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Imperial College Business School Imperial College London Private Equity Growth Investing in India Consumer Staples (FMCG) – Food and Beverage industry by Mr. Miraj Patel CID: 00998853

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Page 1: Private Equity growth investing model for Nestle India Limited

Imperial College Business School Imperial College London

Private Equity Growth Investing in India Consumer Staples (FMCG) – Food and Beverage industry

by Mr. Miraj Patel CID: 00998853

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Synopsis

Private equity is gaining much popularity within the financial world and more and

more funds are coming to the fore. The private equity business model is different to

banks as they focus more on growth through value creation compared to interest

income. The aim of this report is to primarily understand what private equity means,

the stages in private equity, valuation techniques, the difference to venture capital

and to then come up with a growth-investing proposal within the food and beverage

sub-sector of the consumer staples FMCG industry in India. To arrive at this

proposal, a thorough historical analysis of the Indian economy and consumption

levels its carried out and then followed by the understanding of the potential for

economic and consumption growth, key drivers of this growth, the trends shaping

the FMCG industry and the determinants for success within the FMCG industry.

After successful analysis and blending this analysis with the base lying concepts of

economics, strategy and finance, Nestle India is chosen as the best company to

invest in over the next 5 year horizon. A complete financial analysis of the company

with its projected growth is also depicted through this report.

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Index Chapter

No. Topic Page

number Acknowledgement 3

1 An Introduction to Private Equity 4 1.1 What is private equity? 4 1.2 A private equity fund 4 1.3 Objectives of a private equity investment 5 1.4 Differences between venture capital, growth capital and

late stage capital 5

1.5 Valuation methods in private equity. 6 2 The India Chapter 9 2.1 The Indian economy: a brief 9 2.2 The consumption story 10 2.3 Consumption downward spiral 10 2.4 The potential for revival 12 2.5 New government initiative: an attempt to revive 12 3 The Indian consumer staples (FMCG) industry 14 3.1 The industry overview 14 3.2 Trends shaping the FMCG industry 15 3.3 Industry analysis 16 3.4 Key growth drivers of the FMCG sector 18 3.5 Current trends in FMCG sector 20 3.6 FMCG sub-sector analysis 22 4 Growth Capital/Investing 26 4.1 Pre-requisites for growth investing 26 4.2 Financial comparative analysis 28 5 The Investment Proposal 30 5.1 The business model 30 5.2 Marketing mix 30 5.3 SWOT analysis 31 5.4 Financial projections 32 5.5 Financial shenanigans 33 6 Conclusion 34 References 35 Appendix i 39 Appendix ii 40 Appendix iii 41

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Acknowledgement The past one-year on the full time MBA at Imperial College Business School has

been a holistic experience for me. It was a an extremely enriching experience and

the program truly challenged me and polished various aspects of my personality

starting from concepts of economics, strategy and finance to the softer side of

ethics, governance and leadership. It offered me an opportunity to interact, work and

excel with students having different experiences and from various cultures. This

report stretched my abilities, pushed me to my limits and is a thorough reflection of

all my concepts, learning and skills. Firstly, I would like to thank my program director

Katja Ahoniemi for initiating and organizing the Perspectives on Practice thus giving

me an opportunity to reflect all that I have learnt over the past one year. This report

comes across as a blend of economics, strategy and finance and I am truly thankful

to all the professors involved in all the core modules which laid down the platform for

me to write this report. I would like to extend a special appreciation to my mentor for

this report Andreas. T Angelopoulos - professor of Private equity, Imperial college

business school and Mr. Hemant Patel – Managing partner, Alder Capital for always

supporting me through my analysis. My family has been a great support pillar,

especially my closest friend and colleague, Gulfy Suri, and it is all of the people

mentioned above that have made this year to be a successful and a one never to

forget.

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1 An Introduction to Private Equity

1.1 What is private equity?

‘Private’ can be referred to as the risk capital that is provided outside the capital

markets. The word ‘private’ has got nothing to do with keeping anything as a secret;

it simply contrasts with the ‘public’ quoted markets.

‘Equity’ on the other hand can be described as an umbrella under which you can

find a range of financial instruments that enable you an equitable share in the profits

and losses of a business. Equity, under the phrase private equity, has a broader

meaning – the total amount of capital that is put both, at the risk of loss and a share

in any capital gain.

1.2 A private equity fund

A private equity fund can be defined as a cluster or a club which comprises of

institutional investors such as pension funds, insurance companies, endowment

funds, investment funds, banks, family offices, high net worth individuals (HNI) as

well as the private equity fund managers themselves. The objective of a private

equity fund is to invest in equity or risk capital in various or a range of companies

generally known as a portfolio of companies with a view to primarily generate capital

gains/ profits from the sale of investments rather than from fees, dividends and

interest payments. A private equity fund typically may take a minority or majority

stake in the businesses where seed, early and growth capital would be the former

and leveraged buyouts would be the latter. The term leveraged is used when some

other form of debt capital is raised in order to fund the investment.

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A snapshot of a typical private equity fund – image available [online] from:

https://upload.wikimedia.org/wikipedia/commons/thumb/a/a3/Private_Equity_Fund_

Diagram.png/350px-Private_Equity_Fund_Diagram.png

Objectives of a private equity investment Any and all investors wish to make returns. Returns could be in form of income,

interest, and dividends or by sale of a particular investment when it has been made

more valuable. The motive of private equity is to buy stakes in businesses, actively

manage those businesses and then take the gains through sale or IPO once the

business has increased in value. Private equity is predominantly about generating

capital gains and is focused on increasing shareholder value.

