pharama - 5 company analysis

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Cost of Capital: Pharmaceutical Sector Section 2 (MBA F&B) 2/25/2012

By-

Purav Gudhka

Saswata Gauna

Shaivi Sharma

Sharad Thampy

Yash Khandelwal

Yogesh Nivangune

2

Table of Contents Cost of Capital: Pharmaceutical Companies – Summary .................................................................................................. 3

Source of Data ................................................................................................................................................................... 3

List of Companies Analysed .............................................................................................................................................. 3

Authors and Contribution ............................................................................................................................................. 3

Objective ........................................................................................................................................................................... 4

Divi’s Laboratories Ltd ....................................................................................................................................................... 6

Divis’s Laboratories: Charts & Graphs ........................................................................................................................... 7

Dishman Pharmaceuticals & Chemicals Ltd ...................................................................................................................... 8

Dishman Pharmaceuticals: Charts & Graphs ................................................................................................................ 9

Ajanta Pharma Ltd........................................................................................................................................................... 10

Ajanta Pharma: Charts & Graphs ................................................................................................................................ 11

Strides Acrolab Ltd .......................................................................................................................................................... 12

Strides Acrolab Ltd.: Charts & Graphs ......................................................................................................................... 13

Opto Circuits ................................................................................................................................................................... 14

Opto Circuits: Charts & Graphs ................................................................................................................................... 15

Jubilant Life Science Ltd .................................................................................................................................................. 16

Jubilant Life Science: Charts & Graphs ........................................................................................................................ 17

3

Cost of Capital: Pharmaceutical Companies – Summary

Source of Data List of Companies Analysed www.bseindia.com Divis Laboratories

www.moneycontrol.com Dishman Pharma

www.rediffmoney.com Ajanta Pharma

www.tradingeconomics.com Strides Arcolab

Opto Circuits

Jubiliant Life Sciences

Authors and Contribution Name Contribution

Purav Gudhka (8829846069) Data and Analysis of Divis Laboratories

Saswata Gauna (8829919352) Data and Analysis of Dishman Pharma

Shaivi Sharma (8766005400) Data and Analysis of Ajanta Pharma

Sharad Thampy (8829878960) Data and Analysis of Strides Arcolab

Yash Khandelwal (8107865026) Data and Analysis of Opto Circuits

Yogesh Nivangune (8829878943) Data and Analysis of Jubiliant Life Sciences

Synopsis: After analyzing trends of WACC for various companies, we can say that CAPM reflects the market trends better than the other models as the company’s returns are calculated using stock beta and market returns, while WACC calculated using the EPR model follows the EPS trend and WACC calculated using the Gordon’s model follows the DPS trend. Notes:

1. Market Return (Rm) is calculated by taking geometric mean of annual market returns of ten years preceeding the respective year taken for calculation.

2. Risk Free Rate (Rf) is considered as a average of Government Bond Yield for 10 years Notes from 1998 to 2011 which comes to 7.92%.

http://www.bseindia.com/

http://www.moneycontrol.com/

http://www.rediffmoney.com/

http://www.tradingeconomics.com/

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Objective

To analyze trends in Weighted Average Cost of Capital of chosen pharmaceutical companies by using different methods for calculating of Cost of Equity.

Appropriateness of Methodology

Cost of Debt:

Cost of debt (long term loans – secured and unsecured) was calculated using the data available but Cost of Debt (Debentures and Bonds) could not be done since most of the companies have not issued any debentures and Bonds and even if they have issued it was not possible to find the exact data to calculate its cost for the same.

Debt financing is done through two ways (i) Loans and (ii) Issue of debentures. When a company borrows it uses financial leverage; so that it can increase its profitability but at the same time it is exposed to financial risk. In general cost of debt is less than cost of equity.

The following methodology describes how cost of debt was arrived at i.e. the methodology used and various parameters involved.

Methodology and Parameters involved in calculating Cost of Debt (Kt)

Identified average total debt (long term loans including both secured and unsecured loans) from company’s balance sheets for a period of 5 years.

Average total Debt = (Total debt for current year + Total debt for previous year) / 2

Though corporate tax rate applicable to Corporate is around 33% with surcharges and education cress, to provide an exact picture of tax rate effective tax rate is used by considering any tax benefits availed.

