Financial Analysis on ITC Group

Submitted to Prof. D.V Ramana

Submitted by

Mani Tiwari (25) Mayank Agarwal (26) Medisetty Srikanth (27)

Table of Contents –

1. Executive Summary…………………….042. Environmental Analysis………………...053. The Indian FMCG Industry……………..074. Company Overview…………………….105. FSA: ITC Limited………………………126. FSA: Inter Company Analysis………….287. Du-Pont Analysis……………………….428. Economic Value Addition………………449. Accounting Policies……………………..4610. Appendix………………………………..50

ACKNOWLEDGEMENT

“There is joy in work. There is no happiness except in the realization that we have accomplished something”

-Henry Ford

The making of any project requires contribution from many people, right from inception till its completion. In our case also, there had been a few people who have made this happen. It was not only learning but also an enriching experience.

We would like to thank Prof. Ramana for explaining the concepts of Financial Accounting to us, for being a source of inspiration and for the valuable suggestions provided throughout. His constant follow-ups and result orientation ensured that we successfully meet the deadlines.

The making of any project requires contribution from many people, right from inception till its completion. In our case also, there had been a few people who have made this happen. It was not only learning but also an enriching experience. We thank our colleagues and friends for providing constant encouragement and help. Finally, we are grateful to our families for their moral support and understanding.

“Teachers open the door, but you must enter by yourself”

- Chinese Proverb

1. Executive Summary

The project assigned to us was to study the financial health of any organization in the country. We decided to choose one of India’s biggest companies in a sector that has rapidly grown over the last few years and a company where leaders like Mr. Y.C. Deweshwar are made, or rather, a company that has been made my Mr. Deweshwar.

Through this report, we try and analyze the environment in which ITC Limited is operating.

Through a thorough environment, industry and company analysis, we aim to understand the external factors influencing the company and its decision making. Later, we try and evaluate the various ratios to appreciate their impact on company’s performance over the last three years.

A Dupont analysis is also done to check the credibility of company as per shareholders, financial analysts and other mutual funds.

The financial statements of last three years are identified, studied and interpreted in light of company’s performance. Critical decisions of distributing dividends, Issue of bonus Debentures and other current news are analyzed and their impact on the bottom line of the company is assessed.

As a benchmark, we also analyze various components of the company vis-à-vis other competitors in the same segment.

Finally, we also study the accounting policy of the company is also studied with respect to valuation of Fixed Assets, Inventory, Investments and Employee related liabilities to end with the amount of Economic Value Added by the players in that segment for the FY 2007.

2. Environmental AnalysisWell-established distribution networks, intense competition between the organized and unorganized segments characterize the FMGC sector.

It is expected to grow by over 60% by 2010. That will translate into an annual growth of 10% over a 5-year period. It has been estimated that FMCG sector will rise from around Rs 56,500 crores in 2005 to Rs 92,100 crores in 2010.

Hair care, household care, male grooming, female hygiene, and the chocolates and confectionery categories are estimated to be the fastest growing segments, says an HSBC report. Though the sector witnessed a slower growth in 2002-2004, it has been able to make a fine recovery since then. For example, Indian Tobacco Company Limited (ITC) has shown a healthy growth in the last quarter. An estimated double-digit growth over the next few years shows that the good times are likely to continue.

Growth Prospects

With the presence of 12.2% of the world population in the villages of India, the Indian rural FMCG market is something no one can overlook. Increased focus on farm sector will boost rural incomes, hence providing better growth prospects to the FMCG companies.

Better infrastructure facilities will improve their supply chain. FMCG sector is also likely to benefit from growing demand in the market. Because of the low per capita consumption for almost all the products in the country, FMCG companies have immense possibilities for growth. And if the companies are able to change the mindset of the consumers, i.e. if they are able to take the consumers to branded products and offer new generation products, they would be able to generate higher growth in the near future. It is expected that the rural income will rise in 2007, boosting purchasing power in the countryside.

However, the demand in urban areas would be the key growth driver over the long term. Also, increase in the urban population, along with increase in income levels and the availability of new categories, would help the urban areas maintain their position in terms of consumption.

At present, urban India accounts for 66% of total FMCG consumption, with rural India accounting for the remaining 34%. However, rural India accounts for more than 40% consumption in major FMCG categories such as personal care, fabric care, and hot beverages. In urban areas, home and personal care category, including skin care, household care and feminine hygiene, will keep growing at relatively attractive rates. Within the foods segment, it is estimated that processed foods, bakery, and dairy are long-term growth categories in both rural and urban areas.

The following factors make India a competitive player in FMCG sector:

Availability of raw materials

Because of the diverse agro-climatic conditions in India, there is a large raw material base suitable for food processing industries. India is the largest producer of livestock, milk, sugarcane, coconut, spices and cashew and is the second largest producer of rice, wheat and fruits &vegetables. India also produces caustic soda and soda ash, which are required for the production of soaps and detergents. The availability of these raw materials gives India the location advantage.

Low cost labor

Low cost labor gives India a competitive advantage. India's labor cost is amongst the lowest in the world, after China & Indonesia. Low labor costs give the advantage of low cost of production. Many MNC's have established their plants in India to outsource for domestic and export markets.

Presence across value chain

Indian companies have their presence across the value chain of FMCG sector, right from the supply of raw materials to packaged goods in the food-processing sector. This brings India a more cost competitive advantage

3. The Indian FMCG Industry

The Indian FMCG sector is the fourth largest in the economy and has a market size of US$13.1 billion. Well-established distribution networks, as well as intense competition between the organised and unorganised segments are the characteristics of this sector. FMCG in India has a strong and competitive MNC presence across the entire value chain. It has been predicted that the FMCG market will reach to US$ 33.4 billion in 2015 from US $ billion 11.6 in 2003. The middle class and the rural segments of the Indian population are the most promising market for FMCG, and give brand makers the opportunity to convert them to branded products. Most of the product categories like jams, toothpaste, skin care, shampoos, etc, in India, have low per capita consumption as well as low penetration level, but the potential for growth is huge.

The Indian Economy is surging ahead by leaps and bounds, keeping pace with rapid urbanization, increased literacy levels, and rising per capita income.

The big firms are growing bigger and small-time companies are catching up as well. 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 Lever. Pepsi is at number three followed by Thums Up. Britannia takes the fifth place, followed by Colgate (6), Nirma (7), Coca-Cola (8) and Parle (9). These are figures the soft drink and cigarette companies have always shied away from revealing. Personal care, cigarettes, and soft drinks are the three biggest categories in FMCG. Between them, they account for 35 of the top 100 brands.

THE TOP 10 COMPANIES IN FMCG SECTOR

1. Hindustan Unilever Ltd.2. ITC (Indian Tobacco Company)3. Nestle India4. GCMMF (AMUL)5. Dabur India6. Asian Paints (India)7. Cadbury India8. Britannia Industries9. Procter & Gamble Hygiene and Health Care10. Marico Industries

The companies mentioned are the leaders in their respective sectors. The personal care category has the largest number of brands, i.e., 21, inclusive of Lux, Lifebuoy, Fair and Lovely, Vicks, and Ponds. There are 11 HLL brands in the 21, aggregating Rs. 3,799 crore or 54% of the personal care category. Cigarettes account for 17% of the top 100

FMCG sales, and just below the personal care category. ITC alone accounts for 60% volume market share and 70% by value of all filter cigarettes in India.

The foods category in FMCG is gaining popularity with a swing of launches by HLL, ITC, Godrej, and others. This category has 18 major brands, aggregating Rs. 4,637 crore. Nestle and Amul slug it out in the powders segment. The food category has also seen innovations like softies in ice creams, chapattis by HLL, ready to eat rice by HLL and pizzas by both GCMMF and Godrej Pillsbury. This category seems to have faster development than the stagnating personal care category. Amul, India's largest foods company, has a good presence in the food category with its ice-creams, curd, milk, butter, cheese, and so on. Britannia also ranks in the top 100 FMCG brands, dominates the biscuits category and has launched a series of products at various prices.