1.3 Difference between venture capital, growth capital and late stage capital

Private equity involves investing in businesses from the early stage venture termed

as venture capital investments where the investee company is at a fairly nascent

stage and in the early years of its incorporation, growth and development capital

where the investee company is looking at new market expansion/penetration or

competitor acquisition and finally late stage capital or what we call a buyout where

the fund buys a majority stake and then carries out a complete operational

turnaround to create value.

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Source lecture notes, Prof. Andreas T Angelopous, Private Equity and

Entrepreneurial finance. Imperial College Business School.

The image above shows private equity financing on the time line starting from early

stage to late stage capital. In seed finance, start-up finance and growth capital

financing, the venture capital fund or private equity fund takes a minority stake in the

business and it is usually all equity financed. Leveraged buyouts and specialized

finance investments are usually at a late stage in the life of a business where the

private equity fund takes majority stake, usually >2/3, and the investment is financed

with a certain ratio of debt and equity.

1.4 Valuation methods in private equity Prior to investing at any stage, a private equity fund has to value the investee

company and assess whether it will be a profitable investment or not. In other

words, it is critical to assess whether the company is valued at par, over valued or is

it undervalued. The private equity fund therefore assesses the enterprise value and

the equity value of the company.

Enterprise value: it can be defined as the total value of the entire company which

takes into account the market value of equity, debt and offsets the cash.

Enterprise value (EV) = Market value of equity (Market cap) + market value of debt

– cash

Equity value: it can be defined as the total value of outstanding shares of the

company. In other terms it is simply the market capitalization.

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Equity Value (EqV) = Market value per share x Number of shares outstanding.

Enterprise value is more widely used in private equity as when the value of the

company is driven by its capital structure and enterprise value takes into account

both equity and debt.

There are various valuation methods used in private equity.

Price of a recent investment:

Under this type of valuation, the instrument of a company is valued under the

implied market value of the company under that round of the investment. First time

investments are usually valued at cost and further investments may be valued at the

price of the last investment.

Earning Multiple:

This is probably one of the most common and widely used method of valuation

within the private equity space. An array of multiples can be used such as Price to

earnings (P/E) multiple, EBIT multiple (EV/ earnings before interst and tax) or

EBITDA multiple (EV/ earnings before interest, tax, depreciation and amortization).

These can be calculated based on historical data, current financials or projected

incomes of the company. It can be safely said that this is one of the most effective

way to value the company as we can assess the multiple the company is trading at

in the market compared to its competitors.

Valuation  methods  

Price  of  a  recent  investment  

Earning  multiple    

Net  asset  valuation    

DCF  of  the  company  

DCF  of  the  investment    

industry  benchmarks  

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Net Asset Valuation:

This is generally used when a business is not profitable and with those businesses

that deal in purchase and management of fixed assets. Thus these companies are

valued with reference to their net asset value of tangible assets. Goodwill created by

acquisition is normally excluded.

Discounted Cash Flow (DCF) of the company:

The present value of any asset is the value of the future cash flows of the asset

discounted back in time by a discount rate till the cash is received. This is a very

sensitive method of valuation as it is based on various assumptions such as

discount rates, WACC (weighted average cost of capital) and the timing of cash

receipts. In addition, there is a risk of over-valuation as it is assumed that the

business will be a growing perpetuity and the terminal value drives up the valuation.

Discounted cash Flow (DCF) from the investment:

An investment that generated most of its returns from predictable cash payments

and not majorly from terminal payment at sale, DCF valuation could be more

accurate. The NPV (net present value) rule applies where a positive NPV means

that the investment will generate cash over and above the investment and a

negative NPV implies that the investment is loss making.

Industry benchmarks:

This form is valuation is usually used by venture capitalists for start-up companies

that do not have any historical financial statements. For example the value of a

social media company can be computed by the value per user if it is user driven. It

is very difficult to assess accurately the value of a company using industry

benchmarks as it moves away from future cash generation and there is lack of past

financial performance.

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2 The India Chapter

For this report, the main area for focus will be the Indian consumer staples sector

(FMCG) and to compute an analysis of the most promising company to have a

growth investment in over a five year horizon.

The FMCG sector, historically categorized as non-cyclical in nature, is composed of

companies whose primary lines of business are food and beverage, household

items, beauty & care and tobacco. In an event of an economic downturn, the

demand for these products does not witness a drastic slow down. If the demand for

staples does not grow by much the producers have very few options to raise their

stock prices – reduce price to gain more market share, reduce cost, or differentiate

their products.

Investing in the FMCG sector could be boring to some people due to the unflashy

characteristics of the industry and a lack of windfall gains. Despite this, the FMCG

sector does provide the investors with an opportunity to diversify their portfolio in

terms of capital risk, as it is a relatively easy sector to understand, has a low beta

and a low correlation to the market.

2.1 The Indian economy: A brief

13 years after China, in 1991, India started off on its journey to economic revolution.

Dr. Manmohan Singh, the finance minister then, was in charge to save the country

from bankruptcy. India’s economic growth has accelerated ever since over the past

quarter of a centaury and so has the spending power of the citizens. Real average

household disposable income has roughly doubled since 1985 and with rising

incomes and increased household consumption, a new middle class has emerged.