Effective tax rate (T) = Tax paid / Profit before tax

Nominal interest rate on loans is calculated by dividing Total Interest paid upon Average Total Debt.

Nominal Interest rate (I) = Interest Paid / Average Total Debt

Given the Nominal Interest rate and effective tax rate, Cost of Debt (Kt) is calculated using below formula:

Kt = I * (1-T)

Cost of Equity:

Cost of Equity is calculated using Gordon, Earnings Price Ratio and CAPM models for calculating Cost of Equity. Cost of equity is more challenging to calculate as equity does not pay a set return to its investors. Similar to the cost of debt, the cost of equity is broadly defined as the risk weighted expected return required by the investors. The following methods were used to calculate cost of equity.

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1. Gordon’s Model:

Ke = (D0*(1 + g)/P0) + g

Here,

Ke = Cost of Equity

D0 = Dividend per share paid by the company for the current year (Rs.)

g = Annual growth rate in dividends and is calculated using geometric mean of growth in dividends in the past years or by multiplying retention ratio with ROE

P0 = Current market price of the shares (Rs.)

2. Earnings – Price Ratio Approach:

Ke = E0*(1 + g) / P0

Here,

Ke = Cost of Equity

E0 = EPS for the current year (Rs.)

P0 = Current market price of the shares (Rs.)

3. CAPM approach:

Ri = Rf + βi (Rm – Rf)

Here,

Ri = Cost of Equity

Rf = Risk free rate

Rm = Market return

βi = Beta of the return of company with respect to market returns

Weighted average Cost of Capital:

The weighted average cost of capital (WACC) of a firm refers to how much on an average it costs a firm to raise money. The importance of the WACC is in its relation to the evaluation of projects. The firm’s WACC is the cost of capital for the firm’s mixture of debt and stock in its capital structure.

WACC = wd(cost of debt) + ws(cost of equity/retained earnings) + wp(cost of preference stock)

Here,

wd = weight of debt in the firm’s capital structure ws = weight of share capital wp = weight of preference share capital

