BUSINESS ANALYSIS OF ASIAN PAINTS INTRODUCTION Asian Paints Limited (APL) incorporated in 1942 ranks among the top ten decorative paint companies in the world. It has presence in decorative and industrial coating segment of the paint business. Besides, the Company operates around the world through its subsidiaries Berger International Limited, Apco Coatings and SCIB Chemicals. APL has its presence in almost all the segment through its brands Royale in the premium segment, Apcolite in the mid-segment, Gattu, Tractor, Utsav and 3- Mango etc. in the lower segment.
Vision Asian Paints aims to become one of the top five Decorative coatingscompanies world-wide by leveraging its expertise in the higher growthemerging markets. Simultaneously, the company intends to build long termvalue in the industrial coatings business through alliances with establishedglobal partners Mission To be the worlds largest decorative paints company worldwide and to be fifth largest manufacturing company worldwide. ABOUT THE COMPANY Asian Paints is India’s largest paint company and Asia’s third largest paint company,with a turnover of Rs 66. 80 billion.
The group has an enviable reputation in the corporateworld for professionalism, fast track growth, and building shareholder equity. AsianPaints operates in 17 countries and has 23 paint manufacturing facilities in the worldservicing consumers in over 65 countries. Besides Asian Paints, the group operatesaround the world through its subsidiaries Berger International Limited, Apco Coatings,SCIB Paints and Taubmans. Forbes Global magazine USA ranked Asian Paints among the 200 Best SmallCompanies in the World for 2002 and 2003 and presented the ‘Best under a Billion’award, to the company.
Asian Paints is the only paint company in the world to receivethis recognition. Forbes has also ranked Asian Paints among the Best under a Billioncompanies in Asia In 2005, 06 and 07, the company has come a long way since its small beginnings in 1942. Four friends whowere willing to take on the world’s biggest, most famous paint companies operating inIndia at that time set it up as a partnership firm. Over the course of 25 years AsianPaints became a corporate force and India’s leading paints company. Driven by itsstrong consumer-focus and innovative spirit, the company has been the market leader inpaints since 1968.
Today it is double the size of any other paint company in India. AsianPaints manufactures a wide range of paints for Decorative and Industrial use. In Decorative paints, Asian Paints is present in all the four segments v. i. z Interior WallFinishes, Exterior Wall Finishes, Enamels and Wood Finishes. It also introduced manyinnovative concepts in the Indian paint industry like Colour Worlds (Dealer TintingSystems), Home Solutions (painting solutions Service), Kids World (painting solutions forkid’s room), Colour Next (Prediction of Colour Trends through in-depth research) andRoyale Play Special Effect Paints, just to name a few.
Asian Paints has always been ahead when it comes to providing consumer experience. It has set up a Signature Store in Mumbai where consumers are educated on coloursand how it can change their homes. Vertical integration has seen it diversify into products such as Phthalic Anhydride andPentaerythritol, which are used in the paint manufacturing process. Asian Paints also operates through APPG (50:50 JV between Asian Paints and PPG Inc, USA, one of thelargest automotive coatings manufacturer in the world) to service the increasingrequirements of the Indian automotive coatings market.
Another wholly ownedsubsidiary, Asian Paints Industrial Coatings Limited has been set up to cater to thepowder coatings market which is one of the fastest growing segment in the industrialcoatings market. Asian Paints also operates in Road Markings, Floor Coatings andGeneral Industrial Liquid paints segments in industrial coatings. RESEARCH AND DEVELOPMENT At Asian Paints, Research and Development (R&D) plays an important role in developing new products and innovations, and reducing costs by value re-engineering of formulations.
In India, the company’s 140 strong R&D team consisting of 7 doctorates and around 115 qualified scientists, has always backed the company’s business plan and demands of the market place. Right from the company’s inception, all its decorative products for the Indian market and also in the overseas market have been developed in-house. In the last few years, our R&D efforts have been focused on developing new exterior finishes, economy emulsions and distempers. Asian Paints’ R&D team has successfully managed to develop High-end exterior finished and wood finishes in-house, which was earlier imported into the country.
These products are currently marketed under Asian Paints Elastomeric Hi-Stretch Exterior paint and Asian Paints PU wood finish respectively. The R&D team also provide technological support and develop customised products for the company’s international operations spanning across 19 countries. The company is also in the process of setting up new a new R&D centre near Mumbai (India). INTERNATIONAL PRESENCE OF ASIAN PAINTS Today the Asian Paints group operates in 17 countries across the world. It hasmanufacturing facilities in each of these countries and is the largest paint company ineleven countries.
