MGTE 41233-

Corporate Finance

Valuation for Nestlé Lanka PLC

B.Sc (Hons) in Management & Information technology

Department of Industrial Management
Faculty of Science
University of Kelaniya
 MGTE 41573 - Corporate Finance

Assignment 02

Lecturer : Dr. Suren Peter

Date of Submission : 2nd September, 2019
Final Marks :

Group Members
IM/2013/036 - Erandika Lakmali
IM/2013/025 - Madhavie Warnakulasuriya
 Contents
1. Introduction .........................................................................................................................4
2. Valuation Methods ...............................................................................................................6
2.1 Discounted Cash Flow Approach ..................................................................................6
2.2. Dividend Discount Model Approach ............................................................................... 11
2.3. Asset Valuation Approach........................................................................................... 12
2.4. Profit Multiplier Approach .......................................................................................... 13
2.5 Comparable Approach ..................................................................................................... 16
2.6 Precedent Transaction Approach ..................................................................................... 16
2.7 Book Value Approach ..................................................................................................... 17
2.8 Liquidation Value Approach ............................................................................................ 17
Conclusion ............................................................................................................................ 20
 1. Introduction

Nestlé S.A. is a Swiss multinational food and drink company headquartered in Vevey, Vaud,
Switzerland. It is the largest food company in the world, measured by revenues and other metrics,
since 2014. Nestlé's products include baby food, medical food, bottled water, breakfast cereals,
coffee and tea, confectionery, dairy products, ice cream, frozen food, pet foods, and snacks..

Nestlé’s history dates back to 1866, when the Anglo-Swiss Condensed Milk Company opened the
first European condensed milk factory in Cham, Switzerland. A year later, Nestlé’s founder Henri
Nestlé, a German pharmacist, launched his Farine lactée – a combination of cow’s milk, wheat
flour and sugar - in Vevey, Switzerland, saving the life of a neighbor’s child. Nutrition has been
the cornerstone of our company ever since.

Nestlé established its presence in Sri Lanka more than a century ago, commencing as a trading
company in 1906 with condensed milk and infant-food products. Reinforcing their roots in the
island, Nestle became a public-quoted company in 1983 and commenced commercial production
in 1984.

Today, the local portfolio comprise the country’s best loved brands, where their state-of-the-art
production facility manufactures over 90 % of their products sold in Sri Lanka, including,
Nestomalt, Milo, Milkmaid, Nespray and Maggi. It is one of the leading Food and Beverage
companies in Sri Lanka today, providing direct employment to almost 1,200 people and positively
affecting the livelihoods of over 23,000 distributors, suppliers, farmers and their families. Their
corporate ambition is to be the recognized leader in Nutrition, Health and Wellness – which is
captured in the simple phrase 'Good Food, Good Life'. They have ensured that all food and
beverage brands, regardless of category or eating occasion, enhance their consumer lives by not
only offering the best taste and pleasure but also the best nutritional profile in its category as part
of a healthy diet.

Nutrition plays a profound role in peoples’ life. Nestlé’s strategy focuses on delivering distinct
benefits to people through the food and beverages, products and services we provide. Over 150
years they have built a successful business by understanding and anticipating the needs of society,
and continuously adapting ourselves to seize the opportunities presented. The fast-evolving needs
and expectations of society today reconfirm the validity of their Nutrition, Health and Wellness
strategy. The world is at an inflection point. The speed, intensity and the breadth of change is
unprecedented. Digital disruption is reshaping this industry, their relationships with our suppliers
and retailers, and with the people who buy our brands. Advances in science and technology are
opening up new opportunities for us to play a role in addressing the challenges society faces.
 2. Valuation Methods
2.1 Discounted Cash Flow Approach

Discounted cash flow (DCF) is a valuation method used to estimate the value of an investment
based on its future cash flows. DCF analysis attempts to figure out the value of a company today,
based on projections of how much money it will generate in the future. DCF analysis finds
the present value of expected future cash flows using a discount rate.If the value calculated
through DCF is higher than the current cost of the investment, the opportunity should be
considered. The big advantage of this approach is that it can be used with a wide variety of firms
that do not pay dividends, and even for companies that do pay dividends. In this variation, the free
cash flows are generally forecasted for five to ten years, and the terminal value is calculated to
account for all the cash flows beyond the forecast period.

