Finding Out the Leverage Trends across the

Sector
The following Table describes the debt equity ratio as a measure of leverage
across the FMCG sector in India. The period for the data is December 2000-
December 2009. The table also shows the average of the industry during the
period.

Dec Dec Dec Dec Dec Dec Dec Dec Dec- Dec-
'00 '01 '02 '03 '04 '05 '06 '07 08 09

HUL 0.04 0.03 0.02 0.80 0.70 0.02 0.03 0.06 0.20 0.00

Nestle 0.33 0.33 0.33 0.33 0.33 0.33 0.33 0.33 0.33 0.33

ITC 0.24 0.15 0.04 0.02 0.03 0.02 0.02 0.02 0.02 0.01

Dabur 0.71 0.54 0.40 0.22 0.15 0.09 0.05 0.04 0.13 0.17

Colgate 0.04 0.05 0.02 0.01 0.01 0.02 0.02 0.02 0.02 0.02
Palmolive

Marico 0.02 0.02 0.04 0.05 0.18 0.58 0.85 1.02 0.95 0.73

Brittania 0.67 0.59 0.45 0.24 0.05 0.02 0.01 0.08 0.08 0.37

Average 0.29 0.24 0.19 0.24 0.21 0.15 0.19 0.22 0.25 0.23

Debt-Equity during the period under study

Hindustan Unilever Limited in the period under study breached the industry
average from downside to a position above industry average. On the other hand
Nestle maintained a constant ratio of 0.33 during the period.

The following figure shows the Graphical representation of D/E trends in the
industry. In the figure the Dark Bold Dotted line shows the Industry average
during the period under study.

Tracing out the Movement in respect of the

Industry Average
This section aims to illustrate the correlation of the Debt-Equity of various
players of the FMCG sector to the Industry average. In other words, it depicts the
comparative movement between two.

Analyzing the correction by various players in FMCG

sector to the industry average.
The period under study is 2000-2009. As on year ending December 31, following
players were operating above the industry average:

➢ Marico
➢ Nestle
➢ Brittania
While the following players were operating below the industry average for D/E:
➢ Hindustan Unilever Limited
➢ ITC Limited
➢ Dabur
➢ Colgate-Palmolive

The following table shows squared differences of the D/E of

respective companies to the industrial average
 Dec Dec Dec Dec Dec Dec Dec Dec Dec- Dec-
'00 '01 '02 '03 '04 '05 '06 '07 08 09

HUL 0.0618 0.046 0.028 0.312 0.245 0.017 0.025 0.026 0.001 0.054
8 6 3 5 0 6 5 9 2

Nestle 0.0013 0.007 0.020 0.008 0.014 0.030 0.020 0.011 0.006 0.009
3 9 4 9 5 4 0 7 4

ITC 0.0029 0.008 0.021 0.047 0.031 0.018 0.027 0.041 0.051 0.049
8 0 6 5 2 8 8 9 6

Dabur 0.1735 0.087 0.046 0.000 0.003 0.004 0.018 0.034 0.013 0.003
7 2 3 3 2 7 0 9 9

Colgate 0.0643 0.037 0.027 0.052 0.039 0.018 0.027 0.041 0.051 0.045
Palmolive 6 2 0 0 2 8 8 9 3

Marico 0.0748 0.050 0.021 0.035 0.000 0.180 0.440 0.632 0.493 0.247
1 0 4 8 7 1 9 2 2

Brittania 0.1418 0.119 0.070 0.000 0.024 0.018 0.031 0.020 0.028 0.018
8 2 0 8 2 2 9 1 8

Over the period under study, ITC & Marico have deviated from industry average.
Their squared difference from the industry average has increased from 0.0029 to
.0496 & 0.0748 to 0.2472 respectively. While in case of Britannia, there has been
marginal improvement in the squared difference towards industry average.
Dabur is the player operating closest to the industry average.

