Financial Accounting Project: Final Report

Financial Analysis of Hindustan Uniliver Limited

Submitted To:
Prof. D.V.Ramana

Submitted by:
Arun Sharma

DATE: 24th September 2007

CONTENTS

Section I: Background

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 A. Acknowledgement…………….…………………….……..…………3

B. Industry and Environment Analysis…………………………….……4

C. Brief Introduction of Hindustan Uniliver Limited…………………………….9

Section II: Detailed Analysis of HUL

1. Board of
Directors………………………………………………...... 11
2. Ownership………………………………………………………
…...11
3. Shareholding
Pattern………………………………………………...12
4. Performance Trends of the
company………………………………..13
5. Ratio Analysis: Time Series
Analysis………………………………14
5.1. Liquidity Ratios…………………………………………………….....14
5.2. Solvency Ratios…………………………………………………...……16
5.3. Profitability Ratios…………………………………………………….18
5.4. Market Based Returns………………………………………………... 22

6. Dupont Analysis……………………………………………………...23

7. Economic Value Addition……………………………………………24

8. Accounting Policies…………………………………………………..26

9. Ratio Analysis: Inter Company Analysis –HUL and ITC……………29

10. Conclusion…………………………………………………………..34

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A. Acknowledgements

We are highly grateful to Prof D.V.Ramana for making the course of Financial

Accounting interesting to learn and easy to understand. We wish to thank XIMB

Academic Team for assigning Prof. Ramana to take the introductory course on Finance

and Accounting. We pay heartily gratitude to Ramana sir for giving us his valuable time

and the immense interaction opportunities to resolve our queries. We are also thankful to

Mr. Alok for answering our queries regarding the quizzes and assignments, especially

when Ramana was not available in the campus.

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B. Industry and Environment Analysis:
Indian FMCG Sector in a nutshell: The Indian FMCG sector is the fourth largest
sector in the economy with a total market size in excess of US$ 13.1 billion. It has a
strong MNC presence and is characterized by a well established distribution network,
intense competition between the organized and unorganized segments and low
operational cost. Availability of key raw materials, cheaper labor costs and presence
across the entire value chain gives India a competitive advantage. The FMCG market is
set to treble from US$ 11.6 billion in 2003 to US$ 33.4 billion in 2015. Penetration
level as well as per capita consumption in most product categories like jams, toothpaste,
skin care, hair wash etc in India is low indicating the untapped market potential.
Burgeoning Indian population, particularly the middle class and the rural segments,
presents an opportunity to makers of branded products to convert consumers to branded
products.
Growth is also likely to come from consumer 'upgrading' in the matured product
categories. With 200 million people expected to shift to processed and packaged food
by 2010, India needs around US$ 28 billion of investment in the food-processing
industry. The Indian FMCG sector gives employment for three million people in
downstream activities. Within the FMCG sector, the Indian food processing industry
represented 6.3 per cent of GDP and accounted for 13 per cent of the country's exports
in 2003-04.A distinct feature of the FMCG industry is the presence of most global
players through their subsidiaries (HLL, P&G, Nestle), which ensures new product
launches in the Indian market from the parent's portfolio.

What is in India for FMCG: FMCG Sector is expected to grow by over 60% by 2010.
That will translate into an annual growth of 10% over a 5-year period. It has been
estimated that FMCG sector will rise from around Rs 56,500 crores in 2005 to Rs
92,100 crores in 2010. Hair care, household care, male grooming, female hygiene, and
the chocolates and confectionery categories are estimated to be the fastest growing

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segments, says an HSBC report. Though the sector witnessed a slower growth in 2002-
2004, it has been able to make a fine recovery since then. For example, Hindustan
Unilver Limited (HUL) has shown a healthy growth in the last quarter. An estimated
double-digit growth over the next few years shows that the good times are likely to
continue.

Growth: With the presence of 12.2% of the world population in the villages of India,
the Indian rural FMCG market is something no one can overlook. Increased focus on
farm sector will boost rural incomes, hence providing better growth prospects to the
FMCG companies. Better infrastructure facilities will improve their supply chain.
FMCG sector is also likely to benefit from growing demand in the market. Because of
the low per capita consumption for almost all the products in the country, FMCG
companies have immense possibilities for growth. And if the companies are able to
change the mindset of the consumers, i.e. if they are able to take the consumers to
branded products and offer new generation products, they would be able to generate
higher growth in the near future. It is expected that the rural income will rise in 2007,
boosting purchasing power in the countryside. However, the demand in urban areas
would be the key growth driver over the long term. Also, increase in the urban
population, along with increase in income levels and the availability of new categories,
would help the urban areas maintain their position in terms of consumption. At present,
urban India accounts for 66% of total FMCG consumption, with rural India accounting
for the remaining 34%. However, rural India accounts for more than 40% consumption
in major FMCG categories such as personal care, fabric care, and hot beverages. In
urban areas, home and personal care category, including skin care, household care and
feminine hygiene, will keep growing at relatively attractive rates. Within the foods
segment, it is estimated that processed foods, bakery, and dairy are long-term growth
categories in both rural and urban.

