumbai, India and employs over 16,500 workers, whilst

also indirectly helping to facilitate the employment of over 65,000 people. The company was renamed

in June 2007 as "Hindustan Unilever Limited".

HUL's products include foods, beverages, cleaning agents and personal care products.

Financial position as of March 2014:

• Operating profit margin - 15.73%

• Net profit margin - 13.23%

• ROCE - 140.03

• Current ratio - 0.77

• Quick ratio - 0.46

• Debt to equity ratio - 0.01

2.2 ITC (Indian Tobacco Company)

ITC Limited or ITC is an Indian conglomerate headquartered in Kolkata, West Bengal. Established

in 1910 as the Imperial Tobacco Company of India Limited, the company was renamed as the Indian

Tobacco Company Limited in 1970 and further to I.T.C. Limited in 1974. The company completed

100 years in 2010 and as of 2012-13, had an annual turnover of US$8.31 billion and a market capitalisation

of US$45 billion. Its diversified business includes five segments: Fast Moving Consumer Goods (FMCG),

Hotels, Paperboards & Packaging, Agri Business & Information Technology.




• ROCE - 47.54%




2.3 Nestle India

Nestlé S.A. is a Swiss multinational food and beverage company headquartered in Vevey,

Switzerland. It is the largest food company in the world measured by revenues. Nestle India is a

subsidiary of Nestle S. A. of Switzerland. Nestle started its Indian journey in 1912 by entering the dairy

business.


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Nestle's product segments include milk products and nutrition, beverages, prepared dishes,

chocolates and confectioneries.




• ROCE - 47.79%




FMCG brands would need to focus on R&D and innovation as a means of growth. Companies

that continue to do well would be the ones that have a culture that promotes using customer insights

to create either the next generation of products or in some cases, new product categories.

3.0 Objective and Methodology Followed

The objective of this paper to find out the justified price multiples of HUL, ITC Ltd and Nestle

India using prices calculated on the basis of absolute valuation techniques like dividend discount

models and free cash flow models and comparing these with the current multiples of these companies.

As each of the above companies was into multiples business segments, the valuation was done

on a SOTP basis (sum of the parts basis) by forecasting the growth trends in each of the business

segments of the companies (based on the growth drivers and corporate actions) and summing them.

The absolute valuation method followed was based on its suitability to the companies' business model.

3.1 Methodology

3.1.1 Free Cash Flow model

In corporate finance, free cash flow to firm (FCFF) is a way of looking at a business's cash

flow to see what is available for distribution among all the securities holders of a business entity. This

may be useful to parties such as equity shareholders, debt capital holders, preferred shareholders,

convertible security holders, and so on when they want to see how much cash can be extracted from

a company without causing issues to its operations.

The free cash flow can be calculated in a number of different ways depending on objective and

what accounting information is available. A common definition is to take the earnings before interest

after taxes, add depreciation & amortization, and then subtract any changes in working capital and

capital expenditure. Depending on the objective, a number of refinements and adjustments may also be

made to try to eliminate distortions.


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The free cash may be different from the net income for a particular accounting period, as the

free cash flow takes into account the expenditure of capital goods and the expenditure required in

working capital.Free cash flow measures the ease with which businesses can grow and pay dividends

to shareholders. Cash flows can be negative even for profitable business.

The free cash flow can be calculated as:

EBIT*(1-Tax rate) + Non-cash charges - Changes in working capital - Capital expenditure =

Free Cash Flow

According to the discounted cash flow valuation model, the intrinsic value of a company is the

present value of all future free cash flows, plus the cash proceeds from its eventual sale known as

terminal value. The presumption is that the cash flows are used to pay dividends to the shareholders.

Some investors prefer using free cash flow instead of net income to measure a company's

financial performance, because free cash flow is more difficult to manipulate than net income. The

problems with this presumption are itemized at cash flow and return of capital.

3.1.2 Free Cash Flow to equity model

In corporate finance, free cash flow to equity (FCFE) is a method which evaluates how much

cash can be distributed to the equity shareholders of the company as dividends or buybacks of stock-

after payment of all expenses, reinvestments, and debt repayments. Whereas dividends are the cash

flows actually paid to shareholders, the FCFE is the cash flow simply available to shareholders.The

FCFE is usually calculated as a part of DCF or LBO modelling and valuation. The FCFE is commonly

known as the levered free cash flow.

