A financial analysis and valuation of Cipla has been undertaken for study. The aim of the company is to create wealth for its shareholders. Discounted cash flow, total shareholder return, net asset value and price/earnings methods are used to analyse whether the company has created wealth for its shareholders. The Net asset value and Total Shareholder Analysis are historical in nature. Therefore the preferred method used is the discounted cash flow method. Sensitivity analysis is carried out to depict the best scenario and worst scenario results as it is dicey to conduct accurate future analysis.
Company Profile
Chemical industries and Pharmaceutical Laboratories (Cipla) was founded by Mr. Khwaja Abdul Hamied and was set up in 1935. He was the sole provider of the patent and research formula. The company got registered as a public company in August 17, 1935. The original birth of Cipla took place in September 22, 1937 when its first product was launched in the market. The Cipla set up its first research division to attain self-sufficiency in technology and product innovation. Its exports were touching new heights and excellence awards were achieved in abundance. In 1985, Cipla also got an approval from the US FDA for its bulk drug manufacturing facilities. By the year 2000, the company had already started manufacturing units in Mumbai, Goa, Sikkim, Indore and Baddi (H.P). The product portfolio of company includes prescribed drugs, animal products, over the counter (OTC) products, products that provide flavours and fragrance, agrochemicals and technology (CIPLA 2011).
Financial Position
The company had spent Rs 9415.86 crores on purchase of investment and fixed assets in the year 2009-10. In the same year, the company had repaid a loan of worth Rs 1397.44 crores which accounts for the net cash flow of the company.
Table 1: Financial Position of Cipla - 2010
Particulars (in Rupee crores)
Year
2004-05
2005-6
2006-07
2007-08
2008-09
2009-10
Sales
2181.26
2891.36
3438.24
3997.9
4960.6
5359.52
Net Profit margin
503.72
841.46
972.23
1091.78
1286.71
2036.32
EPS
13.66
20.26
8.61
9.02
9.99
12.49
Cash Flow Generated
-128.77
145.35
238.56
254.84
178.92
-471.61
Source: (Adapted from Cipla Annual Report 2010a)
The sales of Cipla have grown by 145.7% in just 5 years. The net profit margin has reached 2036.32 crores with a growth rate of 304.25% which means that the company has enjoyed a very good profit growth over this period (Cipla Annual Report 2010a). Cipla has a 5.38% market share and continues to lead the charts followed by Ranbaxy and GlaxoSmithKline (Business Standard 2010).
Market Share
Company
No of
products
Domestic
turnover
(Rs cr)
Market
share
(%)
Growth*
(%)
Cipla
924
2,155.29
5.38
18
Ranbaxy
565
1,968.24
4.91
13.7
GSK
177
1,743.15
4.35
18
Piramal Health
750
1,644.26
4.11
22.8
Zydus Cadila
735
1,484.84
3.71
21.2
Sun Pharma
516
1,449.83
3.62
22
Source: (Cipla Annual Report 2010b) Source: (Adapted from Business Standard 2010)
Future Forecast of Cipla
Cipla is India's largest pharmaceutical company by sales. It has a different model compared to the other generic players as it has tied up with local players in the international market instead of having a direct presence overseas. This makes it less vulnerable to generic competition. Cipla's 1QFY2011 results were better in terms of the operating profit. Lower growth in the domestic front was offset by higher export sales abroad. Cipla is about to start a venture in the Indore SEZ which would contribute towards its growth significantly in the next 6-12 months. Cipla exports to more than 175 companies and its exports accounted for a 54% turnover in the year 2010. Cipla's domestic formulation segment is expected to grow by 10% in 2011.
The Cipla expects growth momentum in domestic front as well. Operating profit would increase by leaps and bounds. Expiring patent and technological know-how could create future threats. Sales are at CAGR 14.4% and EPS is expected to grow to 17.6. The sales of CIPLA is expected to reach Rs 7009 crores with a 28.7% growth. EBITDA could be expected to grow to 22.4%. The Return on Equity is projected as 19.5% and the Return on Capital Employed as 17.5% (Angel Research 2011).
Source: (Angel Research 2011)
Shareholder Value Analysis
Booth (1998) emphasized that creating shareholder value is the main goal of the firm. Shareholder value analysis is the process of analysing how business decision affects the economic value (Wenner and LeBer 1989). The economic value is measured by discounting the expected cash inflows with cost of capital.