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 Indian Competitiveness and Comparison with the World Markets: The following
factors make India a competitive player in FMCG sector:

• Availability of Raw Materials: Because of the diverse agro-climatic conditions

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

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

• Presence across value chain: Indian companies have their presence across the value
chain of FMCG sector, right from the supply of raw materials to packaged goods
in the food-processing sector. This brings India a more cost competitive
advantage. For example, Amul supplies milk as well as dairy products like
cheese, butter, etc

Few indicatives of Indian FMG Market

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 Figure B.1:Consumption Chart

Table B.1: Rural –Urban Profile of Market

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Figure B.2: Consumption Pattern

Table B.2: Consumer Profile

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 Figure B.3: Labour Cost Pattern

C. Brief Introduction of Hindustan Uniliver Limited

(Formerly Hindustan Lever Limited)

Brief History: Hindustan Unilever Limited, erstwhile Hindustan Lever Limited (also
called HLL), headquartered in Mumbai, is India's largest consumer products company,
formed in 1933 as Lever Brothers India Limited. Its 41,000 employees are headed by
Mr.Harish Manwani, the non-executive chairman of the board. HLL is the market leader
in Indian products such as tea, soaps, detergents, as its products have become daily
household name in India. The Anglo-Dutch company Unilever owns a majority stake in
Hindustan Lever Limited.

Recently in February 2007, the company has been renamed to "Hindustan Unilever
Limited" to provide the optimum balance between maintaining the heritage of the
Company and the future benefits and synergies of global alignment with the corporate
name of "Unilever".

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Prominent Brands: Kwality Walls ice cream, Lifebuoy, Lux, Breeze, Liril, Rexona,
Hamam, Moti soaps, Lipton tea, Brooke Bond tea, Bru Coffee, Pepsodent and Close Up
toothpaste and brushes, and Surf, Rin and Wheel laundry detergents, Kissan squashes and
jams, Pond's talc and creams, Vaseline lotions, Fair & Lovely creams, Lakmé beauty
products are some of the prominent brands of the company.

Power Brands: In mid-2000 after M.S. Banga took over the reins at HLL, the company
decided that it would focus on 30 odd 'Power Brands' and carefully plan its entry into
new businesses. Intuitively this made sense, instead of spreading your resources all over
the place concentrate on a few brands. But what it meant was that power brands had to
grow at higher rates to compensate for the loss of sales from other brands. Unfortunately,
the other brands have shrunk faster vis-à-vis the rate at which the power brands have
grown. This has hit the top line of the company. The company's Vanasapti brand, Dalda,
is a case in point

Appointment of Doug Baille : The appointment of an expat, Doug Baillie, as the CEO
of consumer heavyweight HLL is seen as an indication of the parent company’s desire to
hasten the process of ‘Unileverising’ the Indian subsidiary, it is reliably learnt. Informed
sources said Unilever was not very satisfied with the pace of harmonization of HLL vis-
à-vis other global subsidiaries. Within Unilever, it was felt that there was some
opposition from HLL’s senior management who wanted HLL’s ‘Indian ness’ to be
maintained.

Project Shakti: It is an initiative take by the group as a way of fulfilling its social
responsibility by empowering the less privileged sections of the society we live in. The
objectives of Project Shakti are to create income-generating capabilities for
underprivileged rural women by providing a small-scale enterprise opportunity, and to
improve rural living standards through health and hygiene awareness.

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Hindustan Lever Network: In February 2003 Hindustan Unilever Limited has launched
a new division called Hindustan Lever Network. This division markets a wide range of
Fast Moving Consumer Goods through Network Marketing. Network Marketing was
pioneered in the United States of America in the 1940s by companies like Amway
Corporation and operates by recruiting individuals as consultants. These consultants are
paid a commission on the purchases made by them and on the purchases made by those
recruited by them.

1. Board of Directors:

Chairman: Harish Manwani

CEO and Managing Director: Douglas Baillie

Vice Chairman: M.K.Sharma

Managing Directors Food: S.Ravindranath

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Director Finance and IT: D.Sundaram

Directors: A.Narayan
V.Narayanan
D.S.Parekh
C.K.Prahalad
S.Ramadorai

2. Ownership:

The company is a publicly held organization. The majority of the shares are held by the
parent company Unilever limited.