[McKinsey global institute, 2007]

India has witnessed a significant economic growth in the recent past, growing to

7.3% in 2015 from 6.9% in 2014. The reforms initiated by the Indian government to

improve the economic fundamentals like FDI, RBI’s inflation focus have all

contributed to this rapid growth in 2015. Today, India ranks seventh globally in terms

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of GDP at current prices and is expected to grow at 7.5% in 2016 [IMF World

economic outlook, 2015].

2.2 The Consumption story

The growth of household consumption in any economy depends on various factors

such as growth of private disposable income, population demographics, extent of

urbanization, sensitivity of interest rates, availability of credit and finally the inflation

as it affects the real purchasing power of the consumer. Pre 2008 crisis, it was all

rosy for the Indian economy as the private household consumption was on the rise

year on year. The consumer spending kept on increasing even in the post crisis

period (2007-08 to 2011-12) because of the surge in discretionary spending which

was driven by low interest rates, increased government spending (effect of the 6th

pay commission), improved trade, increased employment in the non-farming sectors

and a boost in the rural income. Household consumption contributed to

approximately 57% share in the total GDP till 2011-12 and was growing roughly at a

rate of 7-8% each year. However, since 2011-12, the GDP growth has plateaued

out a bit due to a slump in household consumption.

2.3 Consumption downward spiral

It is critical to understand what caused a slowdown in the household consumption.

Inflation could play a major part, high interest rates or even a dip in the growth rate

of GDP. The slowdown in consumption poses a huge threat to drag down the Indian

economy. In 2012-13 the household consumption had a growth rate of 4% which is

quite modest compared to 2011-12 where it was 7.9%

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Source: The Hindu Business Line [online] available from:

http://www.thehindubusinessline.com/opinion/the-falling-consumption-

story/article5029404.ece

Further analysis of the situation showed that the inflation had remained fairly high,

which reduced the real purchasing power of the consumers. To curb inflation, the

Reserve Bank of India (RBI) kept the interest rates high. To counter high interest

rates, the consumer borrowing dropped and the rate of savings increased causing

the consumption expenditure to fall.

Moderation of household disposable income does not affect the demand in all

sectors equally. For example, the consumer staples or FMCG industry did not

witness a drastic drop in sales due to the inelastic nature of demand, but, however,

increased household disposable income does contribute to increased demand in the

FMCG industry. Industry like luxury goods and consumer durables to get affected as

the demand for theses products can be put on hold in times of tough economic

situations.

The consumption is also affected by factors from outside the economy. For

example, if consumers perceive that the economic scenario outside of India will

remain bleak too, there will prevail overall pessimism, which will impede the growth

of consumption.

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2.4 The potential for revival

The Chinese slowdown, falling international price of commodities and a better

monsoon in an agricultural driven economy like India will help curb inflation to some

effect. The continuous depreciation of the rupee may restrict the RBI’s agenda of

interest rate cut but it means that local business can benefit from exports.

The rural expenditure, however, in this situation comes as boon as it is still pretty

robust. The occurrence of numerous festivals and a decent performance of the

farming sector are some positives.

The earlier growth rate of around 8% in household consumption is unlikely to return

in 2013-14, but a mild recovery can be expected from the formation and

implementation of new policies and the composition of the annual budget.

2.5 New Government initiatives: an attempt to revive consumption

Although there are number of initiatives that the newly elected government, under

the leadership of Prime minister Mr. Narendra Modi, has taken in an attempt to

boost consumption, there are a few key initiatives which have really had a telling

impact.

Foreign direct investment:

The new government has eased the FDI policy to aid competition domestically. As

per the earlier policy, any international business must have an Indian partner, a

Foreign Direct Ivestment

Abolshing of Licencing

Tax reforms

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50/50 joint venture, if it were to operate within the domestic boundary of India. As

per the new policy, international companies can set up businesses and operate as a

sole ownership without requiring any Indian partnership. As a result, there has been

a huge inflow of foreign capital in terms of cash as well as technology. It has

increased competition amongst the major market players and has reduced overall

prices.

Abolishing of Licensing:

New businesses have to obtain fewer licenses if they were to set up and operate

within the country. Earlier obtaining multiple licenses was vey painstaking hence it

restricted the establishment of newer and smaller business. The relief afforded by

the government has not only increased the number of new businesses set up but

also significantly boosted the employment rate.

Tax reforms:

One of the major changes has been made to the tax exemption limits. The tax

exemption limits have been raised, meaning there will be considerable rises in the

level of personal disposable income that will aid consumer spending. Indirect taxes

such as central excise, state VAT, entertainment tax, luxury tax, and octroi have

been major deterrents in the transfer of good and services. They hamper the

manufacturing industry adversely. GST will subsume all these taxes to ensure a

smoother functioning and exchange of goods and services. Finance minister Mr.

Arun Jaitly, in his recent interview with Doordarshan in May 2015, predicts that the

newly introduced tax reforms will fuel the economic growth by 9-10%.

Post the new reforms implemented by the government and according to the mid-

year update of the United Nations World Economic Situations and Prospects, the

Indian economy is expected to grow at 7.6% in 2015 and 7.7% in 2016. As reported

by the IMF, this growth is a consequence of increased investor confidence in the

economy, lower overall food prices and improved policy reforms.

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3 The Indian Consumer Staples (FMCG) industry

After concluding that the Indian economy has started seeing a bullish trend and the

consumer spending is beginning to rise as a residue to the new government

reforms, an analysis of these trends on the FMCG industry is critical prior to

devising a robust growth investment model.