Assuming there is no preferred stock outstanding:

FCFE = FCFF + Net Borrowing - Interest*(1-t)

where

• FCFF is the free cash flow to firm;

• Net Borrowing is the difference between debt principals paid and raised;

• Interest*(1-t) is the firm's after-tax interest expense.

Arguably the best reason to like DCF is that it gives the closest value to an intrinsic stock value.

3.1.3 Dividend discount model

The dividend discount model (DDM) is a method of valuing a company's stock price based on

the theory that its stock is worth the sum of all of its future dividend payments, discounted back to

their present value. The equation most widely used is called the Gordon growth model. It is named

after Myron J. Gordon of the University of Toronto, who originally published it along with Eli Shapiro

in 1956 and made reference to it in 1959.


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The equation for DDM is as follows:

P = (D1/(r-g))

Where P is the current stock price. g is the constant growth rate in perpetuity expected for the dividends.

r is the constant cost of equity capital for the company. D1 is the value of the next year's dividends.

The maindrawback of this method is that it cannot provide a value for a company unless it pays

dividends. In today's market, the vast majority of companies do not pay a regular dividend. Many

companies instead choose to focus on growth and reinvest their profits into the company. According

to this model, the stocks of those companies would not be worth anything. However, in practice a lot

of these companies are very valuable and profitable.

Another drawback of this model is that one has to make many assumptions in order for the

formula to work. One has to predict whether a company will continue to pay the same dividend, or

whether it will continue paying dividends at all. If theses assumption goes wrong or does not work

formula becomes worthless.

3.1.4 Equity Valuation: The ComparableApproach

The basic essence of the comparable approach is that an equity's value should bear some

resemblance to other equities in a similar industry. For a stock, this can simply be determined by

comparing a firm to its key rivals, which are comparable in terms on net worth or sales revenue.

Discrepancies in the comparable values between similar firms could spell opportunity.

Common market multiples include the following: enterprise value to sales (EV/S), price to earnings

(P/E), enterprise multiple,price to book (P/B) and price to free cash flow (P/FCF). To get a better

indication of how a firm compares to rivals, analysts can also look at how its margin levels compare.

The concept behind relative valuation is that the value of a company is determined in relation to

how similar companies are priced in the market. A typical method to do a relative valuation on a

publicly listed company is a follows:

• Creating a list of comparable companies (comparable in terms of sales or rnetworth), often

industry peers, and obtain their market values.

• Converting these market values into comparable trading multiples, such as P/E, price-to-book,

enterprise-value-to-sales and EV/EBITDA multiples.

• Comparing the company's multiples with those of its peers to assess whether the firm is overvalued

or undervalued.

The main advantages of multiples are that they are relatively easy to use.Like any valuation tool,

relative valuation has its limitations. The biggest limitation is the assumption that the market has valued

the company correctly. To the degree that markets can be over or under valued in the aggregate,


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relative valuation will fail.A carefully designed DCF, by contrast, should help investors to identify

companies that look inexpensive against expensive peers.

Although DCF analysis certainly has its merits, it also has its own limitation. DCF valuations

can fluctuate wildly which depends upon the assumptions that one believes about how a company will

operate and how the market will respond to those assumptions.Inputs like- free cash flow forecasts,

discount rates and perpetuity growth rates - are not realistic, the fair value generated through DCF for

the company won't be accurate and it is of no use for assessing stock prices.

DCF works best when there is a high degree of confidence about future cash flows. But things

can get problematic when it's difficult to predict sales and cost trends with much certainty. While

forecasting cash flows a few years into the future is hard enough, pushing results into infinity -

terminal value (which is a necessary input) is nearly impossible.

4.0 Analysis and Interpretation

4.1 Hindustan Unilever Limited

HUL is into 5 business segments, as mentioned earlier, viz:

• Soaps and detergents

• Personal care products

• Processed foods

• Beverages

• Other business segments (Pureit, etc)

Split-up of HUL's standalone revenue amongst the 5 segments:


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Average EBIT margins across the segments

On a standalone basis, HUL's revenue for the financial year 2013-14 was INR 28,947.06 crores.