3. Shareholding Pattern (as on 31.05.2007):

The majority of shares of the company are held by 9 foreign corporate bodies. They hold
54.2% of the total shares. The names of the companies and their share %age are:

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Unilever PLC 33.7%
Brooke Bond Group Limited 4.84%
Unilever UK & CN Holdings Limited 2.72%
Brooke Bond South India Estates Ltd 2.39%
Unilver PLC 2.31%
Unilever Overseas Holdings AG 1.81%
Brooke Bond Assam Estates Ltd 1.49%
Unilver Overseas Holdings AG 1.3%
Unilver Overseas Holdings BV 0.85%

The public shareholding of the company is varied and comprises of Mutual funds/UTI
(3.74%), Banks (.3%), Insurance Companies (12.41), FII (12.28), thus the total
institutional public shareholding is 28.73%

In non institutions, corporate bodies hold 1.83%, while 17.56% shares are held by
individuals. In addition to that.46% of the shares are held by other individuals and bodies
such as the director & relatives, trusts, NRI’s and clearing bodies. Hence the total public
shareholding comes out to be 48.52%.

4. Performance Trends of the company:

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 Table 4.1: Performance Trend

This table has been taken from the annual report of the HUL for the year ended on 31st
December 2006. This table contains key financial indicators which show the performance
of the company in year 2006 and its performance trend for last 10 years.

5. Ratio Analysis: Time Series Analysis

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5.1 Liquidity Ratios: Liquidity Ratios indicate the company’s ability to meet its short-
term liability. These ratios indicate the availability of liquid asset to meet short term
obligations. Creditors usually check this ratio to assess the ability of firm to meet its
short term obligations.

5.1.1 Current Ratio: Current ratio is obtained by dividing Current Assets by Current
Liabilities. Current ratio gives a quick understanding of the company’s liquidity
position but is subjected to window dressing. Current asset consists of Cash,
Inventory and Debtors as major items. Though Inventory and Debtors are
considered liquid asset, the company may find itself unable to collect debt at
right time and convert inventory into cash when it has to pay its creditors.
Hence this ratio alone can not provide a clear picture of firm’s liquidity
position.

5.1.2 Liquid Ratio: Liquid ratio is a better measure of Liquidity because inventory,
which might not get converted into cash when required to do so, is taken out of
the current asset for calculating this ratio.

5.1.3. Absolute Cash Ratio: It is the best measure of the liquidity since only cash and
near cash items are taken for calculating this ratio. Debtors and Inventory are
taken out of the Current Asset and thus left part of current asset give a better
idea of liquidity of the firm.
5.1.4 Working Capital: It is net current asset that a company has to have in order to
smoothly run its day to day operation.Net Current Asset is difference between
CA and CL. It also indicates how the firm is financing its assets. For example if
a company has CL more than CA, i.e. Negative Working Capital, it implies that
the company is financing its long term asset from short term funds. Generally
CL does not carry any cost and hence it increases the profitability of the firm.

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 5.1.4. Working Capital Days: Working capital days indicate the time taken in
completion of the operating cycle. It is a measure of firm’s policy of collecting
debt, making payment to creditors and average inventory holding period. The
goods are purchased either in cash or on credit, then it remains with the firm as
inventory for some days, then it is sold and debtors are created, then the cash is
collected from debtors. So, WCD is Debtors Days + Inventory Days- Creditor
Days.
5.1.5. Debtors Days: Time taken to convert debtor into cash. It indicates how
efficiently the firm is collecting its debt.
5.1.6. Creditor Days: It indicates how fast the firm is paying back to its creditors.
5.1.7. Inventory Days: How efficiently the firm converts its inventory into debtors,
i.e. how efficient the sales are. It also indicates for how long (on an average)
goods are stocked.
2006 2005 2004
Current Ratio 0.70 0.67 0.89
Liquid Ratio 0.36 0.35 0.49
Absolute Current Ratio 0.26 0.22 0.36
Inventory Days 46.67 43.62 54.07
Debtor Days 13.28 17.25 17.99
Creditor Days 138.59 138.87 140.27
Working Capital Days -78.63 -78.00 -68.21
Table 5.1.1: Key Liquidity Ratio for HUL

1.00
0.90
0.80
0.70
0.60 Current Ratio
0.50 Liquid Ratio
0.40 Absolute Current Ratio
0.30
0.20
0.10
0.00
2006 2005 2004

Figure 5.1.1:Trend of Liquidity of HUL

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Analysis of Liquidity Ratios: Current ratio of HUL has been less than 1 for all the 3
years taken for analysis. This implies that working capital of HUL is always negative.
This is generally considered an aggressive strategy i.e. to financing its long term asset by
short term sources that increases profitability because current liabilities are non interest
bearing items. There is significant difference between CR and LR which indicates that
the current asset of HUL consists of good amount of inventory. Value of sundry debtors
is quite low since there is minor difference between LR and ACR. The liquidity ratios
have decreased from previous year which shows that HUL has reduced its liquidity
further. On analyzing the operating cycle it can be said that HUL takes good amount of
time to pay its creditors and this is how it manage to run its operations with negative
working capital.