The main objective of the top management is to create value for its shareholders i.e. maximizing shareholder's wealth. All operational and strategic decision should lead to maximization of this shareholders wealth. Operational and strategic decisions, directly and indirectly have strong influence on stock market fluctuation. Market price of share reflects all pertinent information related to company's financial and non-financial information. By creating shareholder value, the company is able to achieve market confidence and therefore is able to attract new investors for the growth of the business.
With the help of a value pyramid (as shown in the figure below), Rappaport (1998) highlighted the importance of value drivers in providing shareholder value.
Fig.1: Shareholder Value Pyramid
Source: Self Designed based on the understanding of Shareholder Value Pyramid.
Companies provide value to their shareholders by leveraging on the strategic use of their value drivers. Over a period of time, Cipla varied its strategic focus efficiently to provide value to its shareholders. In 2006, Cipla were providing shareholder value by playing a safe policy of focusing on the business strategy of market capitalization. It had mainly focussed on the domestic front and consolidated its position in the domestic sector (Shrivastava 2006). After achieving market capitalization, Cipla began indulging in an investment centric strategy with a foray into the biosimilar sector by means of strategic acquisitions and mergers in order to increase shareholder value. They acquired stakes in MabPharm, BioMab and MediTab and entered into a merger with Adcock Ingram.
Shareholder value Analysis can be done using the followings methods:
Total Shareholder Return:
Dividend Policy
Market value Added
Economic Value Added
Total Shareholder Return (TSR)
Total Share Holder (TSR) helps in measuring the capital appreciation over a period of one year of investment and cash dividends. This aims at measuring the wealth created for shareholders over the period of last one year. The formula used for measuring the total shareholder return is:
Dividend + (closing share price - opening share price)
TSR =
Opening share price
Cipla has paid dividend worth of Rs 2 per share every year. That is why it is being assumed that the company will be paying the same amount of dividend (Rs 2 per share).
Table 2: Total Share Holder Analysis from 2005 to March 2011
Particulars
Year
2004-05
2005-6
2006-07
2007-08
2008-09
2009-10
Mar-11
Dividend Per Share
2
2
2
2
2
2
Closing Price (31-03-)
259.9
661.95
235.7
219.45
219.75
338
299.7
Total Shareholder Value (%)
155.46
-64.09
-6.05
1.05
54.72
-10.74
TSR in RS
404.05
-424.25
-14.25
2.3
120.25
-36.3
Graph 1: Total Shareholder Return Analysis
The company had delivered 155.46% total return to shareholders during the year 2005-06. The main reason for such a high return rate was that the Indian capital market was at a boom during this period. In this year, the company was having the highest EPS. Later with the onset of economic crisis in USA, India had also suffered setbacks during the year 2006-07. Soon the market price of shares fell back to normalization and Cipla during that time provided a return of -64.09% due to the recession. During 2007-09, the buy and hold strategy by Cipla with reference to its shares was not able to deliver much value to shareholders. However, the year 2009-10, was very rewarding for shareholders with 54.72% return because of the revival of faith of investors into the Indian capital market. Due to the current recessionary period, as of March 2011, returns again dropped to -10.74% leading to losses for the investors.
Dividend Policy
Cipla has a dividend per share policy which is regardless of its EPS. The year 2005-06 had the highest EPS value; yet the company had paid the lowest dividend of 0.10. This year Cipla has a low dividend pay-out ratio of 0.16. During the period of 2006-09, the company had maintained an average dividend payout ratio of roughly 20%. The highest dividend yield over the period of 2005-2010 is 0.91%. The dividend cover was the highest in the year 2005-06. The lowest dividend yield was 0.30% during 2005-06.
To create shareholder value, the company should enhance its dividend per share.