HUL's standalone revenues account for approx. 95% of its consolidated revenues (using the data for

the past 6-7 years). Hence, forecasts were made for the standalone figures and were converted to the

consolidated figures by using the conversion factor of 0.95.

Quarterly segment revenue growth trends (year-on-year basis):

HUL has a regular dividend payout policy with the payout ratio being close to 70% (average

figures) and these are reliably related to the earnings. Hence, dividend discount model is applicable for

calculating the HUL's stock price.


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Tab

le 1

Pro

jecte

d P

/L A

cco

un

t F

igu

res

in c

rore

s


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Table 2

Margins Soaps &

Detergents Personal

care Processed foods Beverages

EBIT 13% 25% 6% 17%

Segments Revenue split up 2014 figures Forecasts Rationale

Soaps and detergents

48% 13,894.59 9%-14%

Expected to perform better owing to consumer spending, and mix improvements… pricing would also play a key role here

Personal care 30% 8,684.12 ~12%

Expecting a pick up in this segment owing to improved consumer spending

Processed foods 8% 2,315.76 8% slightly bearish here

Beverages 12% 3,473.65 10% expecting lipton to do better

Others 2% 578.94 9% A low base effect would translate into high growth…

Assumptions under DCF

1. Depreciation is 1% of topline

2. Tax rate is assumed to be 25%.

3. Standalone revenue is 95% of consololidation.

4. HUL cost of capital is 10%, cost of debt is zero as there is no debt. The cost of equity capital is 10%.

5. Working capital is assumed to be 1.5% of sales.

6. Capex assumed to be 1% of sales.

7. Total numbers of shares outstanding 216.33 cr

As per the figures available on Bloomberg, the cost of equity capital is 10% which is also the

cost of total capital, as HUL has a very low debt to equity ratio. Other than the dividend discount

model, the FCF (Free cash flow model) was also used to calculate the stock price of HUL. For

calculating the free cash flow, it was observed that HUL has negative working capital and this decrease

in working capital was found out to be around 1.5% of the sales of the company. This was the figure

used to calculate the working capital decrease for each of the segments. Similarly, the net capital

expenditure was found out to be around 1% of sales and this was used to calculate the net capex was

each of the segments. Depreciation was found out to be 1% of sales and tax rate was close to 25%.


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HUL has a history of regular dividend payment which reflects the company earnings. Dividend

payout ratio is approximately 70%. This favours the use of DDM for arriving the values of multiplies.

Table 3 Forecasted Revenue Segmentwise

Forecasted revenues segment-wise

2014 2015 2016 2017 2018 2019 2020

Soaps and detergents 13,894.59 15,284.05 17,118.13 19,514.67 21,466.14 23,398.09 25,503.92 Personal care 8,684.12 9,726.21 11,087.88 12,751.06 14,281.19 15,566.50 16,967.48

Processed foods 2,315.76 2,547.34 2,853.02 3,252.45 3,707.79 4,041.49 4,364.81

Beverages 3,473.65 3,821.01 4,203.11 4,707.49 5,272.39 5,799.62 6,263.59

Others 578.94 631.05 687.84 749.75 817.22 890.77 970.94

Table 3 (a) FCFF Segmentwise

FCFF segment-wise 2014 2015 2016 2017 2018 2019 2020 Terminal

Soaps and detergent 1,702.09 1,872.30 2,096.97 2,390.55 2,629.60 2,866.27 3,124.23 65,608.83

Personal care 1,932.22 2,164.08 2,467.05 2,837.11 3,177.57 3,463.55 3,775.27 79,280.57

Processed foods 185.26 203.79 228.24 260.20 296.62 323.32 349.18 7,332.88

Beverages 564.47 620.91 683.01 764.97 856.76 942.44 1,017.83 21,374.51

Others 28.95 31.55 34.39 37.49 40.86 44.54 48.55 1,019.49

Total of PVs 4,892.63 5,008.79 5198.60 5260.27 5218.30 5163.00 98,566.34

Total of PV1,29,307.92 for FCFF . The firm value is rupees1,36,113.60 discounted at 10% of

cost of equity. As HUL has very low debt, firm value is as good as equity value.The value per share

HUL (using FCFE) is rupees 629.19 .

