Financial Modeling Case on FMCG Sector


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Financial Modeling Case on FMCG Sector

  1. 1. © Pristine NOTES TO THE CANDIDATES1. The case describes the situation of a company. Please note that the situation is purely hypothetical and used for instructional purpose only. Any resemblance to any real company is purely incidental.2. For best understanding of the case and to appreciate the results, the participants are advised to develop the complete financial model on their own. However, owing to time constraint, the participants would be given some pre-filled templates at various stages of the training. The participants should be able to get from one template level to another in the time prescribed in the class.3. Participants should read the case carefully till the end to know the various assignments based on the case4. Participants should check their model at each stage with the next level of the template to verify their approach.5. Instructor would facilitate an interactive session6. Participants should raise questions and challenge the approach7. This case pack would be incomplete without the accompanying template sheets
  2. 2. © Pristine 1. FINANCIAL MODELING CASE STUDY: FMCG SECTORLooking through the window of his office, Akshay was wondering how quickly time has passed by.The day was pleasant with bright sunshine outside. With a mug of coffee in his hand, he waslooking at the day to day activities in the premises of Renuka Consumer Products Limited(“RCPL”).Akshay had just completed his MBA when his father expired in late 2004. Since then he hadtaken control of RCPL, a company started by his father and named after his mother Mrs. RenukaDevi.RCPL, a popular name in one of the western states of India, operates in fast moving consumerproducts segments. It manufactures and sells three products: 1. Soaps in packets of 100 gms 2. Hair colour in bottles of 250 ml 3. Liquid Detergents in the bottles of 500 mlSince the time Akshay took control of the operations at RCPL, the company has grown leaps andbounds. The volumes sold across each of the three categories of products have shown significantgrowth over last five years.Exhibit 1: Volumes sold over FY05 – FY09 Sales Volume (Units) FY05A FY06A FY07A FY08A FY09A Soaps (100 gms packet) 187,500 215,625 240,000 285,000 337,500 Hair Colour (250 ml bottle) 281,250 300,000 315,938 333,750 348,188 Detergents (500 ml bottle) 131,250 150,000 163,125 173,438 182,813Besides, RCPL has also managed to consistently increase the sale prices of its products primarilybecause of lack of competition in the areas where it has achieved good marketability.Exhibit 2: Sales Price Movement Sales Price (Rs. / Unit) FY05A FY06A FY07A FY08A FY09A Soaps (100 gms packet) 32 36 40 43 45 Hair Colour (250 ml bottle) 75 80 88 92 95 Detergents (500 ml bottle) 100 112 125 135 145However, Akshay knows that things are no longer going to be as comfortable as they are rightnow. Specially, in a situation when a leading listed player in the consumer products area hasannounced plans to expand in the geographies where RCPL operates. Given the changing
  3. 3. © Pristine www.edupristine.comdynamics of the business, Akshay was thinking through the potential course of actions he cantake to counter the increasing competition.As a first step he decided to take stock of the situation. He asked the chartered account for thehistorical financial statements of the company.Exhibit 3: Historical P&L Statement of RCPL P&L Statement (Rs. Lakhs) FY05A FY06A FY07A FY08A FY09A Revenues 402 486 578 664 748 Costs Raw Material Cost 128 163 184 205 232 Manpower, Salary & Bonus Cost 51 58 72 86 94 Power cost 2 2 3 4 4 Packaging cost 9 10 12 14 16 Advertisement cost 20 41 42 44 46 Commission 20 24 29 33 37 Maintenance Cost 1 1 1 1 1 Insurance Premium 2 2 2 2 2 EBITDA 169 184 233 274 315 Depreciation 100 100 105 110 110 EBIT 69 84 128 164 205 Interest expense 60 59 56 53 50 PBT 9 25 72 112 156 Tax rate 34.0% Taxes 3 9 25 38 53 PAT 6 17 48 74 103