Forecast
2019 2020 2021 2022 2023
FCFF 2135174446 2,177,877,935 2,221,435,494 2,265,864,203 2,311,181,488
Terminal Value 48,072,574,941
Total FCFF 2,135,174,446 2,177,877,935 2,221,435,494 2,265,864,203 50,383,756,429
Discount factor
at 6% 0.92 0.84 0.77 0.71 0.65
Discounted
FCFF 1,958,875,639 1,833,076,286 1,715,355,790 1,605,195,327 32,745,984,663

 Enterprise Value Rs. 39,858,487,704

 Number of shares 53,725,463
 Value per share Rs. 742

Assumptions
Cost of equity / WACC 9%
Risk free rate 8%
Market risk premium 5.2%
Corporate tax rate 28%

Beta 0.00 (Beta against ASPI as per 2nd quarter of 2019 source
CSE website)
Terminal growth rate per annum 4%
 2012 2013 2014 2015 2016 2017 2018
OCF 3,145,324,00 3,823,397,000 5,146,747,000 4,109,900,000 4,072,570,000 4,200,683,000 4,641,410,0
0 00

Add: 33,881,960 22,419,040 7,129,920 8,566,320 12,244,960 63,087,080

Interes
t (1-
tax) 63,252,280
Less: (797,065,000 (454,596,000) (1,100,512,000 (766,584,000) (959,810,000) (2,407,687,000
Invest ) ) ) (2,611,354,
expd. 000)
FCFF 2,382,140,96 3,391,220,040 4,053,364,920 3,351,882,320 3,125,004,960 1,856,083,080 2,093,308,2
0 80
Growt 0.42 0.20 -0.17 -0.07 -0.41
h per
yr 0.13

 Average growth rate of past FCF = 2%

 FCF for 2018 = Rs. 2,093,308,280* (1+2%) = Rs. 2,135,174,446

Cost of Capital
Cost of capital is the required return necessary to make a budgeting project. The cost of capital
typically mean the weighted average of a firm's cost of debt and cost of equity blended. The cost
of capital metric is used by companies internally to judge whether a capital project is worth the
expenditure of resources, and by investors who use it to determine whether an investment is worth
the risk compared to the return. The cost of capital depends on the mode of financing used. It refers
to the cost of equity if the business is financed solely through equity, or to the cost of debt if it is
financed solely through debt. Many companies use a combination of debt and equity to finance
their businesses and, for such companies, the overall cost of capital is derived from the weighted
average cost of all capital sources, widely known as the weighted average cost of capital (WACC).

Nestle Lanka PLC is a fully equity financed company. Therefor the WACC will be equivalent to
the required cost of equity.
Cost of Equity

The cost of equity is the return a company requires to decide if an investment meets capital return
requirements. Firms often use it as a capital budgeting threshold for the required rate of return. A
firm's cost of equity represents the compensation the market demands in exchange for owning the
asset and bearing the risk of ownership. The two methods for cost of equity analyzing are the
dividend capitalization model and the capital asset pricing model (CAPM).

1) Capital Asset Pricing Model

The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk
and expected return for assets, particularly stocks. CAPM is widely used throughout finance for
pricing risky securities and generating expected returns for assets given the risk of those assets
and cost of capital.

The method that calculate the expected return at Nestle using this model is as follows,

ERi = Expected return of investment

Rf = Risk-free rate

βi = Beta of the investment

ERm = Expected return of market

(ERm - Rf) = Market risk premium

Investors expect to be compensated for risk and the time value of money. The risk-free rate in the
CAPM formula accounts for the time value of money. The other components of the CAPM formula
account for the investor taking on additional risk.

Beta (βi )
A beta coefficient is a measure of the volatility, or systematic risk, of an individual stock in
comparison to the unsystematic risk of the entire market. In statistical terms, beta represents the
slope of the line through a regression of data points from an individual stock's returns against those
of the market. The beta for Nestle Lanka PLC was 0.00 against ASPI (as per second quarter of
year 2019).

Risk Free Rate (Rf )

The risk-free rate of 8% was taken as the yield to maturity on the LKR one-year bonds by the end
of September 2019, which was obtained from the website of Central Bank of Sri Lanka.

Cost of equity (Re1) =8 %

2) Dividend Growth Model

Cost of equity can be worked out with the help of Gordon’s Dividend Discount Model. The model
focuses on the dividends as the name itself suggests. According to the model, the cost of equity is
a function of current market price and the future expected dividends of the company.