Nestle seems to be close the industry average while its worth noting that it has
not changed its Debt equity position over the period. While commenting about
HUL & ITC we should keep in mind that they have debt equity ratios very close
zero. Colgate Palmolive and Marico have deviated from the industry average
over the period under study.
Divisional cost of Capital of ITC
What is Pure Play Approach?
In financial management, a pure play is a company whose shares are publicly
traded and that either has, or is very close to having, a single business focus.
Coca-Cola is an example of a pure play in this context because it retails only
beverages. On the other hand, PepsiCo is not a pure play because it also owns
the Frito-Lay snack foods brand.
The pure play approach or pure play method is a method for estimating the
cost of capital for a proposed new project or product line. It involves examining
other companies which are pure plays in the proposed line of business and
inferring a cost of capital based on their capital structures (example: Debt-to-
Equity ratio) and betas.
Methodology
Business segments of ITC Ltd are:

• FMCG
○ Cigarette
○ Others
• Hotels
• Agri-business
• Paperboards, Paper and Packaging

Use of Pure Play Companies as Proxy

For calculating Divisional cost of capital of ITC, proxy Pure Play firms are selected
who are purely operating in the required particular business domain. Their Beta
is calculated and is Unlevered using Hamada’s formula.
Beta of an Unlevered Firm
BU=BL/1+ (1-T)*D/S
Where,
BU= Beta of an unlevered firm
BL=Beta of a levered firm
T=tax rate
D=component of Debt in capital structure
S=component of Equity in capital structure

The unlevered Beta are again Re-Levered using the Leverage Factor of ITC.

Beta of a Levered Firm

BL=BU*(1+ (1-T)*D/S)
Where,
BL=Beta of a levered firm
BU= Beta of an unlevered firm
T=tax rate
D=component of Debt in capital structure
S=component of Equity in capital structure

Calculating the composite weighted average Beta

The next step is to calculate a composite weighted average Beta. The Capital
employed in the various segments is used as base for weights. The capital
employed in the segment is calculated is the difference between segment assets
and segment liabilities.

The final step is to calculate the overall cost of capital.

The Computation
The following table shows the various Pure players and their respective Beta(s).
These Beta(s) are levered with the debt-equity of the respective player and thus
needs to be unlevered.
 Pure Player Beta
(levered)

Cigarettes Godfrey Phillips 0.26048397

3

FMCG Dabur 0.37830485

6

Hotel Indian Hotels 0.93383465

Industry 5

Paper BILT 0.82944073

2

Agri-Business Bambino Foods 0.98388460

4

Agri-Business DFM Foods 0.31601679

5
The table shows the respective D/E ratios.

Pure Player D/E

Cigarettes Godfrey Phillips 0.13

FMCG Dabur 0.17

Hotel Indian Hotels 0.78

Industry

Paper BILT 0.58

Agri-Business Bambino Foods 2.16

Agri-Business DFM Foods 0.85

Using Hamada’s Formula we get unlevered

Beta.
BU=BL/1+ (1-T)*D/S

Unlevered
Beta

Cigarettes Godfrey Phillips 0.23972801

FMCG Dabur 0.33982885

5

Hotel Indian Hotels 0.61457199

Industry 9

Paper BILT 0.59831871

Agri-Business Bambino Foods 0.40346593

4

Agri-Business DFM Foods 0.20178473

9
The Unlevered Beta(s) above is then Re-Levered according to the D/E of the ITC.
D/E Relevered
(ITC) Beta

Cigarettes Godfrey 0.01 0.2413246

Phillips 22

FMCG Dabur 0.01 0.3420921

5

Hotel Indian Hotels 0.01 0.6186651

Industry 1

Paper BILT 0.01 0.6023035

73

Agri- Bambino 0.01 0.4061530

Business Foods 58

Agri- DFM Foods 0.01 0.2031286

Business 46

Relevered Segment Weigh Beta

Beta Capital t

Cigarettes 0.2413246 3139.67 0.244 0.05899

22 45 177

FMCG 0.3420921 1841.69 0.143 0.04905

5 391 298

Hotel 0.6186651 2535.87 0.197 0.12214

Industry 1 439 857

Paper 0.6023035 3699.98 0.288 0.17350

73 075 844

Agri- 0.3046408 1626.61 0.126 0.03858

Business 52 645 135

12843.82 1 0.4422

The re-levered beta(s) of various divisions of ITC are used for calculating
weighted average beta of ITC. The capitals employed in the various divisions are
used as weights.
NOTE: In case of Agri-business division the Average of pure players (Bambino
Foods & DFM Foods) are taken.