5.2. Solvency Ratio: Solvency Ratios indicate the company’s ability to meet its Long-
term liability. These ratios indicate the ability of the firm to return the investment
made by its owners and debt providers in the business, in case the company is
closed down. These ratios are usually seen by the debt providers or financial
institutions in order to assess the risk involved in the business. If the firm is closed
down then first it is liable to pay back its loan and then if it is left with something
that belongs to the share holders.

5.2.1 Debt Equity Ratio: Debt Equity ratio is obtained by dividing Long Term
outside Liability (Debt) by Net Worth. This ratio indicates the risk involved for
loan givers. If it is too high then the owner may not be that much concerned for
profit making since he has invested less in the business and hence getting less
return. If the company makes loss ad closed down subsequently, then the owner
does not loose much and loan givers will have to bear relatively more losses.
This ratio also determines EPS.

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 5.2.2 Interest Coverage Ratio: ICR indicates the firm’s ability to pay the interest of
the loans taken. It is ratio of PBIT to Interest.

5.2.3. Debt to Total Funds: This ratio indicates the share of the debt in total sources
used to fund the business. Since total sources are equal to total assets, this
ratio is analyzed to assess the firm’s ability to meet its long term liability i.e.
ability to pay back its loan, in case the company is closed down.
5.2.4. Reserves and Surplus to Total Fund: This ratio indicates the share of the
Reserves and Surplus in total sources used to fund the business. Since total
source are equal to total assets, this ratio is used to assess the firm’s ability to
meet its long term liability towards its owner that is, ability to return the share
profit made by the business that belongs to shareholders, in case the company is
closed down.

2006 2005 2004

Debt Equity Ratio 0.03 0.02 0.70
Interest Coverage Ratio 159.31 76.67 12.58
Debt to Total Source 0.01 0.01 0.20
RS to Total Source 0.34 0.32 0.26
Table 5.2.1: Key Solvency Ratios

0.80

0.70

0.60

0.50
Debt Equity Ratio
0.40 Debt to Total Source
RS to Total Source
0.30

0.20

0.10

0.00
2006 2005 2004
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 Figure 5.2.1: Trend of Solvency Position of HUL

Analysis of Solvency Ratios: The loans taken by HUL were high in 2004 which is
indicated by high debt to total source ratio and this is why its ICR ratio was low (as
compared to ICR in 2005 and 2006). It has decreased its loan and currently it is financing
its business mostly by net worth and current liability. Debt to equity ratio has decreased
over the years as it has reduced the loans. Its RS to Total source has increased which
indicates that HUL invests accumulated profit into business with decreasing debt. Now
HUL’s assets are financed by net worth and current liability with debt being a small
component of total source.

5.3. Profitability Ratio: Profitability Ratios show how successful a company is in terms
of generating returns or profits on the Investment that has been made in the business
i.e. the Profitability ratios indicates the ability of the firm to generate and distribute
the profit. It can be broadly categorized into profit generating ability (PGA) ratios
and profit distributing ability (PDA) ratios. It can be said the higher these ratios the
better it is for the company.

5.3.1 PBIT to Sales: This ratio is obtained by dividing Profit before Interest and Tax
by Sales. This ratio is a measure of the company’s profit generating ability on a
given volume of sales. This is the most basic ratio of profit generating ability on
sales i.e. sales margin because it does not take into account the interest and
taxes which the company has to pay.

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5.3.2 PBT to Sales: This ratio is obtained by dividing Profit before Tax by Sales. This
ratio gives the company’s profit generating ability on a given volume of sales.
This ratio takes the profit after paying the interest in order to assess profit made
(profit margin) after all the expenses except tax.

5.3.3. Operating Expenses to Sales: It is a measure of the expenses that are incurred
on a particular volume of sales. This ratio can be used to analyze the cost
incurred and find out the ways to reduce the operational cost without decreasing
the sales volume.

5.3.4. Return on Net worth (RONW): This ratio gives an indication about the profit
being made by the firm on the investment made by the owner. This ratio is used
to analyze the business from the perspective of the owner. RONW is an
indicator of profit distributing ability of a firm.

5.3.5 Return on Capital Employed (ROCE): This ratio indicates the profit making
ability of the firm on total capital employed which consists of owners fund and
debt. This is a profit generating ability ratio which is seen by owners and debt
providers.

5.3.6 Return on Total Asset: ROTA tells how efficiently the firm is using its assets
or total sources of fund to generate profit. It is a profit generating ability ratio.

5.3.7 Earning Per Share: EPS is an indicator of profit distributing ability of a firm.
This ratio tells how much profit the firm is making on owner’s investment on a
single share of the company.

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 5.3.8 Dividend per Share: DPS ratio gives an idea of the actual distribution of profit
to the owners i.e. profit distributed to shareholders per share.