Dividend Payment Analysis:
Particulars
Year
2005-06
2006-07
2007-08
2008-09
2009-10
Dividend Per Share
2
2
2
2
2
Earnings Per Share
20.26
8.61
9.02
9.99
12.49
Dividend Cover Share
10.13
4.305
4.51
4.995
6.245
Dividend Payout ratio
10%
23%
22%
20%
16%
Market Price
661.95
235.7
219.45
219.75
338
Dividend Yield
0.30%
0.85%
0.91%
0.91%
0.59%
Source: (Adapted from Cipla Annual Report 2010c)
Market Value Added (MVA)
Market value added is another measure to calculate shareholder value creation. It is the difference between enterprise value (market value) of the company and the amount invested in the form of shareholders equity and debt. Higher value of MVA indicates that the company has created good value/wealth for its shareholders. Negative MVA denotes substantial erosion of wealth of shareholders.
Market Value added = Enterprise Value - Money Invested
Enterprise Value = Market capitalization + Debt - Cash Equivalents
Market capitalization = Current Market Price * No of outstanding shares
Money Invested = Shareholders equity + Debt + Other liabilities
Calculations carried out in Appendix 1.
Table 3: Calculation of Market value added
Particulars
Year
2005-06
2006-07
2007-08
2008-09
2009-10
Market Capitalization = No of Shares * Current Share Price
51452.80
18320.76
17057.66
17080.98
27138.74
Enterprise Value = Market Capitalization+ Debt - cash Equivalents
52785.43
19254.09
18806.62
19372.78
28297.30
Invested Capital = Debt + other long term Liabilities
3458.33
4413.74
5733.21
6859.7
7312.64
Market Value Added = Enterprise Value - Invested Capital
49327.10
14840.35
13073.41
12513.08
20984.66
Cipla has created maximum wealth for shareholders in the year 2005-06 due to high market price. This wealth creation was not sustainable for a long term. We see that the wealth creation index of Cipla had fallen down in the subsequent years. However, due to organic growth, it has again touched new heights of Rs 20984.66 crores in the year 2009-10.
Economic Value Added (EVA)
Economic value added helps us to know if the firm is able to create shareholders wealth. It also measures whether the firm has an ability to earn more than the cost of capital. If earnings (net operating income after tax) exceed the overall cost of capital, it proves that the company has delivered wealth to its shareholders. Tully (1993) defines economic value added as the difference between net operating profit after tax and cost of capital. Cost of capital is the minimum required rate of return which a firm is required to earn, to fulfil the expectations of the shareholders and lenders.
EVA = Net Operating Profit - Taxes - Cost of Capital
Calculations carried out in Appendix 2.
Table 4: Economic Value added for Cipla
particulars
Year
2005-06
2006-07
2007-08
2008-09
2009-10
EBITDA
577.29
801.4
918.65
965.96
1396.1
Tax
33.36%
33.36%
33.36%
33.36%
33.36%
NOPAT
384.71
534.05
612.19
643.72
930.36
Shareholders' Equity
1983.27
3236.27
3755.82
4350.75
5914.09
Cost of equity = DPS/EPS*100
10%
23%
22%
20%
16%
EVA
188.92
-217.69
-220.59
-227.31
-16.65
Only in the year 2005-06, has the company been able to create wealth for its shareholders. During the period 2006-10, the company has given negative returns, resulting in erosion of economic value added. The reason for this negative wealth is the high cost of equity. In the year, 2005-06, cost of equity was very less. It was up to 10%. Otherwise, in the subsequent year, cost of equity was high and had reached up to 23%. However, in the year 2009-10, cost of equity fell down to 16%. Due to this, the erosion on the economic value added has reduced as compared to the previous years.
Efficient Market Hypothesis (EMH)
Efficient Market Hypothesis states that the market is efficient when prices fully reflect information at all times in capital market. It is assumed that the existing stock prices replicate information about company's performance and therefore leaves no scope for earning abnormal returns consistently. Fama(1970) has propounded the notion of capital market efficiency. He has defined three forms of efficiency.
Weak Form: The weak form of efficiency shows that share prices move randomly irrespective of available information and happenings of previous day. It is the negation of technical analysis. It says that analysis of past share price movement does not help investor to develop trading strategy based on historical prices information. Bombay Stock Exchange (BSE) where Cipla is trading has a weak form efficiency as proved by the research conducted by Sharma and Mahendru (2009). Due to this, it is not easy to predict market share price changes of Cipla based on the past information and happenings.