In the household care category (like mosquito repellents), Godrej and Reckitt are two players. Goodknight from Godrej, is worth above Rs 217 crore, followed by Reckitt's Mortein at Rs 149 crore. In the shampoo category, HLL's Clinic and Sunsilk make it to the top 100, although P&G's Head and Shoulders and Pantene are also trying hard to be positioned on top. Clinic is nearly double the size of Sunsilk.

Dabur is among the top five FMCG companies in India and is a herbal specialist. With a turnover of Rs. 19 billion (approx. US$ 420 million) in 2005-2006, Dabur has brands like Dabur Amla, Dabur Chyawanprash, Vatika, Hajmola and Real. Asian Paints is enjoying a formidable presence in the Indian sub-continent, Southeast Asia, Far East, Middle East, South Pacific, Caribbean, Africa and Europe. Asian Paints is India's largest paint company, with a turnover of Rs.22.6 billion (around USD 513 million). Forbes Global magazine, USA, ranked Asian Paints among the 200 Best Small Companies in the World

Cadbury India is the market leader in the chocolate confectionery market with a 70% market share and is ranked number two in the total food drinks market. Its popular brands include Cadbury's Dairy Milk, 5 Star, Eclairs, and Gems. The Rs.15.6 billion (USD 380 Million) Marico is a leading Indian group in consumer products and services in the Global Beauty and Wellness space.

There is a huge growth potential for all the FMCG companies as the per capita consumption of almost all products in the country is amongst the lowest in the world. Again the demand or prospect could be increased further if these companies can change the consumer's mindset and offer new generation products. Earlier, Indian consumers were using non-branded apparel, but today, clothes of different brands are available and the same consumers are willing to pay more for branded quality clothes. It's the quality, promotion and innovation of products, which can drive many sectors.

Analysis of Indian FMCG Sector

Strengths:

1. Low operational costs2. Presence of established distribution networks in both urban and rural areas

3. Presence of well-known brands in FMCG sector

Weaknesses:

1. Lower scope of investing in technology and achieving economies of scale, especially in small sectors2. Low exports levels3. "Me-too" products, which illegally mimic the labels of the established brands. These products narrow the scope of FMCG products in rural and semi-urban market.

Opportunities:

1. Untapped rural market2. Rising income levels, i.e. increase in purchasing power of consumers3. Large domestic market- a population of over one billion.4. Export potential5. High consumer goods spending

Threats:

1. Removal of import restrictions resulting in replacing of domestic brands2. Slowdown in rural demand3. Tax and regulatory structure

The performance of the industry was inconsistent in terms of sales and growth for over 4 years. The investors in the sector were not gainers at par with other booming sectors. After two years of sinking performance of FMCG sector, the year 2005 has witnessed the FMCGs demand growing. Strong growth was seen across various segments in FY06. With the rise in disposable income and the economy in good health, the urban consumers continued with their shopping spree.

4. Company Overview: ITC GroupITC is one of India's foremost private sector companies with a market capitalization of nearly US $ 15 billion and a turnover of over US $ 4.75 billion. ITC is rated among the World's Best Big Companies, Asia's 'Fab 50' and the World's Most Reputable Companies by Forbes magazine, among India's Most Respected Companies by BusinessWorld and among India's Most Valuable Companies by Business Today. ITC also ranks among India's top 10 `Most Valuable (Company) Brands', in a study conducted by Brand Finance and published by the Economic Times. ITC has a diversified presence in Cigarettes, Hotels, Paperboards & Specialty Papers, Packaging, Agri-Business, Packaged Foods & Confectionery, Information Technology, Branded Apparel, Greeting Cards, Safety Matches and other FMCG products. While ITC is an outstanding market leader in its traditional businesses of Cigarettes, Hotels, Paperboards, Packaging and Agri-Exports, it is rapidly gaining market share even in its nascent businesses of Packaged Foods & Confectionery, Branded Apparel and Greeting Cards. As one of India's most valuable and respected corporations, ITC is widely perceived to be dedicatedly nation-oriented. Chairman Y C Deveshwar calls this source of inspiration "a commitment beyond the market". In his own words: "ITC believes that its aspiration to create enduring value for the nation provides the motive force to sustain growing shareholder value. ITC practises this philosophy by not only driving each of its businesses towards international competitiveness but by also consciously contributing to enhancing the competitiveness of the larger value chain of which it is a part." ITC's diversified status originates from its corporate strategy aimed at creating multiple drivers of growth anchored on its time-tested core competencies: unmatched distribution reach, superior brand-building capabilities, effective supply chain management and acknowledged service skills in hoteliering. Over time, the strategic forays into new businesses are expected to garner a significant share of these emerging high-growth markets in India. ITC's Agri-Business is one of India's largest exporters of agricultural products. ITC is one of the country's biggest foreign exchange earners (US $ 2.8 billion in the last decade). The Company's 'e-Choupal' initiative is enabling Indian agriculture significantly enhance its competitiveness by empowering Indian farmers through the power of the Internet. This transformational strategy, which has already become the subject matter of a case study at Harvard Business School, is expected to progressively create for ITC a huge rural distribution infrastructure, significantly enhancing the Company's marketing reach.

ITC's wholly owned Information Technology subsidiary, ITC Infotech India Limited, is aggressively pursuing emerging opportunities in providing end-to-end IT solutions, including e-enabled services and business process outsourcing.

ITC's production facilities and hotels have won numerous national and international awards for quality, productivity, safety and environment management systems. ITC was the first company in India to voluntarily seek a corporate governance rating. ITC employs over 21,000 people at more than 60 locations across India. The Company continuously endeavors to enhance its wealth generating capabilities in a globalizing

environment to consistently reward more than 4,46,000 shareholders, fulfill the aspirations of its stakeholders and meet societal expectations. This over-arching vision of the company is expressively captured in its corporate positioning statement: "Enduring Value. For the nation. For the Shareholder.”

5. Financial Statement Analysis: ITC Ltd.

1. Ratio Analysis

A) Liquidity Analysis

Working Capital: Higher the current assets of a company and lower the current liabilities, greater is the working capital. A larger chunk of working capital can be used to fund the long term liabilities of the company and therefore, the larger the working capital, the better it is for the company.

The following table gives the working capital of the three companies under consideration for the three year period.

Figure I

Working Capital

-15000.00

-10000.00

-5000.00

0.00

5000.00

10000.00

15000.00

20000.00

25000.00

30000.00

2004-05 2005-06 2006-07

Year

Wo

rkin

g C

apit

al

(In

Rs.

Mil

lio

n)

ITC Marico HLL

Working Capital Days: Working capital days is defined as the ratio of the working capital to the current liabilities of the company in any year.

For ITC Limited, the working capital shows more than a proportionate increase when compared to the current liabilities of the company across the three years’ of consideration. This therefore reflects in better liquidity of the company and is shown by the upward movement of the working capital ratio in the graph below.

Figure II

Working Capital Days

24540.51

5234.52

17051.91

44619.10

39655.60

34896.80

0.15

0.43

0.55

0.00

5000.00

10000.00

15000.00

20000.00

25000.00

30000.00

35000.00

40000.00

45000.00

50000.00

2004-05 2005-06 2006-07

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illi

on

0.00

0.10

0.20

0.30

0.40

0.50

0.60

Wo

rkin

g C

apit

al D

ays

Working Capital Current Liabilities Working Capital Days

Current Ratio: Current ratio is defined as an indicator of short-term debt paying ability of a company. It is determined by dividing current assets by current liabilities. The higher the ratio, it is believed that, the more liquid the company.

Here we observe that the current ratio of ITC is increasing over the three year period under consideration. This is evident from the graph given below.

Figure III

Current Ratio

44619.10

34896.8039655.60

69350.80

56561.40

40264.80

1.15

1.43 1.55

0.00

10000.00

20000.00

30000.00

40000.00

50000.00

60000.00

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80000.00

2004-05 2005-06 2006-07

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illi

on

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80C

urr

ent

Rat

io

Current Liabilities Current Assets Current Ratio

The reason why the ratio increases mainly is because of a more than proportionate increase of the Current Assets when compared to the Current Liabilities.

Liquidity Ratio: Liquidity Ratio also measures a firm’s ability to meet its short-term financial obligations on time. This is calculated by taking the ratio of the

current assets (less the Inventories held by the company.) The ratio is a better measure of liquidity of the company. The graph below shows the change in the same across the last three years.