5.3.9 CFO to PAT: CFO to PAT compares the net cash generated from operational
activities with net profit made by the firm. It gives an idea as to how much
profit is realized and how it is being used in different activities(Investment,
financial, Operational)

Some of the profitability ratio in this report do not match with the values given in
HUL’S summary of performance because the sales figures taken here are after excise
duty whereas the sales figures taken by HUL for calculating these ratios are before
excise duty i.e. Gross Sales.

2006 2005 2004

PBIT/Sales (%) 13.72 12.95 15.96
PBT/SALES (%) 15.38 14.51 15.16
Operating Expense (Other than COGS)/Sales (%) 32.77 30.98 32.32
PAT/OF(RONW) 0.57 0.59 0.57
PBIT/CE(ROCE) 0.61 0.62 0.46
PBIT/TA(ROTA) 0.23 0.23 0.22
EPS 8.41 6.40 5.44
DPS 5.00 5.00 6.00
CFO/PBIT (%) 93.29 133.71 79.59
Table 5.3.1: Key Profitability Ratios for HUL

Analysis of Profitability Ratios: PBIT as percentage of sales is moderately good and

there has not been any significant change in it during last three years. Similar is the case
of PBT/Sales. PBT/Sales are higher than the PBIT/Sales for year 2006 and 2005 which
indicate that PBT is more than PBIT. This implies that interest paid by the company is
negative. On closely watching the financial statement, it has been found that Net Income
from Interest for HUL is positive for the years 2006 and 2005 making PBT higher than
PBIT. That is because Income Received by the company is more than that to be paid.

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There has not been any significant change in operating expense as percentage of sales in
last three years. For FMCG business the operating expense to sales ratio around 30% can
be considered good as the company has to spend heavily on its distribution network and
promotional activities. The profit distributing ability of the firm is excellent with return
on net worth (RONW) being around 58% over the years. The profit generating ability
similar to the profit distributing ability is pretty good with ROCE over 60% during the
year 2005 and 2006. ROCE in year 2005 has increased from the figure of 2004, perhaps
because of the decrease in debt (change in capital structure) and increase in current
liability (non interest bearing item). Return on total asset (ROTA) has been moderately
good with almost constant value of around 22% over the years.

9.00

8.00
7.00

6.00

5.00 EPS
4.00 DPS

3.00

2.00

1.00

0.00
2006 2005 2004

Figure 5.3.1: Profitability Trends of HUL

The face value of Equity Share of HUL is Rs. 1. Analyzing the EPS and DPS, which are
profit distributing ability ratios, for HUL we can see that it has been generating more than
500% times profit for its shareholders over the years. The EPS increased over the years
from Rs.5.xx in year 2004 to Rs. 8.xx in year 2006. It has been generous in distributing
the profit in form of dividend with DPS Rs 6 in year 2004 and Rs. 5 in year 2005 and
2006.

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 CFO/PBIT(%)

160.00
140.00
120.00
100.00
80.00 CFO/PBIT(%)
60.00
40.00
20.00
0.00
2006 2005 2004

Figure 5.3.2:Comparison of CFO and PAT

The trend of CFO/PBIT is worth analyzing since the company’s CFO is close to its PBIT
which indicates that almost entire profit of HUL comes from its operation and the profit
is realized. In year 2005 the CFO is higher than PBIT indicating the negative CFF or CFI
i.e. the company has realized the profit(in form of cash) and invested in long term assets
or paid its long term outside liabilities(loans).

5.4 Market Based Returns: Market based return figures indicate the firm’s position in
the market and the benefits associated with the investment in company. A small
investor, if interested in purchasing the shares of a company, first looks at the
market capitalization of the company and return that he can expect on the price paid
for the share.

5.4.1 Price to Earning Ratio: Return associated with the shares on its market price.
Since the investors buy the share at its market price and not at face value or
book value, this ratio gives information about the actual return on investment.
5.4.2 Market Cap to Net worth (Price to Book Value Ratio): Comparison of market
value of the firm with the owners fund. This can give an idea about the success
of the company in increasing the value of owner’s investment.
5.4.3 Market Capitalization: Market value of the firm. Market capitalization gives
an indication of the company’s financial status in the market. Market

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 capitalization is used to compare the size of the organization in term of market
value.
5.4.4 Average Market Capitalization: Average Market value of the firm over the
year. Average is taken because the market value of shares keeps on changing
and so is market capitalization.

2006 2005 2004

Price to Earning Ratio 31.04 32.06 26.34
Market Value to Book Value Ratio 17.55 18.83 15.09
Market Capitalization (in Million Rs.) 477877.34 434195.38 315878.51
Table 5.4.1: Key Market Indicators of HUL’s Performance

Analysis of Market Based Returns: PER ratio for HUL is not so good with values over
30 in year 2006 and 2005 and somewhat better with value around 25 in the year 2004. It
means an investor will get return around 1/30 times on his actual investment. Market
capitalization of HUL has increased after 2004.