3.1 The industry overview

The FMCG, fast moving consumer goods, is the fourth largest sector in the Indian

economy. The overall market is estimated to increase at a compounded annual

growth rate (CAGR) of 14.7% and is estimated to touch approximately US$ 110.4

billion by the end of 2020. It accounts for roughly up to 2.2% of the country’s GDP

and it currently witnessing a high growth rate by favorable macroeconomic

conditions, an increasing urge to consume and increasing rural incomes.

Sub sector analysis show that food products lead the market segment and account

for 43% followed by personal care, tobacco household care and others at 22%, 16%

5% and 10% respectively.

FMCG revenues by segment (% share) – 2013 [online] available from:

http://www.slideshare.net/iimjobs/india-fmcg-sector-report-may-2014

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3.2 Trends shaping the FMCG industry

Key trends shaping the FMCG industry [Booz & Company 2010] [online] available

from: http://www.strategyand.pwc.com/media/file/CII_FMCG-Roadmap-to-2020.pdf

Consumer related trends:

India is composed of a diverse group of consumers with changing demographic

profiles. These two together brew up some mind-boggling diversity in terms of

consumption trends and patterns. Firstly, consumers are varying of prices in their

search for additional functionality, durability and brand promise. Emergence of new

products and new product categories has also contributed to a change in tastes and

preferences. Finally, businesses are now serving customers with customized

services with which they arte trying to gain customer loyalty in their quest to achieve

more market share. [Booz & Company, 2010]

Market related trends:

These are in context to the evolving geographical markets or the various channels

of distribution available to the FMCG players. The emergence of sub-markets in

India, the growing retail segment and the globalization of FMCG players will

contribute to this trend. FMCG players must keep a close eye on the market trends

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and adapt their products and services, go-to-market strategies as per the evolving

needs in order to stay competitive within the market. [Booz & Company 2010]

Environmental related trends:

These refer to the introduction and evolution of new technologies, legal systems,

government polices and socio-political landscape. FMCG players will have to

continuously adopt their business strategies to keep the interest of the communities

and the sustainability of the environment. [Booz & Company, 2010]

3.3 Industry analysis

An industry analysis is essential to understand the dynamics and the profitability of

the industry. A deep understanding of these dynamics will enable companies or new

entrants to come up with an appropriate strategy.

Prior to devising a growth investment strategy, it is also necessary to understand

these dynamics, as they will drive the performance of the companies in the industry.

a five potter analysis of the FMCG industry [online] available from:

http://www.ibef.org/download/FMCG-August-2015.pdf

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Competitive Rivalry:

There are lots of players within the market – private as well as MNC’s. The private

label brand products are usually priced at a discount to the mainframe brands. This

limits the competition for the weaker brands. In addition, the industry is becoming

highly fragmented due to the influx of more MNC’s post the FDI reform introduced

by the new government.

Threat of new entrants:

Success in the FMCG industry majorly depends upon the market reach and

branding. The more market share you want to capture, the more investment is

needed to set up distribution networks and on aggressive advertisement. This could

be a possible repellant for the new companies with limited financial resources that

are looking to enter this vast market.

Substitute products:

There is an array of options for the consumers to choose from due to the presence

of multiple brands with very narrow lines of product differentiation. Cost

differentiation is the primary factor now days with the consumer becoming more and

more price sensitive. There is a huge price war within the industry.

Bargaining power of suppliers:

A wide pool of local commodity suppliers enables the big FMCG companies to

dictate sourcing prices. The suppliers in this industry are only rising, as they are

attracted towards the volume of demand.

Bargaining power of customers:

Switching costs are low from one brand to another, which keeps the consumers on

their toes if there is any deterioration in the product or service offered to them.

Marketing strategies play a big role in gaining customer loyalty. Consumers are

exposed to an abundance of similar alternatives offered by different brands, as there

is low product differentiation.

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3.4 Key growth drivers of the FMCG sector

As per a report by Eidelweiss in May 2015, the FMCG sector has seen growth not

only in EBITDA margins but also in volume of sales. Price hikes were seized as the

FMCG companies passed on benefits to the suppliers. Some key drivers to this

revival of growth are GDP growth, population growth, per capita income growth,

lifestyle changes and the implementation of new government policies.

GDP growth:

An increase in the GDP growth in the country has increased the employment

opprtunites in the economy which has led to increase in income levels of

consumers. Inflation comes under control and there prevails and air of optimism in

the entire country. This in turn increases the domestic demand for good and

services. In India, approximately more that 50% of the GDP is consumed internally.

Population growth:

As per reports by the CIA (central intelligence agency) publised in August 2015,

28.09% of the poulation agest between 0-14 years and majority of the population,

58.80%, is between the age of 15-54 years leaving a small chunk of 13.11% over 55

years of age.

current age structure in india [online] available from:

https://www.cia.gov/library/publications/resources/the-world-factbook/geos/in.html

Majority of the population is young who earn and spend – a prerequisite for growth.

As more and more young people join the workforce, their dependency on the aging

population decreases. There are fewer aged people in India compared to most other

countries thus decreasing burden on the youth and leaving more money in its hand

to spend.

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Key drivers for growth:

Source: booze & company, 2010 [online] available from:

http://www.strategyand.pwc.com/media/file/CII_FMCG-Roadmap-to-2020.pdf

Per capita income growth:

The income per capita is expected to grow at more than 15% over the next 5 years

meaning higher personal disposable income. Modern trade in tier II/III cities is

increasing. Growing income is increasing the demand for goods and services within

the country.