The group operates in five regions across the world viz. South Asia,South East Asia, South Pacific, Middle East and Caribbean region through the fivecorporate brands viz. Asian Paints, Berger International, SCIB Paints, Apco Coatingsand Taubmans. The Group operates as: ? Asian Paints in South Asia (India, Bangladesh, Nepal and Sri Lanka) ? SCIB Paints in Egypt ?Berger in South East Asia (Singapore), Middle East (UAE, Bahrain and Oman),Caribbean (Jamaica, Barbados, Trinidad & Tobago) ? Apco Coatings in South Pacific (Fiji, Tonga, Solomon Islands and Vanuatu) ? Taubmansin South Pacific (Fiji and Samoa)
COMPETITORS OF ASIAN PAINTS JOINT VENTURE AsianPPG Industries Limited, a joint venture between Asian Paints (India) Limited and PPG Industries, Inc. USA with 50:50 equity sharing was established in February 1997 with the objective of providing solutions to the paint requirements of Indian Automobile manufacturers. The joint venture brought together two leading companies with strengths in technology, manufacturing and customer insight. PPG Industries s a $11 billion manufacturer of coatings, chemicals and glass. It is the world leader in automotive and industrial coatings.
Coatings businesses constitute 56% of its turnover and PPG is the leading supplier to most automotive manufacturers in the world. PPG Industries is also a technology leader with patented technologies in the Cathodic Electro Deposition process. PPG also produces protective and decorative coatings, sealants, adhesives, metal pre-treatment products, flat glass, fabricated glass, continuous-strand fibre glass products and specialty chemicals. With headquarters in Pittsburgh, PPG has 108 manufacturing facilities. PORTERS 5 FORCES ANALYSIS OF ASIAN PAINTS
Threat from substitute products: •Price risk leads to high risk from substitute products. Threat from new entrants: •Low capital intensive & minimal government interference leads to low entry barrier. •Additional threat from foreign players setting up base in India. Bargaining power of suppliers: •Major raw material being crude based (constitutes 40-50% of total raw material cost) suppliers have more control over the prices. Bargaining power of customer: •Low bargaining power in the hands of the customers. Internal Market Environment: •Organized market controlled by 5-6 players. Market is seasonal in nature. •Imports are minimal due to high cost attached for formulae modification. •Product differentiation a key parameter for success. STRATEGIC FEATURES OF ITS MARKET LEADING POSITION ?Comprehensive product portfolio across segments and price points: Asian Paints has the most comprehensive product portfolio across price points. It is a leader across all the segments of decorative paints e. g. Exterior Emulsions, Interior Emulsions (water-based paints), Enamels (solvent-based paints), Wood Finishes and Distempers. Presence across the price points nables it to capture any up/down trading and retain the consumer in its folds. ?Strong distribution reach: strong competitive advantage Asian Paints has the largest distribution footprint, with nearly 23,000 dealers (more than 15,000 ‘Colour World’ outlets) spread across the length and breadth of the country. It is pertinent to note that paints category, unlike consumer staples, doesn’t have distributors and stockists structure of distribution. Companies need to have direct supply chain engagement with dealers owing to the complexity of the storage and transportation of paints.
It has bestowed significant competitive advantage to Asian Paints owing to its long relationships with paint dealers. This acts as an entry barrier for the existing players as well as those looking at increasing penetration. ?Robust pricing power: Asian Paints is the pricing leader in the Indian Paints industry. Nearly 75% of its revenues accrue from Decorative paints, where pricing power is superior compared to Industrial paints. In Industrial paints, pricing power is limited, given the bargaining power of buyers. Strong brand equity of Asian Paints also helps in sustaining the pricing power.
Over the years, Asian Paints has been able to maintain volume growth in double digits, despite taking necessary price increases to pass on the input cost inflation. ?Innovation in product offerings and marketing strategies: Asian Paints’ ability to innovate product offering has been well complimented by its marketing strategies and desire to establish deeper consumer connect. Asian Paints is credited for introducing many innovative concepts in the Indian Paints industry. Some examples are as follows: oColour World (Tinting Machines) oSignature Stores oSmall Packs Home Solutions (painting solution service) oSpecial Effects/Textured paints oColour Next (prediction of Colour Trends) oColour Ideas Stores Today,”Colour World” outlets stand at 14,600. Essentially, a Colour World outlet has a tinting machine which costs Rs2. 5 lakhs and is paid for by the distributor. It requires a dealer to stock base paint and provides shades by mixing the base paint with various pigments. It reduces the inventory investment by distributor as it doesn’t need to carry host of SKUs. Also, it reduces space cost incurred by the distributor.