Semi Strong Form: This form of efficiency describes that share price depicts all the information about historical prices and widely available knowledge pertaining to company. The investor who invests precious time in fundamental analysis would not help investor to earn abnormal return. But this form of efficiency admits insider trading can help the investor to earn an abnormal return.
Strong Form: Strong form of efficiency indicates that stock prices replicate all the relevant information inclusive of inside information which is known to management.
Share Price Movements of Cipla: For 12 months
Source: MoneyControl (2011a)
Share Price Movements of Cipla and Competitors: For 12 months
Source: MoneyControl (2011b)
Table 5: Share Price Analysis of Cipla
Date
Open
close
Change in price
% change in Price
Information
5-Apr-10
343
349.3
6.3
1.836735
Cipla is in talk with GSK, Teva to supply generic drug.
8-Apr-10
336.5
334.2
-2.3
-0.68351
Cipla is about to launch cheaper version of Bayer's Nexaver which was retaliated by Bayer in Supreme Court.
16-Jun-10
340
333.9
-6.1
-1.79412
The company announced that is going to acquire significant stakes in two bio tech companies MabPharm &BioMab for Rs. 300 crore.
13-Aug-10
315.3
315.45
0.15
0.047574
Quarter ending Jun 2010 results were announced.
25-Aug-10
318
308.9
-9.1
-2.86164
The company has declared the acquisition of Meditab Specialties Pvt. Ltd. ("Meditab") for an aggregate consideration of Rs.133.35 crores.
2-Dec-10
368
364.05
-3.95
-1.07337
Supreme Court has overruled petition by Bayer, allowing Cipla to launch cheaper version of Bayer's Nexaver.
20-Dec-10
358.4
365.65
7.25
2.022879
IIFL is bullish about CIPLA and recommend investors to buy Cipla shares.
28-Dec-10
371.8
370.35
-1.45
-0.38999
National Pharmaceutical Pricing Authority (NPPA) sends a notice to Cipla for overpricing of its two drugs.
28-Jan-11
341.1
334.6
-6.5
-1.9056
Cipla responded to media that the company is not going to sell any further stake.
2-Feb-11
330
324.75
-5.25
-1.59091
Declared financial review quarter ending Dec 2010.
Equity Valuation of Cipla
Value of firm can be calculated through value of equity and value of debt. Value of equity helps in understanding and analysing the shareholder value creation. It helps us to find whether or not the firm has added shareholder value. The following three approaches are used to understand the creation and analysis of shareholder value:
Net Asset Value
Price-Earnings Ratio
Discounted cash flow (DCF) approach
Terminal Value
Cost of equity
Sensitivity Analysis
Net Asset Value (NAV)
Net asset Value approaches the company's equity in terms of the value of the company's net asset. To find out the net asset value per equity share, divide net value of company's asset in their balance sheet by the number of outstanding equity shares. In other words, it is the net worth (equity capital plus reserves and surpluses) divided by outstanding shares of the company.
Limitation of NAV:
Balance sheet gives a static and historical view of the assets and liabilities of the firm. Also, the values obtained will be dependent on the accounting policies being followed by the firm. Therefore this valuation model may not give true and fair value of the equity. Intangible assets such as brand equity, intellectual capital and expert management cannot be evaluated. It is historical in nature and ignores future earning potential of the asset. Hence, it would not provide the realistic valuation of the firm.
(Book Value of Assets - Book Value of Total Liabilities)
Value of Share =
No. of outstanding shares
Table 6: Calculation of Net asset Value of share of Cipla
Particulars
Year
2005-06
2006-07
2007-08
2008-09
2009-10
Short Term
908.2
941.26
1247.71
1404.56
1214.33
Long Term
468.91
123.56
580.53
940.24
5.07
Other Long Term liabilities
97.95
112.65
149.15
164.15
179.15
Fixed Asset
1143.62
1461.26
1894.48
2358.81
2695.41
Current Asset
2292.29
2834.68
3743.48
4224.57
4352.13
Investment
22.43
117.8
94.75
81.32
265.1
Total Asset
3458.34
4413.74
5732.71
6664.7
7312.64
Total Liability
1475.06
1177.47
1977.39
2508.95
1398.55
Net Assets
1983.28
3236.27
3755.32
4155.75
5914.09
Book Value per share
25.52
41.64
48.31
53.46
73.66
Book value of share is highest in the year 2009-2010 due to huge investments in fixed assets as compared to its liabilities. Cash Flow Statement informs that the company has repaid huge loan in the same year causing book value per share to reach Rs 73.66. The book value per share was the least in the year 2005-06. Net asset value method of equity valuation is based on historical data and it is one of major limitation of equity valuation.