D1 = Dividends for next year

P0 = Current market price
g = Dividend growth rate

2012 2013 2014 2015 2016 2017 2018

Dividend per share 54.00 60.00 68.50 64.50 80.00 50.00 50.00
Growth per year 0.11 0.14 -0.06 0.24 -0.38 0.00

 The average growth rate of dividends = 1%

 Current share price = Rs. 1726.03
 Cost of equity (Re2) = 3.98%
Terminal Value (TV)

Terminal value (TV)/horizon value, determines the value of a business or project beyond the
forecast period when future cash flows can be estimated. This allows financial models to value a
business with a greater degree of accuracy. As such, TV often comprises a large percentage of the
total assessed value. The Gordon Growth Model, discounted cash flow, and residual earnings use
terminal values that can be calculated with perpetuity growth, while an alternative exit valuation
approach employs relative valuation methods.

To calculate the terminal value the following equation was used.

WACC = weighted average cost of capital

g = expected growth rate into perpetuity

 Terminal value Rs. 48,072,574,941

Analysis

The value of the firm derived from the DCF approach is Rs.742.00, and the weighted average
market price per share is Rs.1726.03 in 2018.So the value of the firm is less since weighted average
market price per share is greater than DCF approach value. This implies that the shares of Nestle
Lanka PLC are overpriced in the market. That is the shares are not worth for Rs.1726.03. So it’s
not worthwhile to buy shares at present scenario.

Hit shows that the company has produced increasing positive OCF, when analyzed the past annual
reports. But, it can also be seen that the capital expenditures are varying in significant amounts
throughout the years. So the company still investing much of its cash back into the business in
order to grow.
2.2. Dividend Discount Model Approach

The Dividend Discount Model (DDM) is a quantitative method of valuing a company’s stock price
based on the assumption that the current fair price of a stock equals the sum of all company’s
future dividends discounted back to their present value. The assumptions used for developing the
model are, intrinsic value of a stock reflects the present value of all future cash flows generated by
a security and dividends are essentially the positive cash flows generated by a company and
distributed to the shareholders.

The dividend discount model can take several variations depending on the stated assumptions.

Dividend Discount
Model(DDM)

One-period Dividend Multi-period Dividend

Gordon Growth Model
Discount Model Discount Model

The Gordon Growth Model (GGM) is used for this valuation. It is the most commonly used
variations of the dividend discount model.

2012 2013 2014 2015 2016 2017 2018

Dividend per share 54.00 60.00 68.50 64.50 80.00 50.00 50.00
Growth per year 0.14 0.11 0.14 -0.06 0.24 -0.38 0.00

Growth Rate 1%
Cost of Equity 9%

 Intrinsic value of the stock = Rs. 631.00

Analysis

This company is a dividend paying company .But those dividends are not stable/ predictable. In
the dividend discount approach, the intrinsic value of the stock is Rs.631.00, which is nearly
similar to the value, derived from the discounted cash flow approach, but still very much less than
the market share price (Rs.1726.03) in 2018, which implies that the overvalued shares are, exist.
According to analysis on dividends discount model approach, it is not worthwhile to invest in the
Nestle Lank PLC’s stocks.

2.3. Asset Valuation Approach

The net asset value (NAV) represents the net value of an entity and is calculated as the total value
of the entity’s assets minus the total value of its liabilities. Most commonly used in the context of
a mutual fund or an exchange traded fund (ETF), the NAV represents the per share/unit price of
the fund on a specific date or time.

In the context of companies and business entities, the difference between the assets and the
liabilities is known as the net assets, the net worth, or the capital of the company. The term NAV
has gained popularity in relation to the fund valuation and pricing, which is arrived at by dividing
the difference between assets and liabilities by the number of shares/units held by the investors.
The fund’s NAV thereby represents a “per-share” value of the fund, which makes it easier to be
used for valuing and transacting in the fund shares.

Valuation Summary
Net Assets (Rs.) 2017 2016

Stated Capital 537,255,000.00 537,255,000.00

Reserves 5,097,901,000.00 4,263,780,000.00
Retained Earnings
Equity 5,635,156,000.00 4,801,035,000.00

Realization Cost 0.1 0.1

Cost of Realization 563,515,600.00 480,103,500.00
Realizable net assets of the company attributable to
5,071,640,400.00 4,320,931,500.00
equity holders
 Ordinary Shares 53,725,463 53,725,463
Realizable net assets value per share 94.40 80.43

Analysis
The Net Asset Value (NAV) per share at 31st of December 2018 is Rs.94.40.And share price as at
31st of December 2018 is Rs. 1726.03. So for a share of Rs. 94.40 worth asset are included and
share price is worthy when look at the investor’s perspective.