As for customer, it provides various shades on the screen; thus, expanding the range of offerings. It also eases the complexity in the entire supply chain as the distributor now has to carry fewer SKUs. Colour World and other such initiatives have helped in increasing the customer participation in the buying process and also strengthens the customer connect of Asian Paints, while enhancing the brand equity. ASIAN PAINTS FUTURE GROWTH STRATEGY ?Sales and distribution has always been a major strategic advantage for the company.
Company has huge distribution network as compared to any other paints manufacturing company. The expenses over advertisements have also been increased from 18% in 2003 to 21% in 2008. ?Apart from this company is increasing its capacity by setting up plants in Haryana and Maharashtra. No other company is planning to increase its capacity in near future hence Asian paints will have a competitive advantage in terms of pricing and it will further support its efficient distribution network. ?Company is targeting the rural market as it has considerable potential.
Now since setting up infrastructure for that is a costly affair, only top players can actually participate. Hence, Asian paints will have an advantage over other firms and will enjoy lesser competition. Company considers the development of technical capabilities to sustain its competitive position in the market place of primary importance. In order to address the needs of the customers in a rapidly changing market place, the Company will continue to strengthen its technical programs and the skills of its technical personnel.
It had started to develop advanced technical capabilities and technology platforms to support its product plans, improve its manufacturing and open new applications. These activities are beginning to pay off. ACCOUNTING ANALYSIS OF ASIAN PAINTS The company prepares the financial statements in accordance with the accounting policy generally accepted in India and complies with the Accounting Standards specified by the Institute of Chartered Accountants of India. On checking with the auditor’s report the following information could e collected regarding the accounting policy followed by the company – •The Company follows accrual basis of accounting. By using accruals, a company can measure what it owes looking forward and what cash revenue it expects to receive. It also allows a company to show assets that do not have a cash value, such as goodwill •The Company follows straight line method for depreciating its assets. The assets have been subdivided under different assets head and the minimum depreciation has been charged as per schedule XIV of the companies Act, 1956.
It has a regular programme of physical verification of its fixed assets by which all the fixed assets are verified in a phased manner, over a period of 3 years. This periodicity of physical verification is reasonable, having regard to the size of the Company and the nature of its assets. •The company has leased tinting systems to operational dealers. This was necessary in order to expand its operation base. By providing the lease the company has increased its sales and distribution network. •According to the auditors Fixed assets disposed off during the year were not substantial and therefore do not affect the going concern assumption. The Companies revenue from sale of goods is recognized on transfer of all significant risks and rewards of ownership to the buyer which is on dispatch of goods. •Raw materials, work in progress, finished goods, packing materials, stores, spares, traded items and consumables are carried at the lower of cost and net realizable value. The comparison of cost and net realizable value is made on an item-by-item basis. Damaged, unserviceable and inert stocks are suitably depreciated. •In determining cost of raw materials, packing materials, traded items, stores, spares and consumables, weighted average cost method is used.
Cost of inventory comprises all costs of purchase, duties, taxes (other than those subsequently recoverable from tax authorities) and all other costs incurred in bringing the inventory to their present location and condition. •Cost of finished goods and work-in-process includes the cost of raw materials, packing materials, an appropriate share of fixed and variable production overheads, excise duty as applicable and other costs incurred in bringing the inventories to their present location and condition.
Fixed production overheads are allocated on the basis of normal capacity of production facilities. •According to the information and explanations given to the auditors, the transactions made in pursuance of contracts and arrangements above and exceeding the value of Rs 5 lakh with any party during the year have been made at prices which are reasonable having regard to the prevailing market prices at the relevant time. The company allows reduction in misappropriation of funds as well gets a fair valuation regarding the difference in margins due to fluctuation in raw material prices. Profit and loss on sale of investments is determined on a first-in-first-out (FIFO) basis. •Sundry debtors are stated after writing off debts considered as bad. Adequate provision is made for debts considered doubtful. Discounts due, yet to be quantified at the customer level are included under the head ‘Current Liabilities and Provisions’. •Short Term Employee Benefits:All employee benefits payable wholly within twelve months of rendering the service are classified as short term employee benefits and they are recognized in the period in which the employee renders the related service.
