Financial analysis of HUL (Unilever), Suzlon and Infosys by vpremkrishnan

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									      INDIAN INSTITUTE OF MANAGEMENT LUCKNOW




 ANALYSIS OF CAPITAL
 STRUCTURE, DIVIDEND
POLICY AND CORPORATE
     VALUATION
 HINDUSTAN UNILEVER LTD, SUZLON &
             INFOSYS

      A PROJECT ON FINANCIAL MANAGEMENT




                   March 2009
                                                TABLE OF CONTENTS

EXECUTIVE SUMMARY ................................................................................................................. 3
SECTION A – HUL (FMCG INDUSTRY) ............................................................................................. 4
1.   Overview ............................................................................................................................ 4
2.   Capital structure ................................................................................................................. 5
3.   Dividend policy ................................................................................................................... 8
4.   Valuation of firm............................................................................................................... 10
5.   Analysis and Recommendations ........................................................................................ 13

SECTION B – SUZLON (ENERGY INDUSTRY) .................................................................................. 15
1.   Overview of the firm ......................................................................................................... 15
2.   Capital Structure Analysis.................................................................................................. 16
3.   Dividend Policy ................................................................................................................. 21
4.   Financing Decisions ........................................................................................................... 22
5.   Valuation of Suzlon ........................................................................................................... 22

SECTION C – INFOSYS (IT INDUSTRY) ........................................................................................... 25
1.   Overview of the firm ......................................................................................................... 25
2.   Capital structure ............................................................................................................... 28
3.   Dividend policy ................................................................................................................. 29
4.   Valuation of firm............................................................................................................... 30
EXECUTIVE SUMMARY
The objective of the project was to understand how financial management decisions are undertaken
in different sectors. For the purpose of study, three sectors have been taken – FMCG, IT and
Renewable energy (RE) electric equipments. The following aspects have been studied

1)   Capital structure
2)   Financing decisions
3)   Dividend Policy
4)   Firm Valuation

Under each sector one company has been chosen as a representative of the sector. For

1) FMCG sector                    – HUL
2) RE Electric Equipments         – Suzlon
3) IT                             – Infosys

Major findings of the study are

1) In IT sectors and FMCG, investments are predominantly handled through equity capital. While in
   RE Electric Equipments sector, investments are handled both through debt as well are equity
2) The capital structure of IT and FMCG sector contains only equity. The capital structure in RE
   Electric Equipments sector has a debt ratio of around 40%.
3) In IT sector, a dividend payout ratio of around 30% is being followed. In RE Electric Equipments
   sector the dividend payout is only around 12%. For FMCG sector the dividend payout ratio is
   almost 100%.
4) The utility of debt for tax benefit is low in both RE Electric equipment sector as well as IT as the
   current tax rate in India for both these sectors is very low. For FMCG sector, through the tax rate
   is 34%, the debt in the capital structure is very low.
5) Though the utility of debt in capital structure does not give any tax related benefit, they raise
   significant funds through debt instruments.



The limitations of the study are generalisation on the basis of a single company for the entire sector.
This is party remediated by the fact that the three selected companies are industry leaders and
would most probably be following the best financial practices in the sector.
SECTION A – HUL (FMCG INDUSTRY)

1. Overview
Hindustan Unilever (HUL) is the largest FMCG (Fast Moving Consumer Goods) company in the
country and has one of the widest portfolios of products sold via a strong distribution channel. It
owns and markets some of the most popular brands in the country across various categories,
including soaps, detergents, shampoos, toothpastes, tea, ice cream and face creams.

1.1. Performance

After stagnating between 1999 and ’04, the company is back on the growth track. In the past three
years, HUL’s net sales have witnessed a CAGR of 11%, while net profit has posted a CAGR of 17%.
HUL sells products at different price points straddled between the entire value chain. In the past few
years, it has diversified into processed foods, ice-creams, water purifiers and specialised chemicals.
But home and personal care (HPC) continues to remain the bread & butter segment for the
company. This division accounted for 72% of HUL’s revenue and 91% of its profit (before interest
and tax) during the year ended December ’07.

1.2. Growth Drivers

The company has been launching new products and brand extensions, with investments being made
towards brand-building and increasing its market share. HUL is also streamlining its various business
operations, in line with the ‘One Unilever’ philosophy adopted by the Unilever group worldwide.
Introduction of premium products and addition of new consumers via market expansion, especially
in rural areas will be HUL’s growth drivers.

1.3. Financials

HUL’s net sales have recorded a CAGR of more than 11% over the past three years, while its net
profit has posted a CAGR of 17% during the same period. While its sales have maintained a secular
growth trend, profit margins have shown an erratic trend during the period. High dividend yield,
steady growth and strong market standing in its product categories have enabled HUL to command
premium valuations, compared to other FMCG companies.