6. Dupont Analysis:

2006 2005 2004

ROCE 0.61 0.62 0.46
Operating Decisions

PBIT/Sales (%) 13.72 12.95 15.96

COGS/Sales (%) 53.61 55.96 53.19
Dep /Sales (%) 1.08 1.13 1.22
Operational Expense/ Sales
(%) 32.77 30.99 32.33

Investment Decisions
Sales/TA 1.65 1.70 1.36

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 Sales/FA 8.01 7.46 6.54
Sales/CA 3.82 3.99 3.00
Sales/Stock 7.82 8.37 6.75
Sales/Debtors 27.48 21.16 20.29
Sales/Cash 29.03 31.15 14.22

Financial Decisions
TA/CE 2.62 2.75 2.04
TA/LTL 100.81 113.99 4.95
TA/OF 2.69 2.82 3.48
TA/Capital 33.17 29.49 33.06
TA/Reserves Surplus 2.92 3.11 3.89
Table 6.1: Dupont Analysis for HUL

7. Economic Value Addition:

Profit is the output of the GAAP driven accounting assumptions. One of the important
accounting assumptions is that the interest is treated as an expense, whereas the dividend
is treated as distribution of profit. Sometimes, such assumption results in situations where
the companies show the accounting profit but may be destroying the wealth of the
shareholders. EVA measures whether the operating profit is enough compared to the
total costs of capital employed.

EVA = NOPAT - (Cost of Capital * Capital Employed)

Cost of capital = Cost of Equity x Proportion of equity from capital + Cost of debt x
Proportion of debt from capital x (1-tax rate).

Cost of capital or weighted average cost of capital (WACC) is the average cost of both
equity capital and interest bearing debt. Cost of equity capital is the opportunity return
from an investment with same risk as the company has.

All figures are in Million Rs. 2006 2005 2004

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Cost of Capital Employed (COCE)
1.Average Debt 1630 3600 15880
2.Average Equity 25150 22000 21160
3.Average Capital Employed : (1) + (2) 26770 25600 37040
4.Cost of Debt, post-tax % 59 34 52
5.Cost of Equity % 164 155 148
6.Weighted Average Cost of Capital % (WACC) 157 138 107
7.COCE : (3) x (6) 4210 3530 3950

Economic Value Added (EVA)

8.Profit after tax, before exceptional items 15400 13550 11990
9.Add : Interest, after taxes 70 120 820
10.Net Operating Profits After Taxes (NOPAT) 15470 13670 12820
11.COCE, as per (7) above 4210 3530 3950
12.EVA : (10) - (11) 11250 10140 8870

Table 7.1: Economic Value Added

Comments: Cost of debt is taken at the effective rate of interest applicable to an AAA
rated company like HLL with an appropriate mix of short, medium and long term debt,
net of taxes. HUL have considered a pre tax rate of 8.90% for 2006 (5.10% for 2005)
after taking into account the trends over the years and market situations.
Cost of Equity is the return expected by the investors to compensate them for the
variability in returns caused by fluctuating earnings and share prices.
Cost of Equity=Risk free return equivalent to yield on long term Government Bonds
(taken at 7.65% for 2006) + Market risk premium (taken at 9%) (x) Beta variant for the
Company, (taken at 0.97) where Beta is a relative measure of risk associated with the
Company’s shares as against the market as a whole. Thus HUL’s cost of equity = 7.65%
+ 9% (x) 0.97 = 16.38%.

EVA Trend over last 10 years:

26
 Figure 7.1: EVA Trend

8. Accounting Policies : Significant Accounting Policies:

8.1. Basis for preparation of accounts: The accounts have been prepared to comply
in all material aspects with applicable accounting principles in India and the
Accounting Standards issued by the Institute of Chartered Accountants of India.

8.2. Revenue Recognition: Sales are recognized when goods are supplied and are
recorded net of trade discounts, rebates, sales taxes and excise duties (on goods
manufactured and outsourced) but include, where applicable, export incentives
such as duty drawbacks and premiums on sale of import licenses. It does not
include inter-divisional transfers. Income from Property Development Activity is
recognized in terms of arrangements with developers, where applicable. Incomes
from services rendered are booked based on agreements/ arrangements with the
concerned parties. Interests on investments are booked on a time proportion basis
taking into account the amounts invested and the rate of interest. Dividend

27
 incomes on investments are accounted for when the right to receive the payment
is established.

8.3. Expenditure: Expenses are accounted for on accrual basis and provision is made
for all known losses and liabilities. Advertising expenses are charged against the
profit of the year to which the activities relate. Revenue expenditure on research
and development is charged against the profit of the year in which it is incurred.
Capital expenditure on research and development is shown as an addition to fixed
assets.

8.4. Goodwill and other Intangible Assets: Intangible assets are stated at cost of
acquisition less accumulated amortization. Goodwill and other intangible assets
(except computer software) are amortized over the assets useful life not exceeding
10 years. Computer software is amortized over a period of 5 years on the straight
line method. Goodwill arising on consolidation in accordance with AS-21 is
amortized over 4 years at quarterly rests commencing from the quarter of
recognition of goodwill.