Price/Earnings Value (P/E)
P/E ratio is calculated as the price of share divided by earnings per share. Financial analysts evaluate the performance and prospect of common stock in terms of P/E ratio. P/E multiplier is used to estimate the value of the share. Expected value of the share could be calculated by multiplying expected EPS and its P/E ratio. Higher P/E indicates overvalued stock whereas low P/E indicates an undervalued stock.
Limitation of P/E
Investors give more weightage to high P/E as it reflects the possibility that the stock would perform. A high P/E ratio is considered good but it could be high not because the share price is high but because earning per share is low. Interpretation of P/E ratio therefore becomes meaningless because of the measurement problem of EPS. Number of arbitrary assumptions is made to estimate earnings per share. Accounting policies may be changed and manipulated which may distort the fair estimation of earnings. Earnings also include non-cash items like depreciation and amortization of intangible assets.
*Calculations carried out in Appendix 3.
Table 7: Calculation of P/E ratio of Cipla during 2005-10 and P/E graph
particulars
Year
2005-06
2006-07
2007-08
2008-09
2009-10
Market Price
661.95
235.7
219.45
219.75
338
Earnings Per Share
20.26
8.61
9.02
9.99
12.49
P/E
32.673
27.375
24.329
21.997
27.062
In 2005-06, Cipla's stock was overvalued with highest P/E of 32.673. In the subsequent years, due to the fundamental correction in the economy, the over-value of the stock was offset to depict a fairer value.
Discounted Cash Flow (DCF)
DCF takes a long-term perspective and focuses on valuation. A number of companies in all use the DCF analysis to evaluate projects. They accept those projects which are expected to generate internal rate of return higher than the cost of capital, or a positive net present value of future cash flows when discounted at the cost of capital. More and more, corporate managers now realize the strong need for the extensive adoption of DCF in evaluating all management actions, projects, business strategies and overall strategic planning.
For the project, a time frame of 6 years (till 2017) has been considered for the projection of the value of Cipla. The reason is that the growth rate used and the required rate of return tends to change and does not yield perfect values as we progress more into the future. World economies have gone into a recessionary state previously, seen in 2001-2002 and then later in 2008-2009. The time gap between these two recessions has been roughly 6 years. Therefore considering the currently concluded recession (on-going in some countries but not in India) the valuation of Cipla till 2017 is considered to be more reliable. Any time frame more than 6 years may lead to major deviation regardless of the valuation method used.
The individual components of Discounted Cash Flow are described below:
Revenue Growth
Cipla's growth rate of revenue has not been consistent for the last five years. It is very difficult to predict the future growth rate of revenue in the years to come. The average growth rate of revenue has been 20%. Hence we have assumed revenue of Cipla would grow normally by a rate of 15% keeping into mind previous year's growth rate.
Table 8: Calculation for Revenue Growth of Cipla
Year
2005
2006
2007
2008
2009
2010
2012
2013
2014
2016
2017
Sales
2181.2
2891.36
3438.24
3997.9
4960.6
5359.52
6163.45
7087.97
8151.16
9373.83
10779.91
Grwth
Rate
33%
19%
16%
24%
8%
15%
15%
15%
15%
15%
Operating Margin
For measuring the growth of operating margin, EBITDA has been taken into consideration. Growth rate of EBITDA during the last four years was around 20% whereas the average growth rate was about 22%. Therefore, projection of EBITDA would be done taking 20% as the rate.
Table 9: Calculation for Revenue Growth of Cipla
Particulars
Year
2005-06
2006-07
2007-08
2008-09
2009-10
2011-12
2012-13
2013-14
2015-16
2016-17
EBITDA
577.29
801.4
918.65
965.96
1396.1
1232.7
1417.6
1630.2
1874.8
2156.0
Revenue
2891.36
3438.24
3997.9
4960.6
5359.52
6163.45
7087.97
8151.16
9373.83
10779.91
% of EBITDA
20%
23%
23%
19%
26%
Depreciation & Amortization (D&A)
The depreciation of Cipla is 14% of EBITDA in the year 2005-06 and 2007-08. In the year 2008-09, it was around 16%. Average comes out to be 14%. Hence, for the next five years, depreciation & amortization would be taken as 14% of EBITDA.