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Divi’s Laboratories Ltd

Calculations for the year (Rs. in Crs.) Mar '12 Mar '11 Mar '10 Mar '09 Mar '08

Expected Cost of Debt:Average Total Debt 27.95 42.75 69.36 120.02 152.07

Interest 2.19 2.76 7.23 10.18 10.57

Profit Before Tax 479.23 391.05 458.34 384.72 226.73

Tax 43.48 44.14 34.09 29.54 34.79

Cost of debt pre tax 7.84% 6.46% 10.42% 8.48% 6.95%

Effective tax rate 9.07% 11.29% 7.44% 7.68% 15.34%

Effective cost of debt post tax 7.13% 5.73% 9.65% 7.83% 5.88%

Expected Cost of Equity:DPS (Rs.) 10.00 6.00 6.00 4.00 10.00

Retention ratio (RR) 64.11% 72.84% 89.08% 91.31% 92.08%

ROE (ROE) 25.85% 24.55% 39.75% 49.94% 43.44%

Growth rate (g) = RR*ROE 16.57% 17.88% 35.41% 45.60% 40.00%

Adjusted Share price 674.95 678.30 472.15 634.43 307.48

Gordon growth model 18.30% 18.93% 37.13% 46.52% 44.55%

Adjusted EPS (Rs.) 32.85 26.05 32.77 27.39 14.85

EPS growth* 47.54% 58.82% 48.16% 36.46% 14.79%


EPS model 7.18% 6.10% 10.28% 5.89% 5.54%

BETA 1.03 1.08 1.02 1.09 0.81

Market Return (Rm)* 16.83% 17.84% 13.31% 12.18% 18.68%

Risk free rate (Rf)** 7.92% 7.92% 7.92% 7.92% 7.92%

CAPM 17.10% 18.63% 13.42% 12.57% 16.64%

AVG Share Capital (in Rs. Crs) 1685.07 1401.94 1067.89 708.01 441.43

Average Total Debt (in Rs. Crs) 27.95 42.75 69.36 120.02 152.07

Average Total Capital (in Rs. Crs) 1713.01 1444.68 1137.25 828.03 593.50

Weight of Share Capital 0.98 0.97 0.94 0.86 0.74

Weight of Debt 0.02 0.03 0.06 0.14 0.26

WACC (Gordon Growth Model) 18.12% 18.54% 35.45% 40.91% 34.64%

WACC (EPS Model) 7.18% 6.09% 10.24% 6.17% 5.63%

WACC (CAPM) 16.93% 18.25% 13.19% 11.88% 13.88%



Total (in Rs. Crs) 8984.36 7581.96 7222.57 6200.61 3339.49


Weight of Debt 0.00 0.01 0.01 0.02 0.05


WACC (EPS Model) 7.18% 6.10% 10.28% 5.93% 5.56%

WACC (CAPM) 17.07% 18.56% 13.38% 12.48% 16.15%

Actual Returns: Mar '12 Mar '11 Mar '10 Mar '09 Mar '08

ROCE (average capital) NA 28.10% 27.26% 40.94% 47.69%

Net Profit NA 435.57 344.2 424.46 353.56

ROE (average share capital) NA 25.85% 24.55% 39.75% 49.94%

Expected WACC (market value):

Expected WACC (book value):

7

Divis’s Laboratories: Charts & Graphs

Inference:

There is very little different between Expected WACC calculated using book value and calculated using market value as the Debt to equity is 5% i.e. 0.05:0.95 and debt taken by the company has been continuously decreasing. Debt to equity ratio was 0.05:0.95 in March 2007 and it reduced to almost 0.01:0.99 in 2011. As a result the WACC calculated is almost equal to cost of equity for the last few years. WACC using Gordon Growth model has been continuously decreasing due to reduction in growth rate as a result of decrease in ROE as growth rates are calculated by multiplying Retention Ratio with ROE. WACC calculated using CAPM model is a function of market risk premium and as the market has been increasing since past decade and beta being almost constant for Divis Laboratories, the cost of equity has been increasing during the last few years for the company.

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Mar '12 Mar '11 Mar '10 Mar '09 Mar '08

Weights : Debt to Equity

Weight of Share Capital Weight of Debt

0%

8%

16%

24%

32%

40%

48%


Expected Value: Book Value

WACC (Gordon Growth Model) WACC (EPS Model)

WACC (CAPM)

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10%

20%

30%

40%

50%


Expected Value: Market Value


WACC (CAPM)

20%

26%

32%

38%

44%

50%

Mar '11 Mar '10 Mar '09 Mar '08

Divi's Lab Ltd : ROCE v/s ROE

ROCE (average capital) ROE (average share capital)

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Dishman Pharmaceuticals & Chemicals Ltd

Calculations for the year (Rs. In Crs.) Mar '12 Mar '11 Mar '10 Mar '09 Mar '08


Interest 39.97 29.91 26.96 9.76 5.77


Tax 8.41 9.04 2.50 11.23 2.89






ROE (ROE) 6.26% 11.49% 16.80% 13.53% 22.96%




Adjusted EPS (Rs.) 4.90 8.72 11.47 7.70 8.57

EPS growth* 77.96% 31.54% -32.87% 11.30% -100.00%


EPS model 8.47% 5.36% 7.70% 3.00% 0.00%

BETA 0.88 0.86 0.72 0.84 0.81

Market Return (Rm)* 16.83% 17.84% 13.31% 12.18% 18.68%

Risk free rate (Rf)** 7.92% 7.92% 7.92% 7.92% 7.92%

CAPM 15.76% 16.45% 11.80% 11.50% 16.64%





Weight of Debt 0.44 0.38 0.36 0.44 0.66


WACC (EPS Model) 7.66% 6.11% 8.34% 2.95% 0.85%

WACC (CAPM) 11.72% 12.95% 10.98% 7.75% 6.58%



Total (in Rs. Crs) 1776.92 1629.24 1819.48 2185.42 1889.57


Weight of Debt 0.28 0.22 0.15 0.13 0.22


WACC (EPS Model) 7.95% 5.80% 7.97% 2.98% 0.29%

WACC (CAPM) 13.20% 14.42% 11.45% 10.40% 13.23%



Net Profit NA 40.12 70.37 92.56 61.38




9

Dishman Pharmaceuticals: Charts & Graphs

Inference:

The company has a very stable dividend payout ratio imbuing confidence; it managed its financial risk well during the period from 2007 to 2010 by issuing FCCBs, and did convert almost 95% of FCCBs to equity share on receipt of investors’ requests. The cost of debt remains more or less stable over the years. The WACC calculated taking market value appears more realistic. The beta of the stock is very stable. We can see that cost of equity going up with debt-to-equity ratio going up as investors expect more return.