The growth rates for the different segments were estimated based on the historic quarterly

growth rates and the outlook on the business. Given that the FMCG sector in India is currently seeing

a slowdown, the growth rates estimated were a bit conservative for all the companies. The growth

rates are dependent on various factors like product mix, consumer spending, current price levels, etc.

The soaps and detergents segment of HUL was not witnessing robust growth lately and grew only by

6% y-o-y in 3QFY15. With the economy expected to do a better and possible increase in consumer

spending, this segment would be able to grow at least 9-10% yearly for the next 4-5 years. New

product launches would and price hikes would also help the growth. The personal care segment of

HUL did quite well in 2QFY15 and 1QFY15 with sales growth above 9% in both quarters. It did not do

as well in 3QFY15, managing just 6.5% growth. However, for the same reasons as with the soaps and

detergent segment, the segment can expected to clock close to 12% growth for the next 4-5 years.

The beverages segment is also expected to show 10%+ growth rate for the next 4-5 years while

processed foods might be able to grow by atleast 8%. Price hikes are expected in the processed foods

segment. The others segment which includes products like Pureit can grow at 9+% for the next 4-5

years.


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The terminal growth for all the above segments was assumed to be around 5% assuming that

the Indian economy would grow at this rate in the long run.

Table 4 Forecasted Revenue Segmentwise

DDM model segment wise 2014 2015 2016 2017 2018 2019 2020

Terminal value

Soaps and detergents 13894.59 15284.05 17118.13 19514.67 21466.14 23398.09 25503.92 - Personal care 8684.12 9726.21 11087.88 12751.06 14281.19 15566.50 16967.48 -

Processed foods 2315.76 2547.34 2853.02 3252.45 3707.79 4041.49 4364.81 -

Beverages 3473.65 3821.01 4203.11 4707.49 5272.39 5799.62 6263.59 - Others 578.94 631.05 687.84 749.75 817.22 890.77 970.94 - Total dividend PVs 22406.76 22877.27 23704.78 23952.90 23760.35 23501.58 278586.57 Sum of Total dividend PVs 440831.799

Per share value 2037.77

For calculating the stock price using the dividend discount models, the method similar to above

was followed, except that the earnings were multiplied with the factor of 75% which reflects the

dividend payout ratio. Adjustments were not made for the capex and working capital and the dividends

were discounted at the cost of equity capital of HUL (which is 10%).

The stock prices calculated by the methods discussed above were then divided by the past

years EPS, sales per share as well book value per share (HUL has 2163 million shares outstanding) to

get the respective ratios.

Table 5 Multiples

Multiples according to FCCF

P/E 26.43

P/S 4.47

P/B 41.53

Multiples according to DDM

P/E 85.60

P/S 14.47

P/B 134.52

Current market multiples

P/E 48.87

P/S 4.4

P/B 57.59


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4.2 ITC Ltd

ITC Ltd is into 5 main business segments as mentioned earlier, viz:

• Cigarettes

• Non-cigarettes FMCG

• Hospitality

• Agri-business

• Paper and packaging

Split-up of ITC's standalone revenue amongst the 5 segments:

Average EBIT margins across the segments


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On a standalone basis, ITC's revenue for the financial year 2013-14 was INR 48175.8 crores.

ITC's standalone revenues account for approx. 95% of its consolidated revenues (using the data for

the past 6-7 years). Hence, forecasts were made for the standalone figures and were converted to the

consolidated figures by using the conversion factor of 0.95, (similar to HUL).

Quarterly segment revenue growth trends (year-on-year basis):

ITC has a regular dividend payout policy with the payout ratio being close to 60% (average

figures) and these are reliably related to the earnings. Hence, dividend discount model is applicable for

calculating the ITC's stock price.