8.5. Impairment of Assets: Impairment loss, if any, is provided to the extent, the
carrying amount of assets exceeds their recoverable amount. Recoverable amount
is higher of an assets net selling price and its value in use. Value in use is the
present value of estimated future cash flows expected to arise from the continuing
use of an asset and from its disposal at the end of its useful life.

8.6 Fixed Assets: Fixed assets are stated at cost less depreciation. Depreciation is
provided (except in the case of leasehold land which is being amortized over the
period of the lease) on the Straight Line Method (SLM) and at the rates and in the
manner specified in Schedule XIV of the Companies Act, 1956. However,
A. certain employee perquisite-related assets are depreciated over four to six
years, the period of the perquisite scheme
B. computers and related assets are depreciated over four years

28
 C. certain assets of the cold chain are depreciated over four / seven years
D. motor vehicles are depreciated over six years and
E. assets of certain subsidiaries are depreciated on the Written down Value
Method (WDV). The difference between the SLM basis and WDV basis is not
significant. Assets identified and evaluated technically as obsolete and held for
disposal are stated at their estimated net realizable values.
8.7. Investments: Investments are classified into current and long-term investments.
Current investments are stated at the lower of cost and fair value. Long- term
investments, other than in Associates, are stated at cost. A provision for
diminution is made to recognize a decline, other than temporary, in the value of
long-term investments. Investments in Associates are accounted for using the
equity method. Interests in Joint Ventures Interests in Jointly controlled entities
(Incorporated Joint Ventures) are accounted for using proportionate consolidation
method.

8.8. Inventories: Inventories are valued at the lower of cost, computed on a weighted
average basis, and estimated net realizable value, after providing for cost of
obsolescence and other anticipated losses, wherever considered necessary.
Finished goods and work-in-progress include costs of conversion and other costs
incurred in bringing the inventories to their present location and condition.

8.9. Sundry Debtors and Loans and Advances: Sundry debtors and Loans and
Advances are stated after making adequate provisions for doubtful balances.

8.10. Provisions: A provision is recognized when there is a present obligation as a

result of a past event, it is probable that an outflow of resources will be required
to settle the obligation and in respect of which reliable estimate can be made.
Provision is not discounted to its present value and is determined based on the
best estimate required to settle the obligation at the year end date. These are
reviewed at each year end date and adjusted to reflect the best current estimate.

29
8.11. Retirement / Post Retirement Benefits: Contributions to defined contribution
schemes such as Provident Fund and Family Pension Fund are charged to the
profit and loss account as incurred. The Companies also provide retirement / post-
retirement benefits in the form of gratuity, pensions, leave encashment and
medical. Such benefits are provided for based on valuations, as at the balance
sheet date, made by independent actuaries.

8.12. Taxes on Income: Current tax is determined as the amount of tax payable in
respect of taxable income for the period. Deferred tax is recognized, subject to the
consideration of prudence, on timing differences, being the difference between
taxable incomes and accounting income that originate in one period and are
capable of reversal in one or more subsequent periods. Deferred tax assets are not
recognized on unabsorbed depreciation and carry forward of losses unless there is
virtual certainty that sufficient future taxable income will be available against
which such deferred tax assets can be realized.

8.13. Foreign Currency Translations: Foreign currency transactions are accounted

at the exchange rates prevailing at the date of the transaction. Gains and losses
resulting from the settlement of such transactions and from the translation of
monetary assets and liabilities denominated in foreign currencies are recognized
in the profit and loss account. Exchange differences relating to fixed assets are
adjusted in the cost of the asset.

8.14. Segment Reporting: The accounting policies adopted for segment reporting are
in line with the accounting policies adopted in consolidated financial statements
with the following additional policies being considered for segment reporting:
A. Inter segment revenue has been accounted for based on the transaction price
agreed to between segments which is primarily market led.
B. Revenue and expenses have been identified to segments on the basis of their
relationship to the operating activities of the segment. Revenue and expenses,

30
 which relate to the enterprise as a whole and are not allocable to segments on a
reasonable basis, have been included under unallocated corporate expenses.