Table 10: Calculation for Depreciation and Amortization of Cipla
particulars
Year
2005-06
2006-07
2007-08
2008-09
2009-10
2011-12(E)
2012-13(E)
2013-14(E)
2015-16(E)
2016-17(E)
EBITDA
577.29
801.4
918.65
965.96
1396.1
1232.7
1417.6
1630.2
1874.8
2156.0
Depreciation
80.18
103.37
130.68
151.79
165.25
188.385
214.7589
244.8251
279.1007
318.1748
% Growth In Depreciation
14%
13%
14%
16%
12%
14%
14%
14%
14%
14%
Average
14% ^
^
^
^
^
Tax Rate
In India corporate tax rate is 30%. Corporate tax for the study including other cess is assumed to be 33.36%.
Capital Expenditure & Interest
Financial leverage and interest burden would increase the financial risk of company. Cipla was having a huge amount of debt in the capital structure. Due to which, financial risk of the company was high. That is why in the year 2008-09, a loan worth Rs 940.24 crores were repaid and loan amount was reduced to Rs 5.07 crores. The situation of debt in the capital structure is very volatile. It is quite difficult to forecast interest obligation for future. So interest liability for calculation of discounted cash flow is taken to Rs 20 crores as a constant. Capital expenditure is taken as capital work in progress. It is expressed as percentage of total assets. The investment rate is ranging from 3% to 9%. Average investment rate comes out to be 5% (capital Work in progress/total asset)
Table 11: Calculation of capital Expenditure
Particulars
Year
2005-06
2006-07
2007-08
2008-09
2009-10
2011-12(E)
2012-13(E)
2013-14(E)
2015-16(E)
2016-17(E)
EBITDA
577.29
801.4
918.65
965.96
1396.1
1232.7
1417.6
1630.2
1874.8
2156.0
Less Depreciation &Amortization
80.18
103.37
130.68
151.79
165.25
188.4
214.8
244.8
279.1
318.2
EBIT
497.11
698.03
787.97
814.17
1230.85
1044.3
1202.8
1385.4
1595.7
1837.8
less interest
10.42
6.95
11.69
32.94
22.95
20.0
20.0
20.0
20.0
20.0
EBT
486.7
691.1
776.3
781.2
1207.9
1024.3
1182.8
1365.4
1575.7
1817.8
less tax
162.4
230.5
259.0
260.6
403.0
341.7
394.6
455.5
525.6
606.4
PAT
649.0
921.6
1035.2
1041.8
1610.9
1366.0
1577.4
1820.9
2101.3
2424.2
Cash Flow= PAT + Depreciation
729.2
1025.0
1165.9
1193.6
1776.1
1554.4
1792.2
2065.7
2380.4
2742.4
investment rate
3%
2%
4%
5%
9%
5%
5%
5%
5%
5%
less capital expenditure
87.01
73.19
233.12
366.32
684.24
718.5
754.4
792.1
831.7
873.3
Working Capital
Working capital has utmost importance for smooth running of Business. Cipla has positive working capital which means that the current asset of the company is more than its current liability. Every year working capital of the company is growing by around Rs 500 crores. That is why, it is assumed that in the years to come, working capital would grow by same amount (that is Rs 500 crores).