Figure IV

Liquid Ratio

44619.10

34896.8039655.60

30004.10

25407.10

14834.00

0.43

0.640.67

0.00

5000.00

10000.00

15000.00

20000.00

25000.00

30000.00

35000.00

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2004-05 2005-06 2006-07

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on

0.00

0.10

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0.70

0.80

Liq

uid

Rat

io

Current Liabilities Current Assets (less Inventories) Liquid Ratio

The company has also shown an increasing trend in the liquidity ratio over the years. The current assets (less inventories) have again increased more than proportionately reflecting in an increasing liquidity ratio.

Absolute Cash Ratio: Another measure of the liquidity of the company, absolute cash ratio measures the ratio of the Cash and Near Cash items in the current assets to the current liabilities of the company.

According to the graph, the absolute cash ratio follows more or less the same trend as the other two liquidity measures. The increase again is because of a more than proportionate increase in the cash items (and near cash items) of ITC Limited.

Figure V

Absolute Cash Ratio

44619.10

34896.8039655.60

22755.74

19034.69

8724.20

0.25

0.48 0.51

0.00

5000.00

10000.00

15000.00

20000.00

25000.00

30000.00

35000.00

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45000.00

50000.00

2004-05 2005-06 2006-07

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In R

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on

0.00

0.10

0.20

0.30

0.40

0.50

0.60

Ab

solu

te C

ash

Rat

io

Current Liabilities Cash and Near Cash Items Absolute Cash Ratio

Inventory days: This measure is one part of the cash conversion cycle, which represents the process of turning raw materials into cash. The company possesses raw materials/finished goods as inventories that it can sell off to turn into cash. It is important to maintain inventories for a company but it is more important that the company maintains the level of it so that there is no liquidity crunch on the balance sheet.

The inventory days for ITC limited have fallen over the years. This is because even though the company has maintained a larger amount of Inventories at the end of every fiscal year so as to cater to the demand in the following years but the cost of goods sold of the company has gone up but more than proportionately when compared to the Inventories thereby resulting in decreasing Inventory days.

Figure VI

Inventory Days

39346.70

25430.80

31154.30

230.49177.07132.79

191.51

175.94

170.71

0.00

5000.00

10000.00

15000.00

20000.00

25000.00

30000.00

35000.00

40000.00

45000.00

2004-05 2005-06 2006-07

Year

In R

s. M

illi

on

160.00

165.00

170.00

175.00

180.00

185.00

190.00

195.00

Inve

nto

ry D

ays

Inventories COGS per day Inventory Days

Debtor Days: This calculation shows the average number of days it takes a company to receive payment from its debtors, the lower figure the better. A high figure suggests inefficiency or potential bad debts.

The graph below for the ITC group reflects a fall in the debtor days of the company. Though, over the period, the total debt to the company has shown an increase, the sales have risen more than proportionately reflecting in lesser credit given to buyers.

Figure VII

Debtor Days

7330.40

6209.40

6351.90

543.80452.41372.27

16.68

14.0413.48

0.00

1000.00

2000.00

3000.00

4000.00

5000.00

6000.00

7000.00

8000.00

2004-05 2005-06 2006-07

Year

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illi

on

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

Deb

tor

Day

s

Debtors Sales per day Debtor Days

Creditor Days: Creditor days is a similar measure to debtor days. It is the average time that a company takes to pay its creditors from whom it takes goods/raw materials on credit facility. Lengthening creditor days may mean that a company is heading for financial problems as it is failing to pay creditors, on the other hand it may mean that a company is simply getting better at getting good credit terms out of its suppliers.

ITC Group is doing well in terms of creditor days. The company pays off its debts at regular intervals and does not try to accumulate them that could lead to payment problems in the future. Though the amount of credit given to the company as increased over the years, the company has registered a higher growth rate in the sales per ay and therefore the cost of the goods sold.

Figure VIII

Creditor Days

25486.50

20413.50

22820.60

230.54177.07132.79

153.73

128.88 110.55

0.00

5000.00

10000.00

15000.00

20000.00

25000.00

30000.00

2004-05 2005-06 2006-07

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on

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40.00

60.00

80.00

100.00

120.00

140.00

160.00

180.00

Cre

dit

or

Day

s

Creditors COGS per day Creditor Days

B) Solvency Analysis

Debt-Equity Ratio: The debt-to-equity ratio offers one of the best pictures of a company's leverage. The higher the figure, the higher is the leverage the company enjoys. Mathematically, it is defined as the ratio of the total debt to the total equity of the company under consideration at any point of time.

Over the last three years, ITC Limited has shown a mix-match of the debt-equity ratio. This is evident from the graph below that the company paid off a significant part of its loan in the FY ’06, but again went in for commercial borrowings in the form of long term loans which resulted in an increase in the debt to the total equity available with the company.

Figure IX

Debt-Equity Ratio

2009.002469.80

1466.80

107541.60

93032.10

80025.70

0.0309

0.0158

0.0187

0.00

20000.00

40000.00

60000.00

80000.00

100000.00

120000.00

2004-05 2005-06 2006-07

Year

In R

s. M

illi

on

0.0000

0.0050

0.0100

0.0150

0.0200

0.0250

0.0300

0.0350

Deb

t-E

qu

ity

Rat

io

Debt Equity DER

Interest Coverage Ratio: The interest coverage ratio is a measurement of the number of times a company could make its interest payments with its earnings before interest and taxes. Lower the ratio, higher is the company’s debt burden. This is measured as the ratio between the profit before interest and taxes to the interest amount paid that year.

The graph below shows the interest coverage ratio of ITC Limited over the three year period. It is observed that ITC has reported a gradual and continuous increase in profit over the last three years of operation. Also, the company’s interest amount has gone down significantly over the last three years. This has resulted in a two way push in the figure for Interest coverage ratio, which is measured as shown above.

Figure X

Interest Coverage Ratio

39299.80

27155.00

32811.20

32.80119.30424.3064.00

275.03

1198.16

0.00

5000.00

10000.00

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35000.00

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45000.00

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illi

on

0.00

200.00

400.00

600.00

800.00

1000.00

1200.00

1400.00

Inte

rest

Co

vera

ge

Rat

io

PBIT Interest Interest Coverage Ratio

Debt to Total Funds: The ratio here is self explanatory and measures the share of the debt to the total capital employed (funds) in the company. Capital employed for this purpose, we define as, the amount of long term liabilities of the company, which comprises of loans and owner’s fund (which includes capital and reserves.)

The diagram below shows the debt share in the total capital employed in ITC limited. The total funds in the organization have been on the up and this contribution is entirely due to the profits that the company is accumulating during the years. The company over the three year period has done away with part of the loans and has possibly substituted a part of the same for cheaper ones. This cumulative effect results in an increase in the capital employed in the company and hence a lower debt share.

Figure XI

Debt Ratio

109550.60

82495.50

94498.90

2009.001466.802469.80

0.030

0.016

0.018

0.00

20000.00

40000.00

60000.00

80000.00

100000.00

120000.00

2004-05 2005-06 2006-07

Year

In R

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on

0.000

0.005

0.010

0.015

0.020

0.025

0.030

0.035

Deb

t R

atio

Total Funds Debt Debt Ratio

Reserves to Total Fund: The ratio between the reserves maintained by the company to the capital employed by it measures the level of self created wealth that is used to fund the company’s operations.

ITC Limited has shown small but continuous increment in the reserve share in the capital employed. This is because over the last three years, the company has maintained about 95% of the reserves as capital employed. It can be seen below that the debt for the company has fallen but the total income, PBIT, and therefore the reserves, have significantly risen over the years

Figure XII

Rererves Ratio

109550.60

82495.50 94498.90

103779.40

89276.90

77531.40

0.940

0.945

0.947

0.00

20000.00

40000.00

60000.00

80000.00

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120000.00

2004-05 2005-06 2006-07

Year

In R

s. M

illi

on

0.936

0.938

0.940

0.942

0.944

0.946

0.948

Res

reve

s R

atio

Total Funds Reserves Reserves Ratio

Debt Service Ratio: Debt Service Ratio is the ratio of net operating income (PBIT) to the debt payments. It is a popular benchmark used in the measurement of an income-producing property’s ability for the business. The higher this ratio is, the easier it is to borrow money for the business.