9. Ratio Analysis: Inter Company Analysis –HUL and ITC

Ratio HUL(2006- 31ST Dec) ITC(31ST March2007)

Current Ratio 0.70 1.63
Absolute Current Ratio 0.26 0.54
Working Capital Days -78.63 56.28
Debt Equity Ratio 0.03 0.02
PBIT/Sales (%) 13.72 30.90
PAT/Sales (%) 12.72 21.17
Depreciation/Sales (%) 1.08 2.86
PBIT/TA(ROTA) 0.23 0.35
PBIT/CE(ROCE) 0.61 0.37
PAT/OF(RONW) 0.57 0.26
EPS 8.41 7.19
DPS 5.00 3.10
Market Price of Share 216.55 150.40
Price to Earning Ratio 31.04 20.92
Market Capitalization (in Million Rs.) 477877.34 565830.00
Table 9.1: Key Ratios of HUL and ITC for the Year 2006-07

9.1. Comparison of Liquidity Position: Current Ratio for HUL is negative whereas it
is positive for ITC. This indicates that HUL has negative working capital and ITC
has positive working capital. ITC is funding its short term asset by long term
funds and HUL funding its long term asset by its short term non-interest bearing
sources (CL). One more difference in liquidity position of the two companies can
be seen through the difference between the CR and ACR. There is huge difference
in ACR and CR of ITC which shows that it has less cash or near cash items in its
current liabilities whereas for HUL the difference is moderate. Working Capital
Days for ITC is positive and WCD for HUL is negative. It can be said that HUL

31
 has more current liability to source its asset and ITC has high current asset which
is sourced by long term sources of fund.

1.8

1.6

1.4

1.2

1 Current Ratio
0.8 Absolute Current Ratio

0.6

0.4
0.2

0
HUL(2006- 31ST Dec) ITC(31ST March2007)

Figure 9.1.1: Comparison of Liquidity Position of HUL and ITC

WorkingCapital Days

80
60
40
20
0
HUL(2006- 31ST Dec) ITC(31ST March2007) WorkingCapital Days
-20
-40
-60
-80
-100

Figure 9.1.2: Comparison of WCD of ITC and HUL

32
9.2. Comparison of Solvency Position: Two companies are similar in terms of their
solvency position as indicated by various solvency ratios.

9.3. Comparison of Profitability: Both the PBIT/Sales and PAT/Sales are higher for
ITC than HUL and the difference in these ratios is quite high which indicates that
ITC has higher profit margin on sales than HUL. Depreciation/Sales ratio of ITC
is almost double of that for HUL indicating higher depreciation and amortization
charged by ITC than HUL. The ROTA figure for ITC is higher than it is for HUL
which shows that ITC is generating more profit than HUL on total asset (or total
sources of funds). The other profit generating ability ratios shows a different
picture. ROCE for HUL is higher than that for ITC which is because HUL is
using more current liabilities to fund its assets hence making more profit on its
capital employed. The RONW for HUL is also higher than that for ITC because
of the same reason. So, it can be inferred that HUL is generating more profit for
on its owners fund than ITC. The difference between PBIT /Sales and PAT/ Sales
is lower in case of HUL due to its net income from interest being positive i.e. it
has earned more interest than it has paid.

33
35

30

25

20
PBIT/Sales (%)

15 PAT/Sales (%)

10

0
HUL(2006- 31ST Dec) ITC(31ST March2007)

Figure 9.3.1: Comparison of Profitability on Sales for HUL and ITC

34
 0.7

0.6

0.5

0.4
HUL(2006- 31ST Dec)

0.3 ITC(31ST March2007)

0.2

0.1

0
PBIT/TA(ROTA) PBIT/CE(ROCE) PAT/OF(RONW)

Figure 9.3.2: Comparison of Profitability on Investment for HUL and ITC

9.4. Comparison of Profit Distributing Ability: Both EPS and DPS are higher for
HUL than ITC which shows that HUL makes more profit for share holders and
distributes higher profit in form of dividend as compared to that distributed by
ITC. PER for HUL is high as compared with that of ITC which makes HUL less
profitable on the actual investment made on equity shares. Market Price of shares
of HUL is more than that of ITC’s share. Market capitalization of ITC is higher
than that of HUL which shows that ITC has more equity capital than HUL.

35
35

30

25

20
HUL(2006- 31ST Dec)

15 ITC(31ST March2007)

10

0
EPS DPS Price to Earning Ratio

Figure 9.4.1: Comparison of Profit Distributing Ability of HUL and ITC

Market Price of Share

250

200

150
Market Price of Share
100

50

0
HUL(2006- 31ST Dec) ITC(31ST March2007)

Figure 9.4.2: Comparison of Market Price of Shares of HUL and ITC

36
 Market Capitalization(in Million Rs.)

580000

560000
540000
520000
Market Capitalization(in Million
500000
Rs.)
480000
460000
440000

420000
HUL(2006- 31ST Dec) ITC(31ST March2007)

Figure 9.4.3:Comparison of Market Capitalization of HUL and ITC

10. Conclusion: The aim of the FA course was to make us understand the business
decisions behind financial transaction that results into a financial statement, which
we feel have been achieved. Financial statements use a different terminology that
we have understood while working on this project. The ratio analysis helps one to
know the financial health/position of the company and compare the firm’s current
performance with its previous performance (Time Series Analysis) and its
performance with the other firm’s performance operating in same industry (Inter
Company Analysis).While working on this project we learned to analyze the ratios
in order to arrive at a conclusion about the company’s performance and its financial
position.

37