According to theoretical framework If NAV per share is greater than the share price because it
derives that the share included assets which are value more than the money invested. Therefore
risk for investor is very low. Since the NAV per share is less than the share price but, the share
price is not much deviated from the NSV per share the risk of losing investor’s money is low
according to this method. So it is recommended for the investor to invest at Nestle Lanka PLC.

2.4. Profit Multiplier Approach

Profit Multiplier Calculation

In profit multiplier, the value of the business is calculated by multiplying its profit. The profit
multiplier method is also known as the Price to Earnings or P/E Ratio, the price being the value of
the company and the earnings being the profit that the company generates.
If pre-tax profit is used, commonly applied profit multiples for small businesses would be between
3 to 4 and occasionally 5. The P/E multiples may be applied higher for larger publicly traded
companies, normally anything from 7 to 12 and in some cases, when they have high growth
potential, even more. This is one of the main reasons why large corporations can acquire a smaller
business and instantly revalue them at a higher price.

Obviously, the multiple that is used have a huge effect on the valuation of the company. A larger
business with a track record of good profits and with several potential buyers is likely to value by
a higher profit multiple.
 Basic and Diluted Earnings per Share = Profit Attributable to Ordinary Shareholders
Weighted Average Number of Shares

Price Earnings Ratio (PE Ratio) = Market Price per Share

EPS

Or

Price Earnings Ratio (PE Ratio) = Entire Market Capitalization

One Year’s Earnings

EPS calculation 2014 2015 2016 2017 2018 Average

Profit Attributable
3,786,893,00 4,124,324,0 4,398,762,0 3,634,217,0 3,485,801,0 3,885,999,
to Ordinary
0 00 00 00 00 400
Shareholders (Rs.)
Weighted Average
53,725,463 53,725,463 53,725,463 53,725,463 53,725,463
Number of Shares
Basic and Diluted
Earnings Per Share 70.49 76.77 81.87 67.67 64.88
(Rs.)

Price Earnings
ratio
calculation(PE
ratio)
Market Price Per
2,105.00 2,049.50 2,001.90 1626 1700
Share
EPS 70.49 76.77 81.87 67.67 64.88
PE ratio 29.87 26.7 24.46 24.03 26.21 26.26
 PE Ratio of Nestle Lanka PLC
35

30
29.87
25 26.7 26.21
24.46 24.03
PE Ratio

20

15

10

0
2014 2015 2016 2017 2018
Year

PE Ratio
Entire Market Capitalization 69,843,101,900
One Year's Earning(Average of past 5 years) 3,885,999,400
PE Ratio 17.98

Analysis

Until the business makes profits at the in a constant manner, the buyer will get Rs.
3,885,999,400.00 per year for the Rs. 69,843,101,900.00 investment. And also this Price Earnings
ratio visualize the payback period which describes how many years it will take to recover the
investment by earnings per year. According to this calculation, after 17.98 years (around 18 years)
it will be able to generate the full return on the investment. The second point is that this PE ration
show off how much the investors are willing to pay for every one rupee that invested .So it is
Rs.17.98.Moreover, this shows how expensive or how cheap one rupee profit is in the market while
trading the stock at a multiple of 17.98.When compare the series of PE ratios on past few years,
the above graph visualize that this PE ration has been declined from 2014 to 2017 and increased
in 2018 than 2016 and 2017. That means the investor demand for a company share has been
declined from 2014 to 2017 and has been increased in 2018.So it will predict to happen in future
which indicates that the company has increase its value for shares from investors suddenly in 2018
and can hope it will continue in future.
2.5 Comparable Approach

The comparable model is a relative valuation approach. A comparable company analysis (CCA)
is a process used to evaluate the value of a company using the metrics of other businesses of similar
size in the same industry. Comparable company analysis operates under the assumption that
similar companies will have similar valuation multiples, such as EV/EBITDA. Analysts compile
a list of available statistics for the companies being reviewed and calculate the valuation multiples
in order to compare them.

For this price-to-earnings, ratios can be calculated and compared of the companies, which belong
to similar business sectors.

2.6 Precedent Transaction Approach

Precedent transaction analysis is a valuation method in which the price paid for similar companies
in the past is considered an indicator of a company’s value. Precedent transaction analysis creates
an estimate of what a share of stock would be worth in the case of an acquisition.