The PBIT for the company has been showing an increasing trend over the last few years (under consideration.) Also, the debt amount for the company has gone down over time. This has therefore resulted in a net increase in the debt service for the period under consideration.

Figure XIII

Debt Service Ratio

39299.80

27155.00 32811.20

2009.001466.802469.80

10.99

22.37

19.56

0.00

5000.00

10000.00

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35000.00

40000.00

45000.00

2004-05 2005-06 2006-07

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on

0.00

5.00

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15.00

20.00

25.00

Deb

t S

ervi

ce R

atio

PBIT Debt Debt Service Ratio

C) Profitability

PBIT (Operating Income) to Sales: The ratio between the profit before interest and taxes (equal to the operating income, in our case) to that of the sales for the given period during which the profit has been earned is a measure of the profitability of the company for that period.

As reported earlier, ITC Limited has done well in the last few years and has continuously reported higher and higher profit every subsequent time. The sales of the company have also experienced a similar trend that has led to the expansion of profit. Because the growth in the two components has nearly been equal, the ratio between them has not changed significantly. It has marginally dropped from 20% to about 19.8% in the FY ’07. This is shown in the diagram below:

Figure XIV

PBIT-Sales Ratio

39299.8027155.00

32811.20

198415.40

165105.10

135853.90

0.200

0.1990.198

0.00

50000.00

100000.00

150000.00

200000.00

250000.00

2004-05 2005-06 2006-07

Year

In R

s. M

illi

on

0.197

0.198

0.198

0.199

0.199

0.200

0.200

0.201

PB

IT-S

ales

Rat

io

PBIT Sales PBIT-Sales Ratio

PAT to Sales: PAT or, the profit after tax is directly correlated with the profit before tax. The interest component is the sole parameter that can differentiate the trend followed by the ratio above and this one.

PAT for ITC Limited, like PBIT, has shown an upward trend. The financing decisions and also the tax have altered the overall impact on the profitability of the company. While PAT has risen by about 23% over the period under consideration, the sales have increased by over 46%. This has resulted to a fall in the PAT-Sales ratio of the company.

Figure XV

PAT-Sales Ratio

26999.70

21914.00

22353.50

198415.40

165105.10

135853.90

0.161

0.135

0.136

0.00

50000.00

100000.00

150000.00

200000.00

250000.00

2004-05 2005-06 2006-07

Year

In R

s. M

illi

on

0.120

0.125

0.130

0.135

0.140

0.145

0.150

0.155

0.160

0.165

PA

T-S

ales

Rat

io

PAT Sales PAT-Sales Ratio

Return on Networth (RONW): The ratio of net income after taxes to total end of the year net-worth of the company is called the RONW for that company. This

ratio indicates the return on stockholder's total equity that is invested in the business.The networth of the company, ITC Limited, has increased over the period under consideration, the increment being about 35% fro the three year period. On the other hand, the increase in the PAT of the company over the two years is about 23%. Therefore the ratio of the PAT to that of the networth of the company has fallen from about 27.4% to 25.1%. This is depicted in the graph below:

Figure XVI

RONW

107541.60

80025.70 93032.10

26999.70

22353.5021914.00

0.274

0.240

0.251

0.00

20000.00

40000.00

60000.00

80000.00

100000.00

120000.00

2004-05 2005-06 2006-07

Year

In R

s. M

illi

on

0.220

0.230

0.240

0.250

0.260

0.270

0.280

RO

NW

Networth PAT RONW

Return on Capital Employed (ROCE): The return on capital employed is another measure of the returns that the business generates. This is expressed as the ratio between the profit before interest and taxes (PBIT) to the Capital Employed (Loans and Owner’s Fund) in the business.

For ITC Limited, it is seen that the return on capital employed in the business increases overtime. While the capital employed rises by about 33% over the last few years under consideration, the PBIT, profit before interest and taxes shows a greater rise (approximately 45%) in the time frame. This therefore results in a net increase in the return on capital employed for the company and the return now stands at about 36% when compared to about 33% in 2004-05.

Figure XVII

ROCE

109550.60

82495.50

94498.90

39299.80

32811.2027155.00

0.329

0.347

0.359

0.00

20000.00

40000.00

60000.00

80000.00

100000.00

120000.00

2004-05 2005-06 2006-07

Year

In R

s. M

illi

on

0.310

0.315

0.320

0.325

0.330

0.335

0.340

0.345

0.350

0.355

0.360

0.365

RO

CE

Capital Employed PBIT ROCE

Return on Total Assets (ROTA): The return on Total Assets is yet another method of calculating the return of the company. This is calculated by taking the ratio between the PBIT (Profit before Interest and Taxes) to the Total Assets of the company.

The total assets for ITC Limited have increased by over 31% in the last three years. As reported earlier, the profit before interest and tax, PBIT, has shown approximately a 45% increase in the stipulated time period. Therefore, ROTA, which is a measure of these two figures, has shown an increase over the years under consideration. The return on total assets has risen from about 23% in 2004-05 to over 25.5% in 2006-07.

Figure XVIII

ROTA

154169.70117392.30

134154.50

39299.80

32811.2027155.00

0.231

0.245

0.255

0.00

20000.00

40000.00

60000.00

80000.00

100000.00

120000.00

140000.00

160000.00

180000.00

2004-05 2005-06 2006-07

Year

In R

s. M

illi

on

0.215

0.220

0.225

0.230

0.235

0.240

0.245

0.250

0.255

0.260

RO

TA

Total Assets PBIT ROTA

Earnings per share: (EPS): Earnings per share, as it is called, are a company's profit after tax (PAT) divided by its number of outstanding (equity) shares. It is therefore measured as the portion of a company's profit allocated to each outstanding share of common stock. EPS serves as an indicator of a company's profitability.

The PAT (profit after tax or earnings) for ITC Limited has risen by over 23% in the last three years of operation. It is to be noted that there was a stock split in the year 2005-06 due to which the face value of the shares changes from Rs. 10/- per share to from Rs. 1/- per share. As a result, the number of shares changed from 248,221,329 in 2004-05 to 3,762,222,780 in 2006-07.

Figure XIX

EPS

0.883

0.0720.060

0.000

0.200

0.400

0.600

0.800

1.000

2004-05 2005-06 2006-07

Year

EP

S

ITC

Dividend per share: Dividend is defined as the amount of profit that is distributed among the shareholders of the company. Declaration of this is dependent solely on the decision of the management, whether they want to retain it for reinvestment or distribute to the shareholders, the actual owners of the company. The total interim dividend divided by the number of equity shares of the company measures the dividend per share in our case.

As mentioned earlier, there was a stock split for ITC Limited in the year 2005-06 that resulted in more than a 10 fold increase in the number of equity shares in the market. Even though the distributed dividend increased over the last few years continuously, the dividend per share fell drastically for the company in 2005-06 to rise again in 2006-07.

Figure XX

DPS

0.312

0.0310.026

0.000

0.050

0.100

0.150

0.200

0.250

0.300

0.350

2004-05 2005-06 2006-07

Year

DP

S

CFO to PAT: The ratio between Cash Flow from Operating Activities (CFO) to Profit After Tax (PAT) measures to what extent operations of the company affect the profit of the company. In other words, how much of the company’s profit comes from core businesses rather than investment and financing decisions.

For ITC Limited, the cash flow from operating activities has shown a great degree of improvement. The net cash flow from operations stands over 41.5% in 2006-07, up from Rs. 15872 million in 2004-05. On the other hand, the PAT has risen by about 23.2% in the same period. Therefore, the net increase in the CFO-PAT ratio for the period has been about 15%. This is shown by an upward rising curve for the CFO-PAT Ratio.