Lifestyle changes:

With the wave of modernization and urbanization hitting India, more and more

people are willing to spend on newer products. The income level of the rural

population is growing and they are keen to come toe to toe with the urban

population. A currently low penetration level and the growing demand for premium

food & beverage, tobacco, personal care ad healthcare products in the rural market

offer much room for growth.

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New government policies:

The new government has approved up to 100% foreign equity in single brand which

is huge boost for international businesses looking to step foot in India. Abolishing of

extra taxes and having a unitary tax law (GST) makes transfer of goods and

services easier. Food Security bill and direct cash transfer subsidies reach about

40% households in India [IBEF, 2015]

3.5 Current Trends in the FMCG sector

The correlation between the dynamics within the FMCG industry and the growth

drivers is what shapes the current trends within the FMCG industry.

Some notable current industry trends are as under.

Product innovation:

After a fairly saturated industry with similar products, FMCG companies are starting

to innovate their products with an aim to achieve a product differentiation

advantage. Product differentiation gives an added dimension to competition.

Customized products:

Due to the enhanced knowledge about products and services and with a wide

variety of products to choose from, the consumers have started to demand products

and services catering to their individual needs and preferences. This is very

challenging for the FMCG companies as it is difficult to tailor products for a very

vastly scattered consumer profile.

Brand conscious consumer:

As the disposable income rises, the consumers are becoming more and more brand

conscious. In addition, the society is moving towards a brand culture where using a

branded product or service relates to a certain level and class in the society. FMCG

companies thus have to spend aggressively on advertising and creating a strong

brand image.

Backward integration:

With not much room to play when it comes to product differentiation and with very

similar products offered by all companies, the only way to increase the profits is to

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backward integrate, meaning, reduce internal costs. FMCG players have gone into a

cost cutting spree in order to attain a cost advantage.

Spreading the distribution network:

The only way to reach the mass markets is to expand the distribution network. In the

FMCG sector, the consumers have an upper hand and are not going to make an

effort to search for products. The onus lies in the hands of the companies to reach

the consumers if they are to access the mass markets and sell bulk products.

Outsourced manufacturing:

This trend is seeing a major upside as third party manufacturing enables the FMCG

companies to concentrate more on the market entry strategies and they can more

efficiently utilize their resources in branding and aggressive advertising. It also

enables them to keep the prices of products low as smaller manufacturers have

fewer overhead costs hence it turns out to be much cheaper to source from outside

rather than produce on their own.

Demand for smaller sized packages:

The price sensitive Indian consumer is beginning to prefer one-time use products.

Tastes and preferences can change continuously hence smaller sized products

means that they can switch easily without worrying about any wastages. This is

good from the FMCG companies’ point of view. A smaller sized package allows

them to keep the prices low as well as keep their margins intact.

Rural market focus:

The rural market contributes to about 50% of the total FMCG market [IBEF, 2015] A

major chunk of the FMCG product demand and the volumes lie in the rural markets

with the ever-increasing income levels, literacy rate and awareness about the

products available in the market.

The successful FMCG companies over the next 5 year horizon are the ones that will

effectively be able to adapt and cater to the above mentioned market trends.

It would be unfair to decide a company for a growth-investing plan based on the

above market trends and growth drivers of the FMCG industry as the FMCG sector

is comprised of many subs-sectors in which various companies operate. Different

products drive the profitability of these companies for example. P&G ‘s profitability is

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driven by household care and personal care products, ITC’s by tobacco products

and Nestle’s by Food and beverage products. Each of the subsectors has varied

dynamic and trends based on the political, economic, technological and social

factors. An in-depth analysis of these sectors will better put us in a position to

narrow down to a company with the highest growth potential.

3.6 FMCG sub-sector analysis

For simplicity, the FMCG sector can be categorized under 3 major sectors – Food

and beverage, Household and personal care and tobacco and others.

Food and beverage has majority of the share with about 47% followed by household

and personal care with 27% and tobacco and others with 26%.

Food and beverage v/s Household and personal care v/s tobacco and others:

Subsector /

Factors

Food and

beverage

Household and

personal care

Tobacco and

others

Political

-Post the 100%

FDI reform,

government

predicts an

investment of

$21.9 billion.

-New regulations

to address supply

chain

inefficiencies.

-Introduction of

incentive schemes

and training

programs to

encourage

employment.

- 100% FDI

promotes the entry

of more

established foreign

companies.

- Although licenses

are reduced, key

licenses are

required to set up

operation plants.

- Essential to

comply with health

and safety

standards.

- Highly regulated

industry.

- Licenses are very

difficult to get.

- Government has

started anti

tobacco and

alcohol campaigns.

- Sale of certain

items is banned

within the country.

Economical - India is an

agricultural driven

- Certain raw

materials need to

- Very high taxes

are levied on

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  23

economy;

agriculture

contributes about

70% towards GDP.

- Diverse agro-

climatic conditions

promote cultivation

of different crops.

- Rising exports

keep the demand

for Indian

agricultural

products on a high.

- Concession on

import duties,

exemption of

central excise on

several items,

service tax

exemption helps

keep the prices of

food low.

be imported hence

prices are

adversely affected

by the fluctuation

in the foreign

exchange rates.

- Influx of MNC’s

has resulted in

reduced business

opportunities for

the local players.

- There has been a

rise in M&A

activities where

Indian companies

are being taken

over by

multinationals.

- MNC’s command

the prices.

companies.

- Huge source of

revenue for the

government.

- Large amounts of

black money in

circulation within

the economy.

- Advertising of

tobacco products

and alcohol is

banned.