Multiples for precedent transaction analysis (year 2018)

Financial Matrices 2018 2017

Revenue 37,336,943 37,601,472
Profit before taxation 4,941,457 4,734,672
Profit after taxation 3,485,801 3,635,841
Shareholder funds 5,635,156 4,801,035

Financial Ratios (2017) (2018)

Earnings per share (EPS) 64.88 67.67

 EPS have shown a growth

2.7 Book Value Approach

This is a good method to value a company with relatively large assets. Therefore, might not be
suitable for companies of smaller size.

In addition, this might be good for companies, which has particularly low profits. In other terms
the companies, which has shown less profit with less financial growth but having a significant
book value because it has lot of valuable assets. In this case, the shares might be selling at a
discounted price of the book value depending on the profit figure.

Book value/Net worth = Total assets – Total liabilities

.
Year 2014 2015 2016 2017 2018 Average
Average Total 10,809,929 12,122,047 13,286,638 15,520,210 17,658,806
Assets(Rs.‘000s)
Total 6,722,001 7,600,411 7,804,064 10,707,411 12,023,650
Liabilities(Rs.‘000
s)
Book Value or 4,087,928 4,521,636 5,482,574 4,812,799 5,635,156 4,908,017
Net
Worth(Rs.‘000s)

Analysis
According to this secondary approach, this company has a net worth of Rs. 4,908,018,600.

2.8 Liquidation Value Approach

Liquidation value method of equity valuation is one of the techniques under Balance Sheet based
methods of valuation which assumes that value of the company under this method will be its
salvage value if the company is shut down.

The net worth or book value of the company reflects its accounting value while the liquidation
value tends to arrive at the company’s residual value assuming that the company sells off all its
assets (at market realizable value) and pays off all the liabilities that it has taken.
 Figure 1 Financial Statement Nestle - 2018

The book value of the company can be calculated as follows

Book value calculation Rs (,000)s
Total Assets 17, 658,806
Less Long-Term Debt 4,634,844
Less Short Term Debt 2,007,954
Less Creditors 1,524,174
Book Value 2,070,271

Liquidity value may slightly differ from the adjusted book value given the fact that when a
company goes to sell off its assets, it may receive lesser value than the market value. Inventory
might have piled up and since business needs to be closed down, inventory may even fetch a
lower value. Furthermore, there might be some expenses incurred on liquidation which also can
be taken into account to arrive at fair liquidation value.
Adjusted Book value

As at 31 Dec 2018 Recovery ratio Rs (,000)s Liquidate value

PPE 20% (Avg) 9,210,242 1,842,048

Capital WIP 90% 673,117 605,805
Inventories 90% 2,987,844 2,689,059
Trade and other receivables 70% 3,361,854 2,353,298
Amount due from related 0% 854,134 0
parties
Cash & cash equivalent 100% 217,731 217,731
Total Assets 17, 304,962 7,707,941

Total Liquidation value of Assets Rs. 7,707,941

Less: Current Liabilities Rs. 8,334,812

Amount available debt, preference shares and Equity shares Rs. (-626,871)

Analysis

Liquidation value method can be used for making investment decisions. If the company is
profitable and industry is growing too, the company’s liquidation value will normally be much
lower than the share price, since share price factors growth aspect which liquidation value does
not.

For companies going through a decline phase or if the industry is dying, the share price may be
lower than the liquidation value; this would logically mean that the company should shut business.
To have arbitrage benefits, smart corporate raiders usually are on a lookout for these kinds of
companies. Since the liquidation value is higher than the market share price, they can buy out the
company stock at a lower price and then sell off the company to make risk-free arbitrage profit .
Stocks with negative Liquidation Value implies that if these companies are liquidated today, the
shareholder’s will not be able to recover their investments. According to the calculation the
company is not even able to pay its current liabilities to the fullest extent

Conclusion

Valuation Method Result

Discounted Cash Flow Approach Market Price per share = Rs. 742

Asset Valuation Approach Realizable net asset value per share = Rs 1726.03

Precedent Transaction Approach EPS = 67.76 (Has increased compared to 2017)

Book Value Approach Net Worth = Rs. 4,908,018,600

Liquidation Value Approach Amount available for debt fund investors, preference
shareholders and equity shareholders = Rs. (-626,871)

According to the book value approach which is a secondary approach this company has a net worth
of Rs. 4,908,018,600

According to the liquidation approach the company is not even able to pay its current liabilities to
the fullest extent while remaining a negative value of Rs. (-626,871,000) to pay for debt fund
investors, preference shareholders and equity shareholders.

Therefore, it is not recommended to buy the shares at the moment.