Figure XXI

CFO-PAT Ratio

20966.10

15872.00

22476.1021914.00 22353.50

26999.70

0.724 0.832

0.938

0.00

5000.00

10000.00

15000.00

20000.00

25000.00

30000.00

2004-05 2005-06 2006-07

Year

In R

s. M

illi

on

0.000

0.100

0.200

0.300

0.400

0.500

0.600

0.700

0.800

0.900

1.000

CF

O-P

AT

Rat

io

CFO PAT CFO-PAT Ratio

D) Market Based Returns

Price-Earning Ratio (PER): Price-Earnings ratio is a measure of the price paid for a share relative to the income or profit earned by the firm per share. A higher P/E ratio means that investors are paying more for each unit of income.

The market value of the shares after the stock split has shown tremendous response from the market. From a figure of about Rs. 90/- in the market in 2004-05, the share traded at Rs. 150/- at the end of 2006-07. Also, the earnings per share, as a result of the split have fallen down drastically to thereby reduce the earnings per share in the last two years. Therefore, a two way positive movement has resulted in almost a 2000% increase in the P-E ratio for the company.

Figure XXII

P/E Ratio

194.50

89.59

150.40

88.28

5.95 7.181.015

20.957

32.674

0.00

50.00

100.00

150.00

200.00

250.00

2004-05 2005-06 2006-07

Year

In R

s. M

illi

on

0.000

5.000

10.000

15.000

20.000

25.000

30.000

35.000

P/E

Rat

io

Market Value Earnings per share P/E Ratio

Market Capitalization: The market capitalization of the company is defined as the market value of the number of equity shares being traded in the market at that point of time.

It is evident from the graph below that the market capitalization for the company has increased during the last three years by about 70%. This increase can be owed to an increase both in the market value of shares as also a split in the shares resulting in a higher number of shares traded in the market. The fall in the capitalization from FY 2006 to FY 2007 is a result of the fall in market value of the shares and a lesser magnitude of demand for the same in the open market.

Figure XXIII

Market Capitalization

334330

732070

565830

0

100000

200000

300000

400000

500000

600000

700000

800000

2004-05 2005-06 2006-07

Year

In R

s. M

illi

on

Price Book Ratio: The Price Book ratio is defined as the ratio between the market capitalizations to the networth of the company at any given point of time. Over the three year period, the market capitalization for the company has shown a net upward trend. The market capitalization rose from about Rs. 22.2 billion in 2004-05 to Rs. 565.83 billion in 2006-07. The networth of the company reported an increase from about Rs. 80 billion in 2004-05 to Rs. 107.5 billion in 2006-07. The net effect on the PB ratio of the company is therefore shown as an increase by about 26% and stands at 5.26 in the year 2006-07.

Figure XXIV

PB Ratio

732070

334330

565830

80025.7093032.10 107541.60

4.18 5.26

7.87

0

100000

200000

300000

400000

500000

600000

700000

800000

2004-05 2005-06 2006-07

Year

In R

s. M

illi

on

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

PB

Rat

io

Market Capitalization Networth P-B Ratio

6. Financial Statement Analysis: Inter Company

Ratio Analysis

A) Liquidity Analysis

Working Capital: Higher the current assets of a company and lower the current liabilities, greater is the working capital. A larger chunk of working capital can be used to fund the long term liabilities of the company and therefore, the larger the working capital, the better it is for the company.

The following table gives the working capital of the three companies under consideration for the three year period.

Figure XXV

Working Capital

-15000.00

-10000.00

-5000.00

0.00

5000.00

10000.00

15000.00

20000.00

25000.00

30000.00

2004-05 2005-06 2006-07

Year

Wo

rkin

g C

apit

al

(In

Rs.

Mil

lio

n)

ITC Marico HLL

It is evident that ITC is by far the best company (among the three) in terms of building up its net current assets. The company is increasingly using its short term funds to pay for the long term liabilities. HLL on the other hand is deteriorating in quality and is gradually getting overburdened by increasing pressures due to a negative working capital.

Working Capital Days:

A comparative analysis across other companies in the FMCG segment shows that HLL has worsened its working capital ratio. In fact, the company has increased the magnitude of the negative working capital because of which a part of the long

term assets are used to fund the short term liabilities. Marico on the other hand, has shown a marginal increase in the working capital ratio and still leads ITC’s working capital ratio by over 50%.

Figure XXVI

Working Capital Days

0.55

0.15

0.43

0.820.56

1.02

-0.25-0.27

-0.05

-0.40

-0.20

0.00

0.20

0.40

0.60

0.80

1.00

1.20

2004-05 2005-06 2006-07

Year

Wo

rkin

g C

apit

al D

ays

ITC Marico HLL

Current Ratio:

The reason why the ratio increases mainly is because of a more than proportionate increase of the Current Assets when compared to the Current Liabilities.

The graph below shows the comparison of ITC vis-à-vis the other two competitors chosen in the market. We observe that in the year 2004-5, Marico had the best Current Ratio but gradually, with a rapid growth in the current assets of ITC, it has come at par with the leaders with the falling trend in the industry (as shown by the other two companies) in the sector.

Figure XXVII

Current Ratio

1.15

1.431.55

2.02

1.561.82

0.950.73 0.75

0.00

0.50

1.00

1.50

2.00

2.50

2004-05 2005-06 2006-07

Year

Rat

io

ITC Marico HLL

Liquidity Ratio:

Also, when compared to the companies, while the current ratio for Marico and ITC converges, the gap is more or less the same for liquidity ratio. This implies that the company as been maintaining a huge amount of inventories (unlike Marico, whose inventory amount is almost constant) that form a part of the company’s current assets. The graph below defines the analysis presented here.

Figure XXVIII

Liquid Ratio

0.43

0.64 0.67

1.08

0.89

1.13

0.55

0.4 0.41

0.00

0.20

0.40

0.60

0.80

1.00

1.20

2004-05 2005-06 2006-07

Year

Rat

io

ITC Marico HLL

Absolute Cash Ratio:

Marico reflects a phenomenal growth in possessing liquid assets to finance its current liabilities. Though, it is to be noted that ITC too shows a more than 100% increase in the absolute ratio. The company is catching up with the leader (among the three) and is therefore on a good growth path.

Figure XXIX

Absolute Cash Ratio

0.25

0.48 0.51

0.70.61

0.98

0.42

0.28 0.31

0.00

0.20

0.40

0.60

0.80

1.00

1.20

2004-05 2005-06 2006-07

Year

Rat

io

ITC Marico HLL

Inventory days:

The following graph gives a comparative performance of the company in the sector. Both HLL an ITC have experienced a fall in the inventory days due to larger sales and larger cost of the goods sold. Also, both companies have maintained a larger and larger stock of inventories over the three year period, every subsequent year. Marico on the other hand has shown more that a 50% increase in sales in the three tear frame but has still maintained almost the same amount of inventories every year for its operations.

Figure XXX

Inventory Days

39346.70

25430.80

31154.30

230.49177.07132.79

191.51

175.94

170.71

0.00

5000.00

10000.00

15000.00

20000.00

25000.00

30000.00

35000.00

40000.00

45000.00

2004-05 2005-06 2006-07

Year

In R

s. M

illi

on

160.00

165.00

170.00

175.00

180.00

185.00

190.00

195.00

Inve

nto

ry D

ays

Inventories COGS per day Inventory Days

Debtor Days:

A comparative analysis of the figure under consideration shows that the debtor days in the industry have a downward trend and ITC is no exception. Companies like HLL and Marico have shown a more significant fall in the figure owing both to increasing sales and lesser comparative credit given.

Figure XXXI

Debtor Days

13.48

16.68

14.04

9.68

15.8316.92

12

15.5415.93

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

2004-05 2005-06 2006-07

Year

Deb

tor

Day

s

ITC Marico HLL

Creditor Days:

Comparatively, ITC has done very well in the FMCG industry. While the other two companies have registered higher growth in the sales per day of the goods, ITC has cut its costs significantly and has maintained low creditors on the other hand to reflect in lower creditor days for the company.

Figure XXXII

Creditor Days

110.55

153.73

128.88138.98

84

54.5

176.56177.27176.52

0.0020.0040.0060.0080.00

100.00120.00140.00160.00180.00200.00

2004-05 2005-06 2006-07

Year

Cre

dit

or

Day

s

ITC Marico HLL

B) Solvency Analysis

Debt-Equity Ratio:

Across the industry, it has been observed that there is a similar sort of a mix and match. While HLL funds its operations from lower and lower loans every year, Marico feels that a tradeoff between usage of capital and usage of loans needs to be done. Increasingly, the latter is funding its operations through more and more debt, possibly because of a lesser cost of the same.