Table 12: Calculation of working capital of Cipla
particulars
Year
2005-06
2006-07
2007-08
2008-09
2009-10
2011-12
2012-13
2013-14
2015-16
2016-17
EBITDA
577.29
801.4
918.65
965.96
1396.1
1232.7
1417.6
1630.2
1874.8
2156.0
Less Depreciation &Amortization
80.18
103.37
130.68
151.79
165.25
188.4
214.8
244.8
279.1
318.2
EBIT
497.11
698.03
787.97
814.17
1230.85
1044.3
1202.8
1385.4
1595.7
1837.8
less interest
10.42
6.95
11.69
32.94
22.95
20.0
20.0
20.0
20.0
20.0
EBT
486.7
691.1
776.3
781.2
1207.9
1024.3
1182.8
1365.4
1575.7
1817.8
less tax
162.4
230.5
259.0
260.6
403.0
341.7
394.6
455.5
525.6
606.4
PAT
649.0
921.6
1035.2
1041.8
1610.9
1366.0
1577.4
1820.9
2101.3
2424.2
Cash Flow= PAT + Depreciation
729.2
1025.0
1165.9
1193.6
1776.1
1554.4
1792.2
2065.7
2380.4
2742.4
investment rate
3%
2%
4%
5%
9%
5%
5%
5%
5%
5%
less capital expenditure
87.01
73.19
233.12
366.32
684.24
718.5
754.4
792.1
831.7
873.3
Working Capital
1384.06
1893.42
2456.19
3015.1
3137.8
3637.8
4137.8
4637.8
5137.8
5637.8
change in working Capital
509.36
562.77
558.91
122.7
500
500
500
500
500
Free Cash Flow (FCF)
Free cash flow helps in measuring how much cash has been generated by business through operations after taking into consideration capital expenditure and change in working capital. The way of computing free cash flow is as follows:
EBIT = Revenue - Operation cost - Depreciation
PAT = EBIT - Interest - Tax
Free Cash Flow = PAT + Depreciation - Capital Expenditure - Increase in working Capital
Table 13: Calculation of Free Cash Flow
particulars
Year
2005-06
2006-07
2007-08
2008-09
2009-10
2011-12
2012-13
2013-14
2015-16
2016-17
EBITDA
577.29
801.4
918.65
965.96
1396.1
1232.7
1417.6
1630.2
1874.8
2156.0
Less Depreciation &Amortization
80.18
103.37
130.68
151.79
165.25
188.4
214.8
244.8
279.1
318.2
EBIT
497.11
698.03
787.97
814.17
1230.85
1044.3
1202.8
1385.4
1595.7
1837.8
less interest
10.42
6.95
11.69
32.94
22.95
20.0
20.0
20.0
20.0
20.0
EBT
486.7
691.1
776.3
781.2
1207.9
1024.3
1182.8
1365.4
1575.7
1817.8
less tax
162.4
230.5
259.0
260.6
403.0
341.7
394.6
455.5
525.6
606.4
PAT
649.0
921.6
1035.2
1041.8
1610.9
1366.0
1577.4
1820.9
2101.3
2424.2
Cash Flow= PAT + Depreciation
729.2
1025.0
1165.9
1193.6
1776.1
1554.4
1792.2
2065.7
2380.4
2742.4
investment rate
3%
2%
4%
5%
9%
5%
5%
5%
5%
5%
less capital expenditure
87.01
73.19
233.12
366.32
684.24
718.5
754.4
792.1
831.7
873.3
Working Capital
1384.06
1893.42
2456.19
3015.1
3137.8
3637.8
4137.8
4637.8
5137.8
5637.8
change in working Capital
509.36
562.77
558.91
122.7
500
500
500
500
500
Free Cash Flow
642.2
442.4
370.0
268.4
969.2
335.9
537.8
773.6
1048.7
1369.1
Cost of Equity (Discount Factor)
It is minimum required rate of return a company must earn to fulfil the expectation of shareholders. Ke is cost of equity and it is used as discount factor to evaluate the performance of new project and discount the future cash flow of company. Capital Asset Pricing Model would be used to calculate cost of equity. CAPM model provides frame work to determine the required return on an asset and indicates the relationship between return and risk of asset. For the common stock, required return is calculated with the help of CAPM. Required return is that return which an investor must earn to bear the systematic risk equivalent to Beta. Required return is generally cost of equity capital. Cost of equity capital (ke) tells us how much company is generating for its common stock holders. For computing ke following formula, could be used.
Required return = Risk free return + Risk premium * Beta of company
Ke = Risk free return + Risk premium * Beta of company
Beta =Co-variance of Cipla/ Variance of Market
Beta = 5.29/4
Beta = 1.32
Ke = 5 + 1.32(-0.06-5)
Ke = 4.92
Ke = 5%
Discount Factor = 5%
Discount factor is used to convert future values into present cash flows. Total present value of cash generated is Rs 34711.75 crores. The cash flows have been discounted at 5% discount rate which is computed through CAPM.