The Company recognizes the undiscounted amount of short term employee benefits expected to be paid in exchange for services rendered as a liability (accrued expense) after deducting any amount already paid. •Defined contribution plans – Defined contribution plans are Provident Fund scheme, employee state insurance scheme andGovernment administered Pension Fund scheme for all employees and superannuation schemefor eligible employees. The Company’s contributions to defined contribution plans are recognizedin the Profit and Loss Account in the financial year to which they relate.
The Company makes specified monthly contributions towards employee provident fund to aTrust administered by the Company. The interest payable by the trust to the beneficiaries everyyear is being notified by the Government. The Company has an obligation to make good theshortfall, if any, between the return on investments of the trust and the notified interest rate. •The company provides three kinds of defined benefit plans for its employees – Defined benefit gratuity plan, Defined benefit pension plan, Defined Post Retirement Medical benefit plan.
The cost of providing defined benefits is determined using the Projected Unit Credit method with actuarial valuations being carried out at each Balance Sheet date. Past service cost is recognised immediately to the extent that the benefits are already vested, else is amortised on a straight-line basis over the average period until the amended benefits become vested. The defined benefit obligations recognised in the Balance sheet represents the present value of the defined enefit obligation as adjusted for unrecognised actuarial gains and losses and unrecognised past service costs, and as reduced by the fair value of plan assets, if applicable. Any defined benefit asset (negative defined benefit obligations resulting from this calculation) is recognised representing the unrecognised past service cost plus the present value of available refunds and reductions in future contributions to the plan. •Other long term employee benefits – Entitlements to annual leave and sick leave are recognised when they accrue to employees.
Sick leave can only be availed while annual leave can either be availed or encashed subject to a restriction on the maximum number of accumulation of leave. The Company determines the liability for such accumulated leaves using the Projected Accrued Benefit method with actuarial valuations being carried out at each Balance Sheet date. •Capital expenditure is shown separately under respective heads of fixed assets. •Revenue expenses including depreciation are charged to Profit and Loss account under the respective heads of expenses. The company has not accepted any deposits from the public. •The Company has neither issued any debentures nor raised any money by public issues during the year. •The Company has not made any preferential allotment of shares to company, firms or parties covered in the register maintained under section301 of the Companies Act, 1956 during the year. •The Company has not granted any loans and advances on the basis of security by way of pledge of shares, debentures and other securities in the year 2009 -10. The Company has neither granted nor taken any loans, secured or unsecured, to or from companies, firms or other parties covered in the register required to be maintained under Section 301 of the Companies Act,1956. •The Company has neither defaulted in repayment of dues to its bankers or to any financial institution in the given past nor did the Company have any outstanding debentures or any outstanding loans from financial institutions. The Company does not have any accumulated losses at the end of the financial year and has not incurred cash losses in the current financial year and in the immediately preceding financial year. •According to the information and explanations given to the auditor’s, amounts deducted/accrued in the books of account in respect of undisputed statutory dues including Provident Fund, Employees’ State Insurance, Investor Education and Protection Fund, Income-tax, Sales-tax, Wealth tax,
Service tax, Customs duty, Excise duty, Cess and other material statutory dues have been generally regularly deposited during the year by the Company with the appropriate authorities. •There were no dues on account of Cess under Section 441A of the Companies Act, 1956 since the date from which the aforesaid section comes into force has not yet been notified by the Central Government. •The following dues have not been deposited by the Company on account of disputes. Sales tax assessment due – Rs. 16. 30 crore Central Dispute – Rs. 1. 23 crore
Income Tax Disputes – Rs. 11. 29 crore •The Company has given certain guarantees on behalf of its dealers and subsidiaries as mentioned in note B – 3 of Schedule M of the accounts. The guarantees on behalf of the dealers and subsidiaries help it to increase its relationship with the dealers. •The Company did not have any term loans outstanding during the year. •The funds raised on short term basis have not been used for long term investment. The above points were gathered after analysing the balance sheet and going through the auditor’s report.
The fixed assets are depreciated in accordance with the Companies Acts, 1956. By following the Straight Line Method the company is able to reduce complexity and also balance out the depreciation cost throughout the machines life. The leasing of tinting systems to vendor is carefully monitored and no defaults have been reported for the past few years. The revenue is calculated on accrual basis after transfer of all the risk hence reducing the risk of bad debts. The investments sales are valued under FIFO method allowing a proper estimation and valuation regarding the return from the investment.