Table 6 Consolidated Profit & Loss account

Particulars Mar '14 Mar '13 Mar '12 Mar '11 Mar '10

Sales Turnover 35,317.08 31,627.54 26,525.43 22,574.70 27,764.55

Excise Duty 0 0 0 0 8,214.66

Net Sales 35,317.08 31,627.54 26,525.43 22,574.70 19,549.89

Other Income 970.95 877.6 784.35 536.1 563.66

Stock Adjustments 112.74 256.84 85.74 272.72 -467.68

Total Income 36,400.77 32,761.98 27,395.52 23,383.52 19,645.87

Expenditure

Raw Materials 13,597.83 12,602.30 9,970.96 8,656.51 7,077.17

Power & Fuel Cost 644.96 579.98 476.74 446.64 410.37

Employee Cost 2,504.24 2,145.63 1,935.11 1,708.50 1,467.89

Other Manufacturing Expenses 0 0 0 0 422.31


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Particulars Mar '14 Mar '13 Mar '12 Mar '11 Mar '10

Selling and Admin Expenses 0 0 0 0 2,278.56

Miscellaneous Expenses 5,630.90 5,382.13 5,018.58 4,366.98 1,142.93

Preoperative Exp Capitalised 0 0 0 0 -75.31

Total Expenses 22,377.93 20,710.04 17,401.39 15,178.63 12,723.92

Operating profits 13,051.89 11,174.34 9,209.78 7,668.79 6,358.29

PBDIT 14,022.84 12,051.94 9,994.13 8,204.89 6,921.95

Interest 6.37 87.18 80.5 70.93 73.54

PBDT 14,016.47 11,964.76 9,913.63 8,133.96 6,848.41

Depreciation 964.92 859.11 745.48 699.09 643.9

Other Written Off 0 0 0 0 0

Profit Before Tax 13,051.55 11,105.65 9,168.15 7,434.87 6,204.51

Extra-ordinary items 0 0 0 0 50.49

PBT (Post Extra-ord Items) 13,051.55 11,105.65 9,168.15 7,434.87 6,255.00

Tax 4,060.93 3,412.07 2,845.76 2,365.45 2,043.62

Reported Net Profit 8,990.62 7,693.58 6,322.39 5,069.42 4,210.78

Minority Interest 109.81 96.38 75.53 61.1 48.84

Share Of P/L Of Associates -10.57 -10.87 -11.28 -9.61 -6.24

Net P/L After Minority Interest

& Share Of Associates

8,891.38 7,608.07 6,258.14 5,017.93 4,118.29

Total Value Addition 8,780.10 8,107.74 7,430.43 6,522.12 5,646.75

Preference Dividend 0 0 0 0 0

Equity Dividend 4,771.91 4,148.46 3,518.29 3,443.47 3,818.18

Corporate Dividend Tax 822.77 705.97 571.68 559.57 635.1


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Table 7

Margins Cigarettes FMCG Hotels Agri Paper

EBIT 65% 6% 8% 10% 18%


Cigarettes 43% 20715.594 8-10%

The impact of tax hikes will adversely affect volumes… however, ITC can pass on the increased cost to the customers to maintain the growth… expecting it to be around 10% in the near term

FMCG 22% 10598.676 11%+

For the same reasons as HUL, expecting good growth here… Cause of concern is the EBIT margins

Hotels 3% 1445.274 8%

Boost in the tourism industry and consumer spending might help this segment… at best, 8% growth… new resort opened might also help

Agri 18% 8671.644 10% Quite volatile…

Paper 14% 6744.612 8-10% recovery expected

Assumptions under DCF

1. Depreciation is 2% of topline


3. Standalone revenue is 95% of consololidation.

4. ITC cost of capital is 10%, cost of debt is zero as there is no debt. The cost of equity capital is

10%.

5. Working capital is assumed to be 3% of sales.


7. Total numbers of shares outstanding 7995.44 mn

ITC has a history of regular dividend payment which reflects the company earnings. Dividend

payout ratio is approximately 60%. This favours the use of DDM for arriving the values of multiplies.


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Table 8 Forecasted revenues segment-wise

Forecasted revenues

segment-wise 2014 2015 2016 2017 2018 2019 2020

Cigarettes 20715.59 22580.00 24612.20 27073.42 29510.02 32165.927 35060.86

FMCG 10598.68 11764.53 13058.63 14886.84 16970.99 18668.093 20534.903 Hotels 1445.27 1546.44 1654.69 1770.52 1912.16 2065.14 2230.35

Agri 8671.64 9538.81 10492.69 11541.96 12696.15 13965.769 15362.346 Paper 6744.61 7351.63 8013.27 8734.47 9607.91 10568.706 11519.89


Table 9 : FCFF segment-wise

FCFF segment-wise

2014 2015 2016 2017 2018 2019 2020 Terminal

Cigarettes 7975.50 8693.30 9475.70 10423.27 11361.36 12383.88 13498.43 267421.75 FMCG 339.16 376.46 417.88 476.38 543.07 597.38 657.12 13018.353