Thus, Beta=0.4422.

Calculation of Cost of Debt (kd)

kd= Interest/Debt *(1-t)

=16/107.17 * (1-0.3399)

=0.09554 or 9.554%

Calculation of Cost of Equity (ke)

ke= Rf + B (Rm-Rf )

=>

Calculation of overall cost of capital

Rs. in Weight Cost

crore

Share Capital 381.82 0.0269

42

Reserves 13682.5 0.9654

6 58
ko =
Debt 107.71 0.0076 .
09554

Analysing the impact of

14172.0 1 stock split
9
The board of ITC Limited decided
to split or sub-divide the Rs 10
face value share into 10 shares of Rs 1 each. The following table shows the
earning per share. It is worth noticing the steep fall in EPS in year 2006 as
compared to the preceding years as the EPS is not adjusted to account for stock
split.

2001 200 200 200 200 200 200 200 200 201
2 3 4 5 6 7 8 9 0
 Earnings Per 39.98 48. 53. 61. 83. 5.5 6.6 7.6 8.0 8.9
Share 48 48 75 92 8 5 8 2 8

The steep fall is characterised by tenfold increase in number of shares resulting

from the split.

To offset the impact of such corporate actions, adjusted EPS is calculated. Such
EPS are adjusted for corporate actions with retrospective effect.

200 200 200 200 200 200 200 200 200 201
1 2 3 4 5 6 7 8 9 0

Adjusted EPS 4.1 4.8 5.5 6.4 7.3 6.0 7.1 8.2 8.6 10.
1 4 3 6 7 8 8 5 64

In 2005 ITC announced a stock split- sub division into 10 shares for every 1 share
held. And a bonus issue was subsequently announced in the ratio of 2:1. This
made 15 shares for every one share held. The market price before these
corporate actions was around Rs. 1900. After the split it came down to around
Rs. 120 (Around 1/15th).

In June 2010 ITC Ltd. announced a bonus issue in the ratio of 1:1.ITC Ltd’s
shareholders will get one share for every existing share by way of a bonus issue.
The last time they got a similar ratio was in 1994, with the previous bonus issue
giving them one share for every two held.

Bonus issues in India generate a lot of excitement, chiefly among retail investors
who like the sound of free shares falling into their demat account. There is also a
belief that companies typically issue bonus shares when they are optimistic
about their future. But there is one thing that is real about bonus shares; if the
company maintains its dividend ratio, the payout shoots up.
In ITC’s case, it would double. And this would be on the back of a step-up in ITC’s
dividend payout in fiscal 2010. It will pay Rs4.50 a share, or 22% more than the
previous year, an outflow of around Rs1,700 crore. It is also paying a special
dividend of Rs5.50 a share, or an additional Rs2,100 crore. While the special
dividend would be a one-time payout, if it keeps the dividend constant at Rs4.50,
after the bonus issue, its dividend payout will double to Rs3,500 crore. And, this
does not include dividend distribution tax. Whether ITC keeps its dividend
constant or not only time will tell, but shareholders will surely expect it to do so.
ITC can afford to pay out more as a dividend for several reasons. For starters, it
generates a lot of cash, for which it has no big capital expenditure plans lined up.
In fiscal 2010, its cash flows from operations were up 40% to Rs6,620 crore. It
has already made significant investments in the capital-intensive portion of its
business portfolio—paper and hotels. The paper division is doing quite well and
an improving economic environment should see it do well. The hotels business
went through a bad phase in 2010, but the worst is behind it. Its flagship
cigarettes business continues to do well, generating profits and cash. Its non-
cigarette consumer business, too, has seen performance improve, with revenue
rising and losses declining. This business also saw its capital employed fall by
18%, a sign that it is becoming more self-sufficient. The bonus issue, thus, will
give ITC a way of getting rid of that extra cash it generates, which will allow it to
preserve or even improve important ratios such as return on capital employed.