The employee benefits are handled beautifully by the company the benefits valuation is done on the accrual accounting basis and the benefits if not calculated are amortized over the next few years under straight line method. The company did not issue any shares, debentures, loans neither did it take any. This highlights the fact that the company is self financed and has achieved the desired capital structure. The company cleared all its dues except for the ones in dispute. No short term loans were outstanding and the short term loans were not misused.
It can be seen that the information disclosed by the company to its shareholder is fairly transparent. The policies used by the company show that the company is being operated smoothly and the books of accounts show no signs of danger for the company in the future. FINANCIAL ANALYSIS OF ASIAN PAINTS Financial analysis of Asian Paints is done by comparing the financial ratios of last few years by analyzing its trends and also comparing it with its nearest competitor Nerolac Paints. S. No. RatiosAsian PaintsNerolac Paints 2006200720082009201020062007200820092010 1Return on capital employed49. 7449. 6857. 3249. 3562. 9427. 324. 4122. 918. 4826. 64 2ROA14. 5477. 5796. 8114. 1162. 3518. 53200. 05220. 33242. 87286. 8 3Gross Profit Margin15. 6615. 3514. 6211. 918. 1115. 9714. 1711. 238. 1612. 11 4Cash Profit Margin9. 4310. 6311. 529. 413. 4215. 8310. 8510. 958. 8211. 13 5Net Profit Margin7. 599. 1110. 287. 9714. 2912. 888. 2796. 589. 04 6Current Ratio1. 081. 090. 991. 130. 891. 612. 141. 881. 531. 3 7Quick Ratio0. 550. 60. 470. 590. 380. 931. 331. 160. 990. 79 8Interest Cover90. 2241. 1669. 7355. 0474. 27180. 74157. 85112. 6875. 24196. 02 9Inventory Turnover Ratio7. 096. 888. 039. 87. 956. 047. 219. 1110. 088. 17 10Debtors Turnover Ratio14. 514. 0314. 7416. 0216. 718. 537. 66. 4778. 21 11Investment Turnover Ratio8. 88. 278. 039. 87. 957. 188. 539. 1110. 088. 17 12Dividend Payout Ratio Net Profit72. 7952. 3650. 8454. 1939. 0341. 9232. 8631. 5838. 3728. 47 1. Return on Capital Employed : Return on capital employed is continuously increasing over the last 5 years for Asian paints from 49. 74 % in 2006 to 62. 94 % in 2010 which shows the company’s profit is continuously increasing. In case of Nerolac paints ROCE is decreasing. It was 27. 33 % in 2006 which fell to 18. 48 % in 2009. This shows that Asian paints is earning more profit than Nerolac paints. 2.
Gross Profit Margin: Gross profit margin of Asian paints was 15. 66 in 2006 which increased to 18. 11 in 2010 which reflects the increasing efficiency of the company while its nearest competitor Nerolac paints whose gross profit margins are decreasing since 2006(15. 97 in 2006 to 12. 11 2010). 3. Cash Profit Margin: Cash profit margin is also increasing for Asian paints continuously since 2006. This reflects that company is selling more on cash than credit which is a good sign. This ratio is decreasing for Nerolacpaints which shows that Nerolac is selling more on credit sales than on cash which is not a healthy indication. 4.
Net profit margin: This ratio for Asian paints was 7. 59 in 2006 which increases to 14. 29 in 2010 which is a good trend as it shows that company’s profit margins are increasing at a faster pace than its sales. This ratio has decreased for Nerolac paints since 2006 which improved a bit in 2010 which clearly shows that while the sales of Nerolac paints is increasing, the profit margins are not increasing at same pace. 5. Current Ratio: Current ratio is more or less stable for Asian paints in last five years which is hovering around 1 while the current ratio for Nerolac paints is higher which went above 2 in 2007 but came back to 1. in 2010. This ratio indicates that Nerolac has better ability to pay back its short –term liabilities from short-term assets as compared to Asian paints. 6. Quick Ratio: This ratio indicates that how quickly company can pay its short term liabilities as it excludes inventory from the current assets because sometimes company cannot convert its inventory into cash immediately. This is a better way to measure the company’s ability to pay its short-term liabilities. This ratio is almost same for Asian paints which is around 0. 5 since 2006 while it is higher for Nerolac paints which is more than 1.