Hotels 52.03 55.67 59.57 63.74 68.84 74.34 80.29 1590.7016

Agri 433.58 476.94 524.63 577.10 634.81 698.29 768.12 15217.419 Paper 647.48 705.76 769.27 838.51 922.36 1014.60 1105.91 21909.527

Total of PVs 10308.13 10196.781 10174.995 10082.89573 9977.7827 9867.6651 177236.15 Firm value

(also equity value due to low debt)

253025.96


As with the case of HUL, the growth rate in revenue of ITC's business segments depends on

factors like consumer spending, product mix, current price levels etc. Given that around 43% of the

company's revenue comes from cigarettes, and that the volumes in the cigarettes business are decreasing

due to tax hikes and price hikes being passed onto customers, ITC's earnings would definitely be

impacted. ITC is looking to increase its revenue from the non-cigarette FMCG business and is looking

at an ambitious figure of 1 lakh crore by 2030 in this segment. However, that said, ITC's margins are

below 5% in this segment but for the purpose of valuation, it has been assumed that ITC is able to

improve its EBIT margins by cutting costs and increasing prices. In fact, in Q3 of FY15, the non-

cigarette FMCG business registered a 11.4% growth in sales. Given the recovery expected in the

economy and the improving consumer sentiment, coupled with product launches expected and capex

investments made for the non-cigarette FMCG segment, ITC is expected to post a modest 8-9%

growth in the cigarettes segment over the next 4-5 years while posting a robust 12+% growth in the

non-cigarette FMCG segment over the same period. The improving economy might see higher levels

of spending and hence a revival is expected in the hospitality and tourism industry, propelled by higher

expected occupancy rates. Also, one of ITC's hotels, a premium luxury resort near Gurgaon started

operations in Q3FY15. Hence, a growth rate of at least 9% is expected in the hospitality segment over

the next 4-5 years. The agri and paper business are also expected to do well in the next 4-5 years,


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posting around 10-11% growth. Going by the trends, ITC's working capital investments and capital

expenditures are expected to be around 3% and 6% respectively of the turnover for each of the

segments, though the capex in the case of non-cigarette FMCG business is expected to be higher,

owing to ITC's ambitious 1 lac crore turnover target by 2030.

As with HUL, the terminal growth for all the above segments was assumed to be around 5%

assuming that the Indian economy would grow at this rate in the long run.

Table 10DDM model segment wise

DDM model segment wise

2014 2015 2016 2017 2018 2019 2020

Cigarettes 20715.59 22580.00 24612.20 27073.42 29510.02 32165.927 35060.86

FMCG 10598.68 11764.53 13058.63 14886.84 16970.99 18668.093 20534.903

Hotels 1445.27 1546.44 1654.69 1770.52 1912.16 2065.14 2230.35

Agri 8671.64 9538.81 10492.69 11541.96 12696.15 13965.769 15362.346

Paper 6744.61 7351.63 8013.27 8734.47 9607.91 10568.706 11519.89

Total dividend PVs

31668.84 31458.65 31566.69 31610.20 31389.10 31131.49

Terminal value 205499.85

Sum of total dividends PV and TV 205499.85

Value per share 493.19

For calculating the stock price using the dividend discount models, the method similar to above

was followed, except that the earnings were multiplied with the factor of 60% which reflects the

dividend payout ratio. Adjustments were not made for the capex and working capital and the dividends

were discounted at the cost of equity capital of ITC (which is 10.3%).

The stock prices calculated by the methods discussed above were then divided by the past

years EPS, sales per share as well book value per share (ITC has 7995 million shares outstanding) to

get the respective ratios.

Table 11 Multiples

Multiples according to DCFE

P/E 27.36 P/S 4.99

P/B 9.64 Multiples according to DDM

P/E 42.64

P/S 7.78 P/B 15.02

Current market multiples P/E 28.69

P/S 7.4 P/B 9.9


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4.3 Nestle India Ltd

Nestle India is into 4 business segments viz:

• Milk products and nutrition

• Beverages

• Prepared dishes

• Chocolates and confectioneries

Split-up of Nestle's revenues amongst the 4 segments:

Nestle's EBIT margins (all the segments together) are around 19%. As data was not specifically

available for the margins for each of the segments, it was assumed that the EBIT margins across all the

segments are 19%.