The graph below interprets the results written above.

Figure XXXIII

Debt-Equity Ratio

0.01870.03090.0158

1.3046

0.9165

0.3030

0.02670.0247

0.7030

0.0000

0.2000

0.4000

0.6000

0.8000

1.0000

1.2000

1.4000

2004-05 2005-06 2006-07

Year

Deb

t-E

qu

ity

Rat

io

ITC Marico HLL

Interest Coverage Ratio:

ITC Limited is by far the biggest “gainer” in terms of the interest coverage ratio. While HLL also intends to be a self funded company by letting off its loans from the open market, ITC follows somewhat the same strategy thereby leading to an increment in the Interest coverage for both. Also, while the increase in the interest coverage for HLL is about 1287%, the ITC Group shows a fabulous 1772% increment in the interest coverage ratio in three years. On the other hand, Marico Limited uses more and more debt to fund its operation resulting in a lower interest coverage ratio when compared to oneself two years back!

Figure XXXIV

Interest Coverage Ratio

1198.16

64.00275.03

8.2920.60

38.15

174.50

84.61

12.580.00

200.00

400.00

600.00

800.00

1000.00

1200.00

1400.00

2004-05 2005-06 2006-07

Year

Inte

rest

Co

vera

ge

Rat

io

ITC Marico HLL

Debt to Total Funds:

Comparatively, HLL, also a very big organization with a significant time period of existence in the market gets self funded and thereby has let go off its debt in

the three years. This has reflected in a lower debt share for the company. Conversely, Marico, an upcoming organization is constantly borrowing money from the market, at a rate that is faster than the accumulation of profits (even though it is doing well in terms of creating wealth for the shareholders, increasing profit.) Graphically, this is depicted below.

Figure XXXV

Debt Ratio

0.0180.030

0.016

0.566

0.478

0.233

0.0260.024

0.413

0.000

0.100

0.200

0.300

0.400

0.500

0.600

2004-05 2005-06 2006-07

Year

Deb

t R

atio

ITC Marico HLL

Reserves to Total Fund:

While ITC has shown an increment in the reserves share to the capital employed, old companies in the market are also picking up the same trend. HLL is gradually using more funds of its own to run its operations. On the other hand, a relatively new organization, Marico has increased the share of debt to acquire a larger position in the market and get more capital.

Figure XXXVI

Reserves Ratio

0.9470.9400.945

0.2970.406

0.562

0.8950.883

0.525

0.0000.1000.2000.3000.4000.5000.6000.7000.8000.9001.000

2004-05 2005-06 2006-07

Year

Res

erve

s R

atio

ITC Marico HLL

Debt Service Ratio:

Across companies, ITC and HLL follow the same trend in the form of the pattern followed for the debt service ratio. Both companies have been reporting large profits and have been letting go of the loans taken from the free market to make them a more self funded organization. Marico on the other hand reflects a falling debt service due to a more than proportionate increase in the debt when compared to the profit for that year.

Figure XXXVII

Debt Service Ratio

19.56

10.99

22.37

0.68

0.43

1.16

25.7928.52

1.110.00

5.00

10.00

15.00

20.00

25.00

30.00

2004-05 2005-06 2006-07

Year

Deb

t S

ervi

ce R

atio

ITC Marico HLL

C) Profitability

PBIT (Operating Income) to Sales:

Other companies in the segment have experienced a similar trend in the ratio defined above. While for Marico, the ratio rose from 7.6% to about 11%, the PBIT figure for HLL is about 14.25% of the Sales. Overall, ITC has the highest return on the investment, if measured by this parameter.

Figure XXXVIII

PBIT-Sales Ratio

0.1980.200 0.199

0.110

0.0900.076

0.140

0.1320.146

0.000

0.050

0.100

0.150

0.200

0.250

2004-05 2005-06 2006-07

Year

PB

IT-S

ales

Rat

io

ITC Marico HLL

PAT to Sales:

Across companies in the industry, the PAT-Sales ratio has shown a trend that hovers around the same value. Companies like HLL and Marico maintain a constant ratio for their company of about 11.1% and 7.2% respectively. This could be because of the increasing tax that the company has to bear with from the second year of consideration.

Figure XXXIX

PAT-Sales Ratio

0.136

0.161

0.135

0.0730.0760.070

0.115

0.1100.107

0.000

0.020

0.040

0.060

0.080

0.100

0.120

0.140

0.160

0.180

2004-05 2005-06 2006-07

Year

PA

T-S

ales

Rat

io

ITC Marico HLL

Return on Networth (RONW):

While ITC Limited was the best company, among the three, when looked at from the point of view of PBIT or PAT to Sales, the company is a laggard when measured in terms of the RONW. Clearly, from the diagram below, it is evident

that the other two companies, Marico and HLL are better performers in terms of the return for the shareholder’s monies. While HLL maintains its high return on the networth of about 57%, Marico has performed strongly in the last two years to rise from a low level of 32% to nearly 60%.

Figure XL

RONW

0.251

0.274

0.240

0.587

0.3320.323

0.5650.5870.573

0.000

0.100

0.200

0.300

0.400

0.500

0.600

0.700

2004-05 2005-06 2006-07

Year

RO

NW

ITC Marico HLL

Return on Capital Employed (ROCE):

According to the return on capital employed, the company that has performed the best (among the three) in terms of wealth creation for the shareholders would be Hindustan Lever Limited. From a figure of about 33.7% in 2004-05, the company now has a ROCE of over 55% in the market. The profit margins for ITC hover around the 35% mark while that of Marico Limited move around 25%.

Figure XLI

ROCE

0.359

0.329

0.347

0.2550.1730.248

0.5510.573

0.337

0.000

0.100

0.200

0.300

0.400

0.500

0.600

0.700

2004-05 2005-06 2006-07

Year

RO

CE

ITC Marico HLL

Return on Total Assets (ROTA):

When considered on the basis of ROTA, ITC fares as well as HLL which had been better in terms of ROCE and RONW. The figures for the two companies hover around the 25% mark in the years under consideration. The corresponding figure for that of Marico is about 20% (on an average) and ranges from a low of 15.2% to a high of 23.5%. This is presented in the diagram below.

Figure XLII

ROTA

0.2550.231

0.245

0.235

0.1520.189

0.256

0.2500.225

0.000

0.050

0.100

0.150

0.200

0.250

0.300

2004-05 2005-06 2006-07

Year

RO

TA

ITC Marico HLL

Earnings per share: (EPS):

The earnings per share of ITC and Marico and ITC have drastically fallen over the last three years. This is because there has been a stock split in both cases that has brought down the face value of the shares in the market resulting thereby in an increment in the number of equity shares available for trade. Therefore, despite an increase in the total earnings offered by the company, the earnings per share fall drastically. On the other hand, the number of shares of HLL in the market remains steady and the earnings (PAT) increases every year. This therefore results in an increment in the earnings when considered in per share terms.

Figure XLIII

EPS

0.0720.883

0.060 1.854

14.979

12.095

6.977

6.153

5.448

0.000

2.000

4.000

6.000

8.000

10.000

12.000

14.000

16.000

2004-05 2005-06 2006-07

Year

EP

S

ITC Marico HLL

Dividend per share:

ITC Limited and Marico over the last few years have experienced a huge fall in the dividend distributed per share because of reasons mentioned above. The earnings per share for the third company, HLL, shows an increase in the dividend distributed per share owing to the increasing dividend paid by the management to the shareholders.

Figure XLIV

DPS

0.0310.312 0.026 0.641

6.200

5.350

2.999

2.500

2.500

0.000

1.000

2.000

3.000

4.000

5.000

6.000

7.000

2004-05 2005-06 2006-07

Year

DP

S

ITC Marico HLL

CFO to PAT:

Other companies like Marico and HLL, operating in the same segment have followed more or less the same trend like ITC. Though, on a larger scale, it should be observed that Marico has reported a 185% increase in the ratio when compared three years back. HLL on the other hand has reported a marginal fall of about 5% in the ratio for the period.