Technological

- New machines

and techniques for

crop harvesting

and cultivation help

increase yield and

reduce costs.

- Introduction of

organic fertilizers

keeps the yield

young and healthy.

- Newer and better

techniques of food

processing

increase turnover

- Foreign

technologies are

being imported by

bigger players,

which immensely

drive down the

costs of

production.

- Not much scope

for product

innovation as the

market is saturated

by a wide variety of

similar products

- Fairly

straightforward

processes for

manufacturing of

tobacco and

alcoholic items.

- Tobacco is a very

labour intensive

industry.

- Branding and

market

segmentation is

key to growth.

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  24

and reduce end

prices.

and product

functionalities.

Social

- Rising disposable

incomes,

urbanization,

young population,

nuclear families

and increased

consumption is

increasing the

demand for food

products.

- Inflow of foreign

food retail brands

and an increased

variety in food

products coupled

with changing

consumer

preferences drive

up the demand.

- People are

getting more and

more aware of

their personal care

and hygiene.

- Rising disposable

incomes is

increasing

consumption of

care products but

the consumers still

are very price

sensitive.

- More and more

people are

becoming aware

about the ill effects

of consuming

alcohol and

tobacco.

- Consumers have

restricted their

consumption of

tobacco and

alcohol.

- More emphasis is

given to clean

eating and

exercising

Key players Pepsico, Nestle,

Britannia, Amul,

Parle.

HUL, P&G, Marico,

Emami, Dabur

ITC, united sprits,

Kingfisher

From the above comparison it is pretty evident that food and beverage is the

dominant industry within FMCG and is set to grow manifold by the changing

dynamics within the country with the new government reforms, rising incomes,

changing consumer preferences, new technologies and more and more availability

of products.

Key growth drivers for food and beverages:

Increasing domestic demand:

With rising incomes, changing lifestyle and food habits, urbanization and a young

population, the demand and consumption of processed food and beverage products

is set to double by 2020 [IBEF, Food processing, 2015]

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  25

Scope for greater exports:

India’s greater integration with the global economies, treaties with other countries,

proximities to key export destination and an increased global demand for food

products from India fuel the domestic demand for the processed foods industry.

Efficient food supply:

Better expected monsoons, wide variety of cultivated crops, a long coastline for

marine products aid the food and beverage industry as the prices of materials are

low which enables Indian companies to remain competitive on the global landscape.

Policy reforms:

Mega food parks and agricultural export zones are attracting FDI to aid

infrastructure development. The approval of the National Mission for Food

Processing comes as a boon for the industry as it promotes operational processing

facilities, provides training for skilled development and capacity up gradation, aids

supply chain logistic and supports the organized food sector.

To narrow the investment proposal down to one company within the food and

beverage industry, it is essential to execute a preliminary financial analysis with a

due diligence of the business model and vision of the major players.

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  26

4 Growth Capital/Investing

Growth capital/investing can be defined as the mid-way point between venture

capital and buy-outs. Growth capital is structured to facilitate the target company’s

already accelerated growth by expanding operations, entering and tapping new

markets or even completing strategic acquisitions. Capital is provided to mature

businesses with proven business models and those having a track record of sales,

costs and profits. Growth equity is not as predominant as venture capital or buy-

outs, however, if the transaction is properly sourced, diligenced, negotiated and

executed, growth capital can provide investors with a lower risk adjusted cost of

capital.

4.1 Pre-requisites for growth investing

Prior to providing growth capital it is extremely essential that an investor assesses

and carries out a thorough due diligence on certain key elements of the business.

The key elements can be discussed as follows:

The business model:

The business model is probably one of the most important elements to be

inspected. It is essential to understand the type of activity carried out (manufacturing

or service), the product or kind of service offered, its uniqueness and sustainability.

In addition, the most compelling part of the business model should be looked at, that

is, what is advantage does the business model offer – cost advantage or product

differentiation

Management team:

A successful, profitable or unique business model can be ruined if a strong

management team does not manage it. At times, it is the faith in the management

that drives the investment process as a strong, skillful experienced and cohesive

management team can even turn a mediocre business model into a profitable one.

Target market:

A sound business model and a strong management team will be a complete waste if

the company does not adhere to the right target market. It is important to

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understand the value add to the customers by the product or service offered by the

company. For example, if nike targeted cricket fans for its range of football shoes,

no matter how highly performing and efficient the shoes may be, it will be difficult to

sell them.

Market volume and growth rate:

Market volume and growth rate is directly related to the demand, which is directly

affected by the disposable income and consumption levels of individuals. The level

of disposable income is currently increasing in India and with urbanization and a

rising rural population; the consumption levels are also on the rise within the FMCG

sector.

Business protection:

Patents and licenses protect the business model or products and services from

being easily replicated. Usually businesses having any sort of patents or those

operating within strict regulations are more prone to attract any sort of investment as

competition is low which is key to profitability.

Competitor mapping:

An analysis of the competitors of the target company is necessary and it is crucial to

understand their business model, target market, pricing strategies too. The target

company should be assessed against its competitor on the value curve, as that is

key determinant of the competitive advantage, which in turn affects the revenues of

the company. Higher the competitive advantage, more the chances of higher

revenues.

Financials and the trading multiple:

The historical income statement, balance sheet and cash flows of the target

company should be analyzed with respect to the market environment to judge the

performance of the company. Generally, cash flows are the true determinants of the

value of the company. Operating margins must be assessed to understand the

efficiency of the business. The rationale behind understanding and analyzing the

trading multiple (EV/EBITDA, EV/Sales or EV/EBIT) is to determine whether the

company is trading at par, premium or a discount with respect to its book value.