  4. 4. © Pristine www.edupristine.comExhibit 4: Historical Balance Sheet of RCPL(Rs. Lakhs) FY05A FY06A FY07A FY08A FY09ASources of FundsShareholders EquityPaid up Capital 550 550 550 550 550Retained Earnings - 6 23 70 144Profit for the year 6 17 48 74 103Equity infusion during the year - - - - -Total shareholders equity 556 573 620 694 797Loan fundsSecured Loans - - - - -Unsecured Loans 500 475 450 425 400Total Loan Funds 500 475 450 425 400Total sources of Funds 1,056 1,048 1,070 1,119 1,197Usage of FundsFixed AssetsGross Block 1,000 1,000 1,050 1,100 1,100Accumulated depreciation 100 200 305 415 525Net Block 900 800 745 685 575WIP - - - - -Investments 37 50 60 80 100Current Assets (Excluding Cash)Inventory 36 60 65 69 72Account Receivables 33 52 55 60 51Loans & Advances 10 14 15 20 16Total Current Assets 79 126 135 149 139Current Liabilities & ProvisionsProvisions for Employees fund 10 6 8 9 9Advances from customers 5 8 12 4 7Commission payable 4 4 10 6 6Insurance premium payable 2 2 2 2 2Accounts payable 16 18 25 22 25Total Current Liabilities & 36 38 57 43 49ProvisionsNet Current Assets (Working 43 88 78 107 89Capital)Cash & Bank Balances 76 110 187 248 433Total Usage of Funds 1,056 1,048 1,070 1,119 1,197
  5. 5. © Pristine www.edupristine.comWhile the past performance looked phenomenal, he knew that he along-with his managementteam has to constantly improve and think ahead of curve lest RCPL should be eaten by thecompetition. He was well aware of the fact that however good his team might be, pastperformances may not be sustained in future unless he does plan well in advance. He quicklysummoned his Sales and Marketing team to seek their inputs on the future sale price points forthe various products RCPL manufacture.Excerpts from the discussion he had with his Sales & Marketing team:“ .Soap segment has seen a high growth phase so far, but due to enhanced penetrationin the rural markets, this segment will see a tapering growth rate from the expected 15% inFY10 to 12% in five years time. Due to lack of fashion consciousness in the villages, haircolour segment will, at the best see a CAGR of 0.5% less than historical CAGR over a fiveperiod time frame. ..Liquid detergents have gained popularity in the rural markets and willcontinue to display a growth rate of 5% - 6% over the same time frame, very much in linewith its growth rate last year ”“ .While RCPL has so far controlled the sale prices of these products at its will, the samemay not happen in future. It will be almost impossible to increase the prices of soaps anddetergents for the next two years and even beyond that, the increase will be limited to 2%to 3%. Hair colour segment still has a possibility of seeing a price CAGR growth rate sameat historical levels ”Akshay quickly realized that in the competitive world, revenue growth alone may not fetch thedesired shareholders’ value creation. He quickly turned his attention to the key cost elements inthe P&L statement. He knew that raw material was the key constituent of the total cost base.There were just four categories of raw materials required for the operations of RCPL.Exhibit 5: Raw materials requirement of key products of RCPL 100 gms 250 ml hair 500 ml Raw Materials volume requirement (ml) soap colour detergent Acid 105 255 505 Specialty chemicals 10 12 25 Ordinary chemicals 5 8 15 Perfumes 10 5 12Acids were the single primary key raw material in terms of quantum of consumption. Specialtychemicals were added to achieve the desired colour and perfumes were added for fragrance.Akshay quickly noticed the raw materials price trend from the exhibit overleaf provided to him bythe Materials Department