So, Nerolac paints is in better position than Asian paints to pay-off its short-term liabilities with its short-term assets. 7. Interest Coverage Ratio: This ratio is an indicator of how easily a company can pay its interest expense from earnings. Asian paints has shown a random trend in this ratio but still it is very high which shows that company is in substantial position to pay its interest expenses. Nerolachas higher ratio for interest coverage than Asian paints, but both the companies are in a very good position to pay their interests as they have less amount of debt so their interest expenses are vey less and this ratio is very good. . Inventory turnover ratio: This ratio almost follows same trend for both the companies and the difference is also not substantial in the absolute values for them. This shows that both the companies are following the similar inventory carrying period proportionate to sales. 9. Debtors Turnover Ratio: This ratio tells us about the conversion of debtors into cash. So higher the ratio, better it is. Asian paints had a ratio of 14. 65 in 2006 which increased to 16. 71 in 2010 which is a good trend while for Nerolac’s ratio has decreased marginally from 8. 3in 2006 to 7 in 2009 which came back to 8. 21 in 2010. This observation tells us that Asian paints is more efficient than Nerolac paints in converting its debtors into cash. 10. Investment Turnover Ratio: This ratio is more or less same for both the companies which shows that they are at par with generating their returns on the investments made by them. 11. Dividend Payout Ratio: Asian paints has a high dividend payout ratio which has decreased over the years but in absolute terms, it is still quite high while it is less for Nerolac paints and has also has shown decreasing trend.
This observation shows that Asian paints has a very good income/profitability over the years by which they have been able to maintain such a high dividend payout ratio. PROSPECTIVE ANALYSIS OF ASIAN PAINTS Prospective Analysis which forecasts a firm’s future is the final step in business analysis. Financial statements forecasting and valuation are two of the most commonly used techniques in prospective analysis. Synthesis of the insights from prospective analysis along with the insights from business strategy analysis, accounting analysis, and financial analysis will help to determine a firm’s future.
These predictions are in turn useful to variety of parties and can be applied in various contexts. Forecasting represents the first step of prospective analysis and serves to summarize the forward-looking view that emanates from all the other three forms of analysis i. e. business strategy, accounting and financial analysis. The forecasting process helps to create an understanding as to how various financial statistics tend to behave on an average, and what might cause a firm to deviate from that average. Usually, few key projections such as sales growth and profit margin drive most of the projected numbers.
In case of Asian paints, we believe that the sales of the company will grow by just about 20% looking at the strong demand in the market. This demand in the market can be attributed to the gradual recovery of the automobile as well as real estate sector. Because of the recovery seen in these sectors, the demand for decorative & industrial paints has shown a gradual increase. However, the profit margins would be affected by an increase in the product prices so as to negate the rising crude oil prices & other inflationary pressures. Therefore, growth rate expectation of 20% for Asian paints appears to be quite reasonable.
These forecasts are then converted into value estimates. This process is known as valuation. There are various valuation techniques with each of them having some advantages as well as some disadvantages. There is no single technique which clearly dominates the other. In order to carry out valuation of Asian Paints, we have used two types of valuation methods: Discounted Cash Flow Method and Price Earnings Multiple Valuation method. Discounted Cash Flow Model This valuation method based on free cash flow is considered a strong tool because it concentrates on cash generation potential of a business.
This valuation method uses the future free cash flow of the company (meeting all the liabilities) discounted by the firm’s weighted average cost of capital (the average cost of all the capital used in the business, including debt and equity), plus a risk factor measured by beta. Forecasts made in the DCF model may have a considerable impact on the valuation. Following are some of the forecasts and assumptions made in this model: ? Projections of the future sales have been made based on the historical values. Asian Paints has been experiencing a CAGR of 20% over the past 5 years.
Therefore, we have estimated that the sales of Asian paints will grow by 19. 86% in the subsequent years. ?As far as depreciation is concerned, we looked at historical depreciation in relation to sales and used an average from these yearsso as to use it in the projection period. In this case, we used 0. 41% of sales. ?Since capital expenditures that the company will have in the future is quite difficult to estimate, therefore, we will use an average of the last five years in relation to sales. In our example the capexhas consistently increased since the year 2007.