Nestle India does not have any subsidiaries and hence the standalone figures would be the firm

figures as well.


31

Yearly segment revenue trends:

Nestle India revenue growth (%):

As can be seen from the above graph, Nestle'stopline growth has declined over the years, and

the drop has been all the more steep in the past year. Even in FY 14, the topline growth in Q1, Q2 and

Q3 were pretty tepid (single digit growth).


32

Table 12 Standalone Profit & Loss account

Particulars Dec '13 Dec '12 Dec '11 Dec '10 Dec '09

Sales Turnover 9,101.05 8,614.15 7,682.22 6,382.78 5,232.59

Excise Duty 0 287.6 191.4 122.57 90.69

Net Sales 9,101.05 8,326.55 7,490.82 6,260.21 5,141.90

Other Income 96.9 31.03 12.35 27.25 14.26

Stock Adjustments -105.32 100 56.93 83.67 6.3

Total Income 9,092.63 8,457.58 7,560.10 6,371.13 5,162.46

Expenditure

Raw Materials 4,059.29 3,909.06 3,671.64 3,168.18 2,478.94

Power & Fuel Cost 385.38 370.89 295.81 219.2 158.87

Employee Cost 741.5 663.38 546.46 433.44 432.38

Other Manufacturing Expenses 0 115.07 120.49 110.91 94.05

Selling and Admin Expenses 0 0 1,200.14 1,026.88 839.22

Miscellaneous Expenses 1,861.98 1,542.81 159.07 130.66 115.98

Preoperative Exp Capitalised 0 0 0 0 0

Total Expenses 7,048.15 6,601.21 5,993.61 5,089.27 4,119.44

Operating profits 1,947.58 1,825.34 1,554.14 1,254.61 1,028.76

PBDIT 2,044.48 1,856.37 1,566.49 1,281.86 1,043.02

Interest 36.51 26.6 9.06 1.07 1.4

PBDT 2,007.97 1,829.77 1,557.43 1,280.79 1,041.62

Depreciation 329.95 277.15 153.33 127.75 111.27

Other Written Off 0 0 0 0 0

Profit Before Tax 1,678.02 1,552.62 1,404.10 1,153.04 930.35

Extra-ordinary items 0 0 0 0 0

PBT (Post Extra-ord Items) 1,678.02 1,552.62 1,404.10 1,153.04 930.35

Tax 560.89 484.69 426.38 326.45 261.97

Reported Net Profit 1,117.13 1,067.93 961.55 818.66 655

Total Value Addition 2,988.86 2,692.15 2,321.97 1,921.08 1,640.50

Preference Dividend 0 0 0 0 0

Equity Dividend 467.62 467.62 467.62 467.62 467.62

Corporate Dividend Tax 79.47 75.86 75.39 77.2 79.47

*Nestle financial year from Jan to Dec

*Based on the dividend payment history, DDM wont work for Nestle India

DPS is constant, not DPR


33

Table 13

Margins Milk

Products/Nutrition Beverages

Prepared dishes

Choc and confectioneries

EBIT 19% 19% 19% 19%


Milk Products /Nutrition 43% 40333.57 10%

consumer spending, etc

Beverages 15% 14069.85 11%-14% this might continue doing well

Prepared dishes 28% 26263.72 12% same as first

Choc and confectioneries 14% 13131.86 8%-9%

combination of consumer spending, mix and price hikes

Assumptions under DCF:

1. Depreciation is 2.5% of topline


3. Cost of capital is 10%, cost of debt is zero as there is no debt. The cost of equity capital is 10%.

4. Working capital is assumed to be 4% of sales.


6. Total numbers of shares outstanding 96.42 mn

The dividend discount model is not applicable to Nestle as the dividend payout ratios have varied

quite a lot over the years, from 83.52% in 2009 to 41.85% in 2013.