Generally, most FMCG companies trade at a premium due to high demand for its

stocks. The trading multiple also helps us understand the level at which the target

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  28

company is trading in the market against its competitors. All these factors are

essential in making the investment decision.

Exit potential:

Growth investing is usually done for a period between 3-5 years after which any

investor seeks a profitable exit. Investments are made generally made only in those

companies having a strong business model with a good growth rate of sales and

profitability. The IRR (internal rate of return) that investors look for at the time of exit

varies from investor to investor and from fund to fund, however an investment

yielding IRR of 20-25% per year can be considered to be a good investment.

Keeping in mind the pre-requisites of growth investing, the companies that are

seeing stable growth are namely Nestle India, Brittania, GlaxoSmithKline Consumer

& Healthcare and Parle Agro.

All the mentioned companies have strong business models, target markets, go to

market strategies, growth prospects and rank amongst the top five food and

beverage companies within India.

A brief analysis of the financials of these companies will further help us narrow down

our choice to the one company which has the most potential for growth over the

next 5 years.

4.2 Financial comparative analysis In million INR

Nestle India Britannia GSKCH

Net revenues 98,548.40 63,422.10 50,754.80

Operating profit (EBIT) 17,925.50 5,426.20 10,160.72

OP % of sales 18.19% 8.56% 20.02%

Profit after tax 11,846.90 3,698.30 6,747.46

PAT % of sales 12.02% 5.83% 13.29%

EPS 122.88 30.84 160.46

P/E 51.95x 59.67x 26.80x

Share price 6384.00 1,840.10 4,300.35

Outstanding shares 96.41 119.92 42.05

Enterprise value (EV) 654,699.54 228,584.39 181,370.00

EBITDA 21,300.90 6,060.00 10,786.18

EV/EBITDA 30.74x 37.72x 16.82x

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  29

From the above comparative analysis, it is pretty evident that Britannia does not

match up to Nestle and GSKCH in terms of revenues or operational efficiency.

Nestle and GSKCH have much superior operational ratios as a percentage of sales

at 18.19% and 20.02% respectively, meaning, these two companies are able to

extract more profits by carrying out efficient operations and by keeping the costs

low.

Nestle and GSKCH have very attractive earnings per share (EPS) of INR 122.88

and INR 160.46 thus making these companies very lucrative in the eyes of the an

investor. Profit after tax is generally not taken as a benchmark to drive investment

analysis and company valuation decisions as the PAT is derived from the income

statement and is bi-product of various accounting assumptions.

Britannia has the highest EV/EBITDA multiple of 37.72x thus making it the least

attractive company for investment. Lower the EV/EBITDA multiple, the better the

investment opportunity, however, other growth drivers such as market share, brand

presence etc. should also be considered before making an investment decision.

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5 The Investment proposal

After detailed financial analysis and taking into account the macro and micro

economic factors, Nestle India Limited pans out to be the most lucrative investment

opportunity.

5.1 The business model

Nestle India has consistently followed its vision and ambition of being a recognized

leader in health, nutrition and wellness in India. It has a strong portfolio of brands, a

capable and talented team and commands immense trust and loyalty of consumers.

It targets the needs of the consumers very effectively and evolves the product

portfolio to match the consumers’ needs. As quoted by the Managing Director, Mr.

Etienne Benet “As a company we maintain high standards and values. Stakeholders

have seen that we are ethical and responsible with strong business principles. In

fact, the way we do business is to Create Shared Value.”

Nestle India has its own manufacturing plants for its products which enables them to

keep maintain the highest level of quality at all times. Its distribution channel and

network ensure availability of its products in the most remote areas of the country.

Nestle has currently invested heavily to increase production capacity to in order to

stay toe to toe with the increased demand.

5.2 Marketing mix

Products:

Nestle operates with 4 different strategic business units namely beverages, milk and

milk products, pre cooked dishes and chocolates. The main brands that sell under

these categories are Nescafe, Maggi noodles, Kitkat etc.

Price:

Price is dependent on the individual market for each product. Nescafe and maggi

are clear leaders and are the cash cows of the business. Nestle has adapted a

consumption or packaging based pricing which enables a consumer to chose which

ever size product they want based on their consumption.

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Placement:

A typical distribution channel is adopted by Nestle. (Manufacturing - C & F agent -

Distributors - Retailers - Consumer). It targets bulk distribution and takes a lot of

care of the players in its distribution network by introducing trade discounts.

Promotion:

Nestle’s promotion techniques are very creative, innovative and witty. For example,

Nescafe focuses on the value of good things in life, kit-kat focuses on “take a break”

and maggi focuses on moments you had with your maggi. Nestle really hits the

ground running with its sales promotion and focuses on its power brands which are

Nescafe, Kitkat and Maggi.

5.3 SWOT analysis

Strength

-Strong brand presence

-Excellent distribution network

-Nescafe and Maggi are the most

powerful brands

-Competitive pricing and value

packaging

Weakness

-Difficult for Kit-Kat to beat Cadbury

-Low margins and penetration for the

milk products.

-Seasonal demand for some products.

Opportunity

-Growing demand for food and beverage

products driven by rural population.

-Overall economic growth leading to

increased disposable income and

consumption.

-Tremendous scope for expansion in the

cold dairy space.

-GST will enable smoother transfer of

products to the end consumer.