  6. 6. © Pristine www.edupristine.comExhibit 6: Raw Materials Price movement Raw Materials prices (Paise/ml) FY05A FY06A FY07A FY08A FY09A Acid 7.7 8.8 9.2 9.5 10.0 Specialty chemicals 3.7 4.5 5.0 5.3 5.5 Ordinary chemicals 1.7 2.5 2.8 3.0 3.5 Perfumes 5.8 6.5 7.0 7.5 8.0He quickly invited Mr. Rao, Head of Materials Department for a discussion on the prices of theraw materials.Excerpts from the discussion he had with Mr. Rao“ For the acids, RCPL has entered into a long term contract with the leading supplier inthe region. Under the terms of the contract, acids will see a price escalation of 5% over thenext five years. For specialty chemicals, he has multiple vendors and due to highbargaining power RCPL enjoys with the suppliers, the price rise in this segment will berestricted to 5%. Ordinary chemicals will display a price rise of 15% to 16% over the sametime horizon while perfumes will display the historical CAGR in terms of its pricegrowth Power cost will display a growth rate in the range of 10% – 11%...”As soon as the discussion was concluded and Mr. Rao left the room; a very commanding andauthoritative female voice shouted at him, “You never seem to keep track of time. It’s lunch time,where had you been?”From the authority and power in the voice, it was evident that the voice was of none other thanRaveena, Akshay’s wife. Raveena was Akshay’s childhood friend and was also his father’schoice as his wife. The two got married in early 2005 when Akshay took control of RCPL andRaveena of Akshay. A wife’s entry into the scene need not always be welcome when one isthinking about the future, however this time Raveena’s entry was perfect in time. Raveena,besides being Akshay’s wife, was also the HR head of RCPL. Over lunch, Akshay figured out thathis HR department had been quite cautious in growing the manpower in the organization.Exhibit 7: Manpower in RCPL Manpower (Nos.) FY05A FY06A FY07A FY08A FY09A Manufacturing 28 30 35 40 40 Marketing 5 5 7 8 9 Corporate 2 2 2 3 3Raveena told him that manpower count will remain the same for this year while she had budgeteda headcount increase of 5% beyond. Knowing that he must be thinking of the cost control, sheanticipated his next question, thus displaying a quality rare in HR and provided information on themonthly salary figures of the employees in different categories.
  7. 7. © Pristine www.edupristine.comExhibit 8: Average monthly salary Monthly salary (Rs./employee) FY05A FY06A FY07A FY08A FY09A Manufacturing 10,000 10,500 11,000 11,100 11,700 Marketing 15,000 16,000 17,000 17,500 18,000 Corporate 16,000 16,500 17,200 17,800 18,200 Bonus (% of salary) 10% 12% 12% 12% 15%She also indicated that the employees have not received any salary hike this year; however shehad budgeted for 5% hike year on year for the next five years. The firm will continue to pay 15%of the salary as bonus in the years to come unless something unforeseen happens. The two hadfinished lunch, post which she left the room without any debate; something you won’t expect atleast from an HR professional who has been queried about the “resources”.Post lunch, it was time for a quick walk and he was joined by none other than Mr. Tibrewala, theguy behind the operations of RCPL. Akshay was aware that the packaging of the end products ofRCPL was outsourced to another firm through a long term contract. Mr. Tibrewala clarified thatpackaging cost will see a meager rise of 2% after remaining constant this year (with respect toFY09). Besides, he promised to mail Akshay the historical packaging rates.At times, our mailbox is so flooded with mails that we simply keep staring at it without knowingwhich ones to open first. But Akshay was quite clear in his mind and he clicked open the mailfrom Mr. Tibrewala as soon as he reached his office after the walk.Exhibit 9: Packaging cost per unit Packaging Cost (Rs. /Unit) FY05A FY06A FY07A FY08A FY09A Soaps (100 gms packet) 1.0 1.1 1.2 1.3 1.3 Hair Colour (250 ml bottle) 1.5 1.6 1.8 1.9 1.9 Detergents (500 ml bottle) 2.0 2.2 2.3 2.5 2.5Akshay knew that RCPL had not been an aggressive advertiser so far. However, in order toincrease penetration of the products and reach wider markets, advertisement-spend had toincrease. He has increased the budgetary allocation of advertising spend to 10% of sales thisyear and he decided to raise it to ~ 14% gradually over next few years. Besides to prevent theretailers and salesman from partnering with any new player in the area, he knew he would haveto gradually increase their commission to 7% from the current levels of 5%.Having been through key items of revenues and growth, it was now time to interact withCorporate Finance department about the future capital expenditure and their funding plans. Thefirm had raised a debt of Rs. 500 Lakhs at an interest rate of 12% in FY05 to be repaid in 20equal installments beginning FY06. The capital expenditure plans for the firm was as follows