We decided to usecapex as 5. 2% of sales. ?Net Working Capital can be calculated by taking the difference between the total current assets and total current liabilities. The projections of total current assets and total current liabilities are carried out by using the average value as the % of sales over the past five years. ?Net change in working capital is the difference in working capital levels from one year to the next. When more cash is tied up in working capital than the previous year, the increase in working capital is treated as a cost against free cash flow. After adding or subtracting the net change in working capital from the cash flow, we finally obtain free cash flow for every year in the projection period. Discounted Cash Flow Model (Rs. in Crores)Actual PeriodC. A. G. R (%)Forecast Period 200620072008200920102011E2012E Sales2,807. 063,389. 794,092. 365,042. 405,794. 0919. 866,944. 808324. 03 % growth20. 7620. 7323. 2114. 9119. 8619. 86 Total Costs2,080. 272,588. 593,059. 943,916. 804,465. 5921. 045278. 056326. 26 % Sales74. 1176. 3674. 7777. 6877. 0776. 0076. 00 EBITDA726. 79801. 201,032. 421,125. 601,328. 5016. 281666. 751997. 77 % margin25. 8923. 6425. 2322. 3222. 932424 Depreciation14. 615. 214. 8315. 7522. 5410. 7928. 4734. 13 % sales0. 530. 450. 360. 310. 390. 410. 41 EBIT711. 83786. 001,017. 591,109. 851,305. 9616. 381638. 281963. 64 Taxes82. 5997. 8484. 0872. 8792. 54150. 56180. 46 (%)11. 6012. 458. 266. 577. 099. 199. 19 CapEx86. 7281. 94308. 04310. 04395. 3361. 13432. 85 % sales3. 092. 427. 536. 156. 825. 25. 2 Total Current Assets562. 07712. 5832. 2985. 781,123. 151393. 131669. 80 % sales20. 0221. 0220. 3419. 5519. 3820. 0620. 06 Total Current Liabilities489. 11649850. 79849. 081,229. 041325. 071588. 23 % sales17. 4219. 1520. 7916. 8421. 2119. 0819. 08 Net Working Capital72. 9663. 5-18. 59136. 7-105. 8968. 0681. 8 % sales2. 601. 87-0. 452. 71-1. 830. 980. 98 Increase/(Decrease) in NWC(9. 46)(82. 09)155. 29(242. 59)173. 9513. 52 Unlevered Free Cash Flow615. 68707. 56571. 651,060. 71952. 641336. 81 After having calculated the free cash flows for the future years, we will now calculate the discount rate so as to determine the present value of these cash flows. Weighted Average Cost of Capital will be the discount rate with the help of which we will discount all the future cash flows. It is essentially a blend of cost of equity and cost of debt. Cost of equity is basically what it costs the company to maintain a share price that is satisfactory.
It has been calculated using CAPM model which is one of the most common methods to find the cost of equity. According to CAPM model, Cost of Equity (Re) = Rf + Beta (Rm-Rf). Rf – Risk-Free Rate – This is the amount obtained from investing in securities considered free from credit risk, such as government bonds from developed countries. We have taken Rf as 6. 9% which is the value of the interest rate of the government securities in India. ? – Beta – This measures how much a company’s share price moves against the market as a whole. The value of Beta for Asian Paints is 0. 3261. Rm – Rf) = Equity Market Risk Premium -represents the returns investors expect, over and above the risk-free rate, to compensate them for taking extra risk by investing in the stock market. In other words, it is the difference between the risk-free rate and the market rate. Rm in case of Asian paints is about 13. 5%. Thus, the Equity Market Risk Premium would be (13. 5% -6. 9%) = 6. 1%. By substituting all these values in the CAPM model, we get the Cost of Equity= 9. 05%. Cost of Debt – The rate applied to determine the cost of debt (Rd) is the current market rate the company is paying on its debt.
In case of Asian Paints, we have used the current year’s interest expense (Rs. 19. 10 Cr), total debt (Rs. 66. 29 Cr) and tax rate of 9% in order to calculate the after-tax cost of debt. After dividing the interest expense by total debt and multiplying it by (1-tax rate), we obtain the After-Tax Cost of Debt = 26. 22%. WACC is the weighted average of the cost of equity and the cost of debt based on the proportion of debt and equity in the company’s capital structure. The total value (equity + debt) of the company (V) = Rs. 1623. 51 Cr. , out of which total debt (D) is equal to Rs. 66. 29 Cr. and total equity (E) is equal to Rs. 1557. 2 Cr. Therefore, WACC = (D/V) * Cost of Debt + (E/V) *Cost of Equity. Substituting all the values, we get, WACC of Asian Paints = 9. 75% Having estimated the free cash flow produced over future period, we need to determine the terminal value of the company. It is determined using the Gordon Growth Model. The formula for calculating terminal value is as follows: Terminal Value = Final Projected Year Cash Flow X (1+Long-Term Cash Flow Growth Rate) (Discount Rate – Long-Term Cash Flow Growth Rate) From the table, we can observe that the final year projected cash flow(year 2012) is Rs. 336. 81 Cr. The discount rate is the WACC of the company i. e. 9. 75% whereas the long term cash flow growth rate is perpetuity growth rate which has been taken by us as the rate at which the economy is expected to grow. Considering the growth rate to be 6%, which is a conservative estimate, and substituting all other values in the formulae, terminal value of Asian Paints comes out to be Rs. 37787 Cr. After determining the terminal value, one must find out the enterprise value of the company.