Threat

-Price fluctuations due to the devaluation

of the rupee.

-Some materials are imported

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5.4 Financial Projections

Income statement: (Appendix i)

We can see that Nestle India saw very high growth rates in 2009, 2010 and 2011 as

the economy and the GDP was very strong at that time. The growth dipped to

10.91% in 2012 and further down to 9.20% and 8.28% in 2013 and 2014

respectively as the economy was going into a downward spiral (refer 2.3) and with

restricted growth in the personal disposable income, the Indian consumer was being

very cautious about its consumption.

As discussed earlier in the report under 2.4 and 2.5, the new government reforms

have significantly boosted levels of personal disposable income between both the

rural and urban population, more importantly the rural population, which is now

resulting in an increased demand of food and beverage products. The company

may not reap the benefits of this increasing demand immediately thus expecting a

growth rate of 10% in 2015, however, this increase in consumption and demand will

have a trickling effect and it is expected that the company will hit again growth rates

of 20% by 2019.

The percentage of gross profits have been fairly stable in the lower 50’s with raw

material, packaging, processing and stocking accounting to nearly 45%. These are

pretty healthy margins to be operating on in such a price sensitive and competitive

industry. The EBITDA margins would see a marginal increase from 20.72% in 2014

to 21.50% in 2019. There will be no interest payments from 2015 onwards as it is

expected that the company has paid off almost all of its debt by year-end 2014.

Depreciation is estimated at about 6.5% of the gross block for the coming years. It

has averaged about 6.5% over the past 3-4 years.

Cash Flow statement: (Appendix ii)

Nestle has seen steady cash flows over the past few years. The cash flow is

expected to grow from INR 511 crore* in 2014 to approximately INR 6787 crore in

2019. This is a result of effective operations, reduced capital expenditure, optimum

asset utilisation and decreased working capital requirements.

The working capital requirements for Nestle are expected to decrease from about

1.84% in 2014 to about 1.5% in 2019. This decrease in requirement of working

                                                                                                               * INR 1 crore = INR 10 million

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capital is due to an improved debtor turnover ratio. Cash recovery from debtors is

expected to be quicker in terms of days.

Nestle has invested heavily in capital equipment to boost production capacity in

anticipation to match the increasing demand. A huge amount of approximately INR

1559 crore and INR 979 crore was made in 2011 and 2012 respectively. No further

significant expenditure is expected to be made in the coming few years till 2019.

Interest payments have virtually come close to zero as most of the debt is paid off

by 2014 with only about INR 20 crore, which is paid off in 2015. Nestle believes in

its philosophy of taking care of its shareholders and hence as a company policy,

dividends of about 45% of profits after tax are taken into account. In all, Nestle is a

steady cash generating company over the next 5 years.

5.5 Financial shenanigans

The impact of the increased sales, steady growth in profit and cash flows puts

Nestle in a commanding position and has boosted the overall value of the company

(Appendix iii). At present the company is has a EV/EBITDA multiple of 30x which

means it is expensive to invest in this company, but future growth potential shows

that it is worth taking this risk.

The market cap of the company is expected to increase from INR 61514 crore in

2014 to INR 128218 crore in 2019 with the Price to earnings (P/E) multiple

remaining constant at 52x in both these years. This means that the company is

seeing organic growth and that it is safe to invest.

It is assumed that the company does not issue any more shares from the period

2014 to 2019 and the total number of shares are 9.64 crore. The increased profits

have significantly boosted the earnings per share (EPS) from INR 122.9 per share in

2014 to INR 256.98 per share in 2019.

The asset turnover ratio, meaning, sales generated per every rupee invested in

assets is constantly on the rise. This means that the operations of the company are

becoming more and more efficient over the years and without having to make any

more capital investments. The ratio is expected to improve from 3.45 in 2104 to 7.92

in 2019.

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6 Conclusion

The Indian economy has had a wavy past few years with the decline in GDP,

extraction of foreign capital, high rates of inflation, decreased personal incomes and

no stability in economic growth. After the change of guard within the government,

implementation of new policies and reforms has seen the economy revive as a

whole. There is now an influx of foreign capital, as investors believe that the

economy will prosper, levels of personal disposable incomes are rising and the

domestic consumption is improving which is boosting the overall GDP.

The FMCG is an industry that is non-cyclical in nature meaning it is not adversely

affected by the economic downturns, however a healthy economy with high

consumption levels does boost the bottom line for the FMCG companies. No matter

how bad the scenario is, there will always remain a certain demand for food and

beverages which makes this industry in specific a lucrative investment opportunity to

reap a steady portfolio growth and to diversify risk.

Amidst this shaky economic environment, a company like Nestle has consistently

believed in its vision and values of excellence, creating value and customer focus

thus showing mettle and intent. It is correctly stated that “when the going gets tough,

the tough get going” and Nestle posts a classic example. It has prepped up for the

battle and withered the economic storm. The economy is now seeing a gradual

revival in GDP, income and consumption levels and Nestle looks to take the early

mover advantage with increased capacity, strong and enhanced distribution

channels and a robust marketing campaign to create a distinct brand image.

An investment in Nestle India pans out to be a profitable one over the next 5 years

and the company is well on its path to high growth in sales, profits, reduced debt

and increased cash flows. The company is estimated to have a compounded annual

growth rate (CAGR) of 16%, which means that this could be a cash cow with low

beta of risk within a diverse investment portfolio.

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Appendix i (all figures INR crore)

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Appendix ii (all figures INR crore)

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Appendix iii