Table 14: Discounted Value of Free Cash Flow and Net Present Value of Cash Flow
2011-12
2012-13
2013-14
2015-16
2016-17
EBITDA
1232.7
1417.6
1630.2
1874.8
2156.0
Less Depreciation &Amortization
188.4
214.8
244.8
279.1
318.2
EBIT
1044.3
1202.8
1385.4
1595.7
1837.8
less interest
20.0
20.0
20.0
20.0
20.0
EBT
1024.3
1182.8
1365.4
1575.7
1817.8
less tax
341.7
394.6
455.5
525.6
606.4
PAT
1366.0
1577.4
1820.9
2101.3
2424.2
Cash Flow= PAT + Depreciation
1554.4
1792.2
2065.7
2380.4
2742.4
investment rate
5%
5%
5%
5%
5%
less capital expenditure
718.5
754.4
792.1
831.7
873.3
Working Capital
3637.8
4137.8
4637.8
5137.8
5637.8
change in working Capital
500
500
500
500
500
Free Cash Flow
335.9
537.8
773.6
1048.7
1369.1
Ke =5%
Present Value interest Factor
0.952
0.907
0.864
0.823
0.784
Discounted Cash Flow
319.948
487.811
668.298
862.777
1072.741
Net cash Flow Generated
3411.575
Terminal Value
Terminal Value includes future cash flows occurring beyond a particular year. The terminal value is calculated in accordance with a discounted cash flow analysis. Long term cash flow growth of industry is 2%.
Terminal Value = Final Year Cash Flow x (1+ Long term cash flow growth rate)
(Discount Factor - Long term cash flow growth rate)
= 1072.741(1+.02)/(5%-2%)
= Rs 36473.16 crores
Net Present Value = 36473.16/(1+05)5
= 36473.16* 0.784
= Rs 28594.95 crores
Enterprise Value = Terminal Value + Net Present value
= 3411.575+ 28594.95
= Rs 32006.525 crores
Sensitivity Analysis
It is the analysis carried out to find out the performance of the company during the period of uncertainty and risk. Long term projection of company cannot be done with accuracy. It is very important to analyse both worst and best performance of company. For the estimating worst/pessimistic case, growth rate for revenue considered was 10%. For Best scenario, growth rate considered was 20%. Normal scenario has been analysed with a growth rate of 15%.
Calculations in Appendix 6.
Table 15: Sensitivity Analysis for Cipla
Scenario
Net Present Value
Terminal Value
Discounted Terminal Value
Enterprise Value
Normal
3411.575
36473.19
28577.7
31989.28
Worst
2938.168
32643.41
25576.97
28515.14
Best
3884.983
40302.96
31578.43
35463.41
Conclusion
The valuation of Cipla has been done by various methods showing different value for the enterprise. Considering the limitation of all the methods, DCF method of valuation proves to be more reliable because of its consideration of free cash flow and future prospects of the company. The value obtained is dynamic and would vary depending on changes in the value of forecasted variables.
Though stock prices are readily available, investors would still like to know the right valuation of the stock prices. Most commonly used method is P/E multiple. It gives immediate assessment and comparability. However, let us consider the scenario of a market meltdown situation where valuation needs to be carried out.
P/E ratio relies on GAAP and accounting policy. It is useful only when compared with P/E ratio of peers in the same industry. P/E ratio is mostly useful in case of market stress. Earlier it was discussed that earnings depend on various parameters and that P/E has to be compared with other variables to provide true meaning.
Net asset value being historical in nature would not give investors a realistic view.
Discounted cash flow method relies on cash flow and weighted average cost of capital. It speaks about the actual tangible benefits to shareholders. It estimates true economic benefit. This approach is based on the cash flow from operations. We know that the projection about future cash flow is very dicey. It may not be hold good and has various factors to consider. However, Discounted Cash Flows use the adjustments for depreciation and amortization and increase/decrease in working capital/capital expenditure. Therefore, presence of free cash flows in calculating valuation helps in making DCF, a preferred method of valuation.
Hence the potential investors have to consider the value of Rs 31989.28 crores for their investment decisions on Cipla which is calculated using the discounted cash flow method for a normal growth rate.
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