Table 14Forecasted revenues segment-wise

Forecasted revenues

segment-wise 2014 2015 2016 2017 2018 2019 2020

Milk Products/Nutrition 40333.57 44366.93 48803.62 53195.95 57983.58 62042.4312 66385.40139

Beverages 14069.85 15476.84 17024.52 18726.97 20599.67 22659.6341 24925.59754

Prepared dishes 26263.72 28890.09 31779.10 35592.59 40575.56 45444.6232 49989.0855

Choc and confectioneries 13131.86 14445.05 15745.10 17004.71 18365.08 19834.2916 21421.03491


34

Table 15 FCFF segment-wise

FCFF segment-wise 2014 2015 2016 2017 2018 2019 2020 Terminal

Milk Products/Nutrition 1915.84 2107.43 2318.17 2526.81 2754.22 2947.02 3153.31 66219.44 Beverages 1167.80 1284.58 1413.04 1554.34 1709.77 1880.75 2068.82 43445.32 Prepared dishes 2048.57 2253.43 2478.77 2776.22 3164.89 3544.68 3899.15 81882.12 Choc and confectioneries 1089.94 1198.94 1306.84 1411.39 1524.30 1646.25 1777.95 37336.86 Total of PVs

6844.37 6833.47 6833.69 6876.93 6842.90 6767.56 129198.90

DCFF/DCFE 170197.82 Per share value 1765.17

Despite the milk products and nutrition segment not doing well in FY 13 and 14, growth can be

expected due to new product launches and price increases, to compensate for the low volume growth

in this segment. The growth can be expected to be around 9-10% over the next 4-5 years. The

beverages segment can be expected to do well, clocking around 10-11% growth over the next 4-5

years. The chocolates and confectioneries segment faces stiff competition from Cadbury and Britannia.

However, recent product launches like premium chocolate alpino and kit kat senses helped to some

extent but overall, the growth in this segment has been moderate. A growth of around 8-9% over the

next 4-5 years is expected. The prepared dishes segment is doing reasonably well thanks to Maggi and

related products and can be expected to grow at around 12% over the next 4-5 years. Maggi has

however been facing stiff competition from Top Ramen and ITC's Yippee noodles lately. Price hikes

can be expected in this segment. The investments in working capital and capital expenditures were

each found to be around 4% of the revenues. Also, Nestle India has 96.42 mn shares outstanding.

As with HUL and ITC, the terminal growth has been assumed to be 5% while Nestle India's cost

of capital is 10%.

Table 16 Multiples

Multiples according to DCFE

P/E 15.24

P/S 1.81

P/B 7.19

Current market multiples

P/E 59.4

P/S 5.4

P/B 29.66

Based on the analysis, table 17 shows the multiples obtained for the three companies.

Table 17

Company Using DCFE Using DDM Current multiples

P/E P/S P/B P/E P/S P/B P/E P/S P/B

HUL 26.43 4.47 41.53 88.63 14.47 134.52 48.87 4.4 57.59

ITC 27.36 4.99 9.64 42.64 7.78 15.02 28.69 7.4 9.9

Nestle India 15.24 1.81 7.19 NA NA NA 59.4 5.4 29.66


35

5.0 Conclusion

As seen above, the value of the multiples calculated using the DCF method is lesser than the

current market multiples. The same is not the case with using the DDM method, which yields higher

figures than the current multiples.

One of the main reasons for the lower multiples using the DCF method include the conservative

revenue growth forecasts. Given that the FMCG sector in India is currently facing a slowdown and

the volume growth in the FMCG sector is on the lower side, the current multiples of the companies are

quite expensive and corrections can be expected in their prices. Hence, the recommendation here

would be a sell verdict until these stock prices reduce to their justified prices.

Given that the FMCG sector in India is overpriced with price multiples on the higher side, the

justified price multiples play a very important role in giving an idea of the fair price.

References

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Paper No. 515.


36

11. Hindustan Unilever Limited. (Numerous Years). Annual Reports of HUL. Retrieved June 2015, from

Hindustan Unilever Limited: http://www.hul.co.in/investorrelations/AnnualReports/

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www.itc.com.hk/en/financial_inform/annual_reports.asp?rpt

13. Kalsie, A. (2014). Valuation of a Troubled Firm: A Case Study on Jet Airways. Manthan: Journal of

Commerce and Management, 1(2), 110-131.

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Price Multiple, Real Valuation. International Journal of Business and Administration Research Review,

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comparison of price multiples using ddm, dcf and current

Documents