1.4. Risks

Being an MNC operating in India, HUL is more conservative in its strategies than its Indian
counterparts. Moreover, given increasing competition, it faces the risk of being overtaken by
domestic players in various categories. Prolonged inflation may lead to margin contraction, in case
HUL is not able to pass on this burden to consumers. The company’s large size also poses a problem,
since it does not give HUL the agility to address the competition it faces from national and regional
players. The current downturn and expected decline in consumer spending also can have an impact
on the company’s revenues.
2. Capital structure
2.1. Overview
The capital structure adopted by HUL during the past decade is as follows:
                                                                                           Rs. crore
Year                 Dec 07      Dec 06      Dec 05       Dec 04     Dec 03     Dec 02      Dec 01


Share Capital        217.75      220.68      220.12       220.12     220.12     220.12      220.12
Reserves Total       1,221.49    2,502.81    2,085.50     1,872.59   1,918.60   3,438.75    2,823.57
Total Equity         1,439.24    2,723.49    2,305.62     2,092.71   2,138.72   3,658.87    3,043.69
Secured Loans        25.52       37.13       24.5         1,453.06   1,603.70   19.62       43.04
Unsecured Loans      63.01       35.47       32.44        18.06      100.61     38.68       40.7
Total Debt           88.53       72.6        56.94        1,471.12   1,704.31   58.3        83.74
D/E Ratio            0.061512 0.026657 0.024696 0.702974 0.796883 0.015934 0.027513



Share capital:
2,17,74,63,355 equity shares of Re. 1 each fully called and paid up were issued and
subscribed.




Employee Stock Option Scheme: The Company has granted share options under the Company’s
Employees’ Stock Option Scheme and share options outstanding as at 31st December, 2007 are
73,06,750. Of these 12,47,400 options have vested in 2004, 17,59,635 have vested in 2005,
19,06,515 have vested in 2006, 10,67,700 have vested in 2007 and 13,25,500 will vest in 2008.

Reserves and surplus:                                                  Rs. lakh
                                                      As on 31 Dec 2007
CAPITAL RESERVES
Capital Reserve                                       422.23
Capital subsidy                                   503.99
Capital redemption reserve                        417.36
Share premium account                             -
Revaluation reserve                               66.59
Other reserves                                    251.05
Employee stock options                            536.66
Total Capital Reserves                            2197.88

REVENUE RESERVES
Export profit reserve                             1221.95
Development allowance reserve                     26.72
General reserve                                   98951.89
Total revenue reserve                             100200.56

TOTAL RESERVES                                    122148.78

2.2. Debt-equity ratio

One of the key features of the FMCG industry is third party manufacturing (TPM). By outsourcing
manufacturing to other smaller players, FMCG companies can concentrate solely on distribution and
marketing. The third party manufacturers are usually small because of which overheads and labour
costs are low. Also, by outsourcing manufacturing, the FMCG company gains a greater control over
logistics as it can get the product manufactured near the market. HUL has around 80 manufacturing
units in India, but also subcontracts manufacturing to around 150 smaller players. Because most of
the manufacturing is outsourced, FMCG companies require very little incremental capital
expenditure. They do not have to invest huge capital in assets to grow earnings. Hence FMCG
companies normally have low debt-equity ratios.

Most FMCG multi-national companies are funded by their parent companies. The MNC parent
normally takes debt to offer higher return to its own shareholders. Hence there is no advantage by
leveraging the Indian subsidiary.

HUL too follows the strategy of maintaining a low D/E ratio, in line with that of other FMCG
companies. A comparison of HUL’s D/E ratio with that of some non-FMCG companies is given below.
In comparison to other FMCG companies, HUL has a slightly higher D/E ratio. This is due to the fact
that the company does not outsource manufacturing totally. However HUL still maintains a D/E ratio
significantly lower than 1.




The changes in HUL’s D/E ratio over the past 10 years are captured below:




The D/E ratio increased from 1.5% in 2002 to 79.6% in 2003. This change in capital structure was the
result of a scheme of arrangement for issue of bonus debentures, which effectively resulted in
conversion of retained profit to debt. As per this scheme, HLL issued one bonus debenture of face
value of Rs.6 for each and every share of Re. 1. It also provided a special dividend of Rs. 2.76 for
every share of Re.1 to be paid simultaneously to the issue of bonus debentures, as part of the
integrated transaction. Deduction at source for both bonus debentures constituting deemed
dividend and on the special dividend was made from the special dividend payable to shareholders so
that the
								
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