Figure XLV

CFO-PAT Ratio

0.8320.724

0.938

1.669

1.897

0.586

1.0361.4531.085

0.0000.2000.4000.6000.8001.0001.2001.4001.6001.8002.000

2004-05 2005-06 2006-07

Year

CF

O-P

AT

Rat

io

ITC Marico HLL

D) Market Based Returns

Price-Earning Ratio (PER):

The industry has altogether shown an increase in the Price-Earnings ratio. It is observed that in the last three years, the value of P/E has risen for all the three companies, whether or not the company has gone in for a stock split. Among the three, Marico has experienced the highest increment in the ratio (in absolute terms), after ITC Limited itself. The following graph reflects the trend in the ratio that has been observed in these three companies over the last three years.

Figure XLVI

P/E Ratio

20.957

1.015

32.674 33.063

3.6042.009

31.03832.05626.339

0.000

5.000

10.000

15.000

20.000

25.000

30.000

35.000

2004-05 2005-06 2006-07

Year

P/E

Rat

io

ITC Marico HLL

Market Capitalization:

Across companies too, the market capitalization has shown a net increase representing a good growth component in the sector and the confidence of the buyers who continue to buy the stocks of such companies. HLL and Marico have consistently shown an increase in the market capitalization for the years under consideration. This is graphically depicted as below.

Figure XLVII

Market Capitalization

565830.00

334330.00

732070.00

37331.703130.841409.40

477877.36434195.34

315878.48

0.00

100000.00

200000.00

300000.00

400000.00

500000.00

600000.00

700000.00

800000.00

2004-05 2005-06 2006-07

Year

In R

s. M

illio

n

ITC Marico HLL

Price Book Ratio:

Across companies, ITC Limited rates poorly for the Price Book Ratio. In fact, while Marico shows a stupendous performance for the three years reflecting a 2887% increase in the PB ratio, ITC reports only a meager 26% increase. Also, HLL reports a 16% increment in the ratio, but still manages to hold its position at the second level pushing ITC to the lowest figure in the industry when compared across the other two companies.

Figure XLVIII

PB Ratio

5.264.18

7.87

19.41

1.200.65

17.5518.8315.09

0.00

5.00

10.00

15.00

20.00

25.00

2004-05 2005-06 2006-07

Year

PB

Rat

io

ITC Marico HLL

ROCE = 0.36

Operating Decision

=0.198

Investment Decision

= 1.29

Financing Decision = 1.41

COGS / Sales =

0.42

Operating Expenses / Sales =

0.36

Depreciation / Sales

= 0.02

Sales / Fixed

Assets = 3.32

Sales / Inventory

= 5.04

Sales / Debtors =

27.07

Sales / Other

current Assets =

8.75

Total Assets / Debt =

0.01

Total Assets /

Networth = 0.70

7. Du-Pont Analysis

Figure XLIX

The above diagram shows the Du-pont analysis for ITC limited for the year 2006-07. The return on the capital employed (ROCE) as per the calculation shown above is about 36%. This can be broken down into Operating decision ratio, PBIT/Sales, Investment decision ratio, Sales/Total Assets and Financing decision ratio, Total Assets/Capital employed.

Further, each of the decisions can be broken down to arrive at the sub-segment wise ratio. The company can cut its expenses wherever the ratio is very high when compared to the other FMCG industries in the country so as to economize its operations/financing/investments. The macro level analysis along with a part of the micro level analysis has been done earlier. We now look at the values that we find out after putting them in a table to make a comparative study.

Table I

Values for 2006-07  ITC Marico HLLCOGS/Sales 0.42 0.53 0.49

Operating Expenses/Sales 0.36 0.35 0.36Depreciation/Sales 0.02 0.03 0.01Sales/Fixed Assets 3.32 7.40 8.86

Sales/Inventories 5.04 7.93 8.65Sales/Debtors 27.07 37.71 30.41

Sales/Other Assets 4.16 5.60 3.51Total Assets/Debt 76.74 2.89 100.81

Total Assets/Capital 40.98 11.92 33.17Total Assets/Reserves 1.49 5.52 2.92

From the table above, we see that the COGS/Sales of all the companies under consideration are about the 50% mark. Though, ITC lags behind its competitors on this

parameter. What ITC needs to do is reduce the cost of consumption of goods that it buys as raw materials from the market. It has to make bulk purchases and needs to increase its negotiating ability through a stronger purchase team.

Operating Expenses/Sales is almost the same for all the three competitors and therefore ITC is using the best practice here for the operational expenses.

Depreciation/Sales is also at a negotiable level for the company. In fact, the company holds a better position when compared to Marico. The company can still try and assume a greater life cycle, if possible, for its machinery and other fixed assets to come at par with the other leading competitors in the domain for the segment.

The company maintains a high amount of fixed assets that accounts for the high depreciation. This is reflected here by the small value of Sales/Fixed Asset as reflected by the company’s balance sheet.

The company also has a policy of maintaining a larger stock of inventories than its other competitors. This is reflected in the low amount of Sales/Inventories that the company possesses.

The company maintains a low figure for Sales/Debtors which is a good sign. The company should make sure that such kind of an advantage over others is maintained.

Sales/Other Assets for the company is at a medium level. The company should try and take measures to overtake the leader by reducing the amount of other assets maintained or conversely increasing the sales of the company if such levels of assets are to be maintained.

Reserves are the liability of the company. ITC Limited maintains a low level for the Total Assets to Reserves ratio thereby implying a larger reserve than required. The company should pay off the reserves to the shareholders so as to move towards the better circle of companies performing the best in the industry.

The higher the figure for the Total Assets to Debt, the better is the company. A larger debt implies a larger inability on part of the company to pay off its debtors. A larger level of fixed assets can fund the payment of debt if the current assets of the company cannot help in funding the same.

Similarly, the company scores very well for the ratio of the Total Assets to Capital and needs to continue to maintain such high standards.

8. Economic Value Addition

Economic Value Added (EVA), or economic rent, is a widely recognized tool that is used to measure the efficiency with which a company has used its resources. In other words, EVA is the difference between return achieved on resources invested and the cost of resources. Higher the EVA, better the level of resource unitization.

EVA is calculated as the difference between the Net Profit (after tax but before interest) less cost of capital employed (equity + debt). Interest is not taken as an expense since this is part of cost of capital (interest on debt).

There is no mentioning of the economic value added for the company in the balance sheet. WE therefore try and calculate the EVA with the assumptions that we take as per the industry trend. We first take a simple regression analysis to calculate the average values of ‘Kd’ and ‘Ke’ by looking at the companies in the FMCG industry.Table II

Kd Ke

Estimated Values 5.90% 16.38%

We now calculate the NOPAT and the Cost of Capital as per the following formula for the three companies for the year 2007. The following table shows the values.

Table III

Figures are in Rs. crores ITC Marico HLLPAT 26,999.70 1,129.10 15,396.70

Interest 32.80 206.00 107.30Tax 0.3124 0.2478 0.1730

NOPAT 27022.25 1284.06 15485.44

We calculate the values of NOPAT for the companies as given above. We look at the Cost to employ the capital after that.

Table IV

Figures are in Rs. crores ITC Marico HLLDebt 2,009.00 2,509.70 726.00

Equity 107,541.60 1,923.80 27,234.90Capital Employed 109,550.60 4,433.50 27,960.90

WaCC 0.1619 0.1045 0.1611Cost of Capital 17733.85 463.19 4503.91

Finally, we compute the economic value added for the companies for the year 2007, by calculating the difference between the NOPAT and the Cost of Capital hence obtained.

Table V

Figures are in Rs. crores ITC Marico HLLEconomic Value Added 9288.41 820.87 10981.53

Thus, we see that all three companies have reported positive economic value additions; the magnitude of value addition differs for each of the players. According to the figures hence obtained, Hindustan Lever adds the highest value to its products and therefore is among the better companies in the FMCG Industry. It has also been noted in the ratio analysis that HLL is always decently scored when compared to the other two companies which are seen at both extremes.

ITC on the other hand is an equally good company, though; we believe there are certain areas that ITC Limited can improve its position upon. These have been mentioned in the Ratio and Du-pont analysis of the company as shown above in the report.