  8. 8. © Pristine www.edupristine.comExhibit 10: Capital expenditure plans Rs. Lakhs FY10P FY11P FY12P FY13P FY14P Capital expenditure 500 100 - 250 220The firm depreciated all capex items using a straight line method over a period of 10 years.Knowing the cash balance available with RCPL and good results so far in FY10, he realized thatno additional external funding will be required in order to carry out the planned expansion.Having assimilated all the information now, Akshay was now wondering how to make use of themto figure out the cash position of the company, its financial health and projected performance. Hewas also thinking of a possible way of arriving at the valuation of the company his father hadcreated. He knew that he had a tough task in his hand. He was reminded of an investmentbanker, Christopher, his batch mate from his MBA College. However, he did not want to employhis services as he feared the magnitude of the fees. Eventually, he called him to seek informationon trading multiples of the listed companies in this sector and also an update on the recent M&Aor PE transactions that might have happened.Gone are the days when investment bankers used to be working 100 hours a week. Thanks tothe recent downturn, bankers now enjoy some free evenings with their loved ones. However,greed for fees never leaves them. Within minutes of the call, Akshay saw a mail from Christopherwho has concisely compiled the data he was looking for.Exhibit 11: Trading multiples of the listed companies in FMCG sector Comp M EV* EV/Sales EV/EBITDA P/E β D/E any Cap* FY09 FY10 FY11 FY09 FY10 FY11 FY09 FY10 FY11 A 1,169 989 2.0 1.8 1.6 8.2 7.3 6.7 18.2 15.3 13.5 1.4 2.0 B 1,321 1,254 2.1 1.9 1.5 9.4 8.5 7.1 19.5 16.4 12.4 1.5 1.9 C 1,456 1,342 2.5 2.3 1.9 9.6 8.8 7.5 20.1 17.2 14.3 1.2 1.5 D 1,289 1,432 2.0 1.8 1.5 8.1 7.7 6.9 19.1 16.6 12.9 1.3 1.3 E 987 1,100 1.9 1.4 1.2 7.5 6.9 6.1 15.1 14.1 12.4 1.0 1.4Note: *EV and M Cap in Rs. LakhsExhibit 12: Transaction Multiples Transaction Multiples Recent Transactions in the same sector/ Industry Year EV/sales EV/EBITDA P/E % stake Co. X acquired Co. Y 2007 2.20 11.20 21.30 100% PE firm F invested in Co. Z 2008 1.20 6.80 12.30 10% Co. A acquired Co. B 2008 2.50 10.00 18.00 51% PE investment in Co. G 2009 1.30 6.20 10.10 5% Co. P acquired Co. Q 2009 2.40 12.00 18.10 26%
  9. 9. © Pristine www.edupristine.comAkshay has a voluminous and strenuous task at hand to determine the value of his firm.However, he had been quick to break a big problem into a series of smaller problems to facilitatehis task.Assignment 1As a first step, prepare cash flow statements from the historical P&L and Balance sheetstatements for the period of FY05 to FY09Assignment 2Conduct ratio analysis based on financial statements available so far and examine the trends inthem. Besides, observe the growth rates and key trends in the revenue and cost items. Quicklyexamine if revenue and cost build up are accurate.Assignment 3Identify key drivers of the revenue and cost. Prepare projected financial statements based on thehistorical trends and the inputs gathered from various departments. Conduct what-if scenario andcheck the sensitivity of the business model on various variablesAssignment 4Based on projected financial statements, build a DCF model to arrive at an approximate equityvalue of the firm. Examine this valuation with respect to the trading multiples and transactionmultiples in the industry