In order to find it, one has to calculate the present value of all the future cash flows including the terminal value, divide them by the discount rate (WACC) and finally add up the results. EV of Asian Paints = (Rs. 952. 64 Cr/1. 0975) + (Rs. 1336. 81 Cr/(1. 0975)2) + (Rs. 37787. 16 Cr/(1. 0975)2) = Rs. 33349. 35 Cr Therefore the total Enterprise Value for Asian paints comes out to be Rs. 33,349. 35 Crores. Asian Paints Rs. 33349. 35 Cr enterprise value includes the company’s debt. As equity investors, we are interested in the value of the company’s shares alone.
Therefore, to come up with a fair value of the company’s equity, we must deduct debt from this value. Fair Value of Asian Paints = Enterprise Value – Debt + Cash or cash equivalents Fair Value of Asian Paints = Rs. 33349. 35 Cr – Rs. 66. 29 Cr + Rs. 28. 58 Cr = Rs. 33311. 64 Cr. After completing the DCF Valuation, we can judge the merits of buying Asian Paints shares. If we divide the fair value by the number of Asian Paints shares outstanding i. e. 9. 592 Crores, we get a fair value for the company’s shares. Therefore, Fair value of the Asian Paints share = Fair value of Asian Paints / No. f shares outstanding = Rs. 33311. 64 Crores / 9. 592 Crores Fair value of the Asian Paints share = Rs. 3472. 86 Current Market Price of Asian Paints share = Rs. 2808. 50 Since, the shares are trading currently at a lower value as compared to the fair value , they could represent a “BUYING” opportunity for investors. PRICE-EARNINGS MULTIPLE VALUATION METHOD The price-earnings ration (P/E) is simply the price of a company’s share of common stock in the public market divided by its earnings per share. By multiplying this P/E multiple by the net income, the value for the business could be determined.
Following is the data of the Earnings per Share of Asian Paints from June, 2009 to March, 2010: YearEPS June, 2009Rs. 17. 14 Sept. , 2009Rs. 26. 51 Dec. , 2009Rs. 18. 63 March. , 2010Rs. 18. 46 As we can observe from this table, Earnings per Share have grown by 2. 22% over one year. Earnings per share for the year 2010 = Net income for the year 2010 / No. of shares outstanding = Rs. 774. 5 Crores / 9. 592 Crores Earnings per share for the year 2010 = Rs. 80. 74 Now the price of the share as on 3rd of September, 2010 = Rs. 808. 50 Therefore, PE multiple = Current Market Price / EPS of the year 2010 = 2808. 50 / 80. 74 = 34. 78 Following is the data of the Earnings per Share from June, 2010 to March, 2011 including the forecasts for few quarters starting from September, 2010. YearEPS June, 2010Rs. 20. 95 Sept. , 2010 (E)Rs. 32. 40 Dec. , 2010 (E)Rs. 22. 77 March, 2011 (E)Rs. 22. 56 Thus, we get the expected EPS for the year 2010-2011 = Rs. 98. 67, Multiplying the PE multiple with the Expected EPS for the year 2010-11, we can determine the target value per share.
In case of Asian Paints, PE multiple = 34. 2&expected EPS = Rs. 98. 67. Therefore, Target price = PE multiple X Expected EPS = 3432. 79 Thus, the target price per share of Asian Paints = Rs. 3432. 79 Since, the shares are trading currently at a lower value i. e. Rs. 2808. 50 as compared to the target value; we would recommend the investors to “BUY” the shares of Asian paints as they seem to be a good bet. REFERENCES •CAPITALINE software •www. moneycontrol. com •www. investopedia. com •www. asianpaints. com •Book: Business Analysis and Valuation using Financial Statements- by Palepu, Healy, Bernard