Finally, Marico is an upcoming company in the FMCG Industry and is doing pretty well in the industry. The company has reflected tremendous growth in the return on investment and is also creating a positive economic value. The company promises to make huge impact on the overall industry and emerge as one of the leaders of tomorrow.

9. Accounting Policies

Convention

To prepare financial statements in accordance with applicable Accounting Standards in India. A summary of important accounting policies, which have been applied consistently, is set out below. The financial statements have also been prepared in accordance with relevant presentational requirements of the Companies Act, 1956.

Basis of Accounting

To prepare financial statements in accordance with the historical cost convention modified by revaluation of certain Fixed Assets as and when undertaken as detailed below.

Fixed Assets

To state Fixed Assets at cost of acquisition inclusive of inward freight, duties and taxes and incidental expenses related to acquisition. In respect of major projects involving construction, related pre-operational expenses form part of the value of assets capitalized. Expenses capitalized also include applicable borrowing costs. To adjust theoriginal cost of imported Fixed Assets acquired through foreign currency loans at the end of each financial year by any change in liability arising out of expressing the outstanding foreign loan at the rate of exchange prevailing at the date of Balance Sheet. To capitalize software where it is expected to provide future enduring economic benefits. Capitalization costs include license fees and costs of implementation / system integration services. The costs are capitalized in the year in which the relevant software is implemented for use. To charge off as a revenue expenditure all up gradation / enhancements unless they bring similar significant additional benefits.

Depreciation

To calculate depreciation on Fixed Assets and Intangible Assets in a manner that amortizes the cost of the assets after commissioning, over their estimated useful lives or, where specified, lives based on the rates specified in Schedule XIV to the Companies Act, 1956, whichever is lower, by equal annual installments. Leasehold properties areamortized over the period of the lease. To amortize capitalized software costs over a period of five years.

Revaluation of Assets

As and when Fixed Assets are revalued, to adjust the provision for depreciation on such revalued Fixed Assets, where applicable, in order to make allowance for consequent

additional diminution in value on considerations of age, condition and unexpired useful life of such Fixed Assets; to transfer to Revaluation Reserve the difference between thewritten up value of the Fixed Assets revalued and depreciation adjustment and to charge Revaluation Reserve Account with annual depreciation on that portion of the value which is written up.

Investments

To state Current Investments at lower of cost and fair value; and Long Term Investments, including in Joint Ventures and Associates, at cost. Where applicable, provision is made where there is a permanent fall in valuation of Long Term Investments.

Inventories

To state inventories including work-in-progress at cost or below. The cost is calculated on weighted average method. Cost comprises expenditure incurred in the normal course of business in bringing such inventories to its location and includes, where applicable, appropriate overheads based on normal level of activity. Obsolete, slow moving and defective inventories are identified at the time of physical verification of inventories and, where necessary, provision is made for such inventories.

Sales

To state net sales after deducting taxes and duties from invoiced value of goods and services rendered.

Investment Income

To account for Income from Investments on an accrual basis, inclusive of related tax deducted at source.

Proposed Dividend

To provide for Dividends (including income tax thereon) in the books of account as proposed by the Directors, pending approval at the Annual General Meeting.

Employee Benefits

To make regular monthly contributions to various Provident Funds which are in the nature of defined contribution scheme and such paid / payable amounts are charged against revenue. To administer such Funds through duly constituted and approved independent trusts with the exception of Provident Fund and Family Pension contributions in respect of Unionized Staff which are statutorily deposited with the Government. To administer through duly constituted and approved independent trusts, various Gratuity and Pension Funds which are in the nature of defined benefit scheme. To

determine the liabilities towards such schemes and towards employee leave encashment by an independent actuarial valuation as per the requirements of Accounting Standard – 15 (revised 2005) on “Employee Benefits”. To determine actuarial gains or losses and to recognize such gains or losses immediately in Profit and Loss Account as income or expense. To charge against revenue, actual disbursementsmade, when due, under the Workers’ Voluntary Retirement Scheme.

Lease Rentals

To charge Rentals in respect of leased equipment to the Profit and Loss Account.

Research and Development

To write off all expenditure other than capital expenditure on Research and Development in the year it is incurred. Capital expenditure on Research and Development is included under Fixed Assets.

Taxes on Income

To provide Current tax as the amount of tax payable in respect of taxable income for the period. To provide Deferred tax on timing differences between taxable income and accounting income subject to consideration of prudence. Not to recognize Deferred tax assets on unabsorbed depreciation and carry forward of losses unless there is virtual certainty that there will be sufficient future taxable income available to realize such assets.

Foreign Currency Translation

To account for transactions in foreign currency at the exchange rate prevailing on the date of transactions. Gains/Losses arising out of fluctuations in the exchange rates are recognized in the Profit and Loss in the period in which they arise except in respect of imported Fixed Assets where exchange variance is adjusted in the carrying amount of the respective Fixed Asset. To account for differences between the forward exchange rates and the exchange rates at the date of transactions, as income or expense over the life of the contracts, except in respect of liabilities incurred for acquiring imported Fixed Assets, in which case such differences are adjusted in the carrying amount of the respective Fixed Asset. To account for profit/loss arising on cancellation or renewal of forward exchange contracts and on maturity or cancellation of options as income/expense for the period, except in case of forward exchange contracts and options relating to liabilities incurred for acquiring imported Fixed Assets, in which case such profit/loss are adjusted in the carrying amount of the respective Fixed Asset. To account for gains/losses on foreign exchange rate fluctuations relating to current assets and liabilities at the year end.

Claims

To disclose claims against the Company not acknowledged as debts after a careful evaluation of the facts and legal aspects of the matter involved.

Segment Reporting

To identify segments based on the dominant source and nature of risks and returns and the internal organization and management structure. To account for inter-segment revenue on the basis of transactions which are primarily market led. To include under “Unallocated Corporate Expenses” revenue and expenses which relate to the enterprise as a whole and are not attributable to segments.

Financial and Management Information Systems

To practice an Integrated Accounting System which unifies both Financial Books and Costing Records? The books of account and other records have been designed to facilitate compliance with the relevant provisions of the Companies Act on one hand, and meet the internal requirements of information and systems for Planning, Review and Internal Control on the other. To ensure that the Cost Accounts are designed to adopt Costing Systems appropriate to the business carried out by the Division with each Division incorporating into its Costing System, the basic tenets and principles of Standard Costing, Budgetary Control and Marginal Costing as appropriate.

10. Appendix

Condensed Financial Statements

Table VI

 Balance Sheet  2006 2005 2004Capital 3,762.20 3,755.20 2,494.30Reserves 103,779.40 89,276.90 77,531.40LTL 2,009.00 1,466.80 2,469.80CL 44,619.10 39,655.60 34,896.80Total 154,169.70 134,154.50 117,392.30Fixed Assets 59,760.00 47,612.10 43,836.20Investments 25,058.90 29,981.00 33,291.30CA 69,350.80 56,561.40 40,264.80Total 154,169.70 134,154.50 117,392.30

Table VII

 Income Statement  2006 2005 2004Sales 198,415.40 165,105.10 135,853.90COGS 84,128.90 64,631.50 48,468.90Operating Expenses 71,357.50 64,339.00 57,101.30Depreciation 3,629.20 3,323.40 3,128.70

PBIT 39,299.80 32,811.20 27,155.00Interest 32.80 119.30 424.30

PBT 39,267.00 32,691.90 26,730.70Tax 12,267.30 10,338.40 4,816.70

PAT 26,999.70 22,353.50 21,914.00

Table VIII

Cash Flow Statement  2006 2005 2004

Opening CIH 9,779.40 1,277.00 1,098.80CFF -10,549.00 -9,637.70 -4,816.60CFI -10,841.50 -2,827.70 -10,953.60

CFO 22,476.10 20,966.10 15,872.00

Closing CIH 10,865.00 9,777.70 1,200.60

Sources:

1. http://www.cmie.com/

2. http://www.naukrihub.com/india/fmcg/

3. http://www.itcportal.com/

4. www. hll .com/ 5. www. marico india.com/ 6. Class notes

Thank you!