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Capital Structure : Weights of Debt to Equity


0%

6%

12%

18%

24%


Expected WACC : Book Value


WACC (CAPM)

0%

4%

8%

12%

16%

20%


Expected WACC : Market Value


WACC (CAPM)

4%

8%

12%

16%

20%

Mar '11 Mar '10 Mar '09 Mar '08

Dishman Pharma : ROCE & ROE


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Ajanta Pharma Ltd



Interest 15.66 19.08 22.03 15.09 11.56


Tax 5.30 5.12 4.53 6.84 4.42





Growth rate (g) = CAGR 25.74% 25.74% 25.74% 25.74% 25.74%



Adjusted EPS (Rs.) 39.70 24.39 18.27 15.21 11.72

EPS growth* 12.95% 10.11% 9.63% 29.76% 0.00%


EPS model 22.39% 14.76% 39.01% 24.65% 16.31%

BETA 0.87 0.86 0.86 1.04 1.17

Market Return (Rm)* 16.83% 17.84% 13.31% 12.18% 18.68%

Risk free rate (Rf)** 7.92% 7.92% 7.92% 7.92% 7.92%

CAPM 15.67% 16.45% 12.56% 12.36% 20.51%





Weight of Debt 0.45 0.55 0.63 0.56 0.49


WACC (EPS Model) 16.35% 11.03% 19.38% 14.51% 12.32%

WACC (CAPM) 12.64% 11.79% 9.50% 9.16% 14.48%



Total (in Rs. Crs) 382.10 339.90 317.16 254.00 193.84


Weight of Debt 0.41 0.60 0.76 0.65 0.56


WACC (EPS Model) 16.80% 10.73% 15.28% 12.98% 11.71%

WACC (CAPM) 12.86% 11.41% 8.87% 8.67% 13.56%



Net Profit NA 47.02 30.27 23.42 18.65




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Ajanta Pharma: Charts & Graphs

Inference:

The Debt to Equity ratio changes from 0.65:0.35 from 2008-09 to 0.41:0.59 in 2010-11. The cost of equity (CAPM) rises and due to this the cost of capital (CAPM) also rises with the rise in market returns. With the increase in EPS the cost of equity (EPR) also increases and due to this WACC (EPR) also increases.

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WACC (CAPM)

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12%

18%

24%




WACC (CAPM)

0%

6%

12%

18%

24%

30%

Mar '11 Mar '10 Mar '09 Mar '08

Ajanta Pharma: ROCE & ROE


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Strides Acrolab Ltd



Interest 70.63 122.64 76.65 21.76 (38.98)


Tax 17.05 96.17 12.29 67.64 68.08

Cost of debt pre tax 2.82% 5.41% 3.66% 1.33% -3.51%


Effective cost of debt post tax 2.66% 4.27% 3.49% 1.14% -2.71%



ROE (ROE) 12.97% 20.68% 19.19% 33.52% 25.92%




Adjusted EPS (Rs.) 17.56 22.87 17.67 26.83 16.14

EPS growth* 2.13% 23.79% 19.23% 40.74% 25.23%


EPS model 6.01% 11.84% 8.64% 12.23% 8.52%

BETA 0.79 0.77 0.66 0.56 0.56

Market Return (Rm)* 16.83% 17.84% 13.31% 12.18% 18.68%

Risk free rate (Rf)** 7.92% 7.92% 7.92% 7.92% 7.92%

CAPM 14.96% 15.56% 11.48% 10.31% 13.95%





Weight of Debt 0.54 0.56 0.61 0.58 0.55


WACC (EPS Model) 4.21% 7.57% 5.52% 5.77% 2.30%

WACC (CAPM) 8.36% 9.20% 6.63% 4.97% 4.72%



Total (in Rs. Crs) 6839.68 6517.67 5641.70 5517.80 10108.16


Weight of Debt 0.37 0.35 0.37 0.30 0.11


WACC (EPS Model) 4.79% 9.21% 6.73% 8.96% 7.29%

WACC (CAPM) 10.46% 11.63% 8.51% 7.60% 12.12%



Net Profit NA 279.63 363.1 260.74 392.27




13

Strides Acrolab Ltd.: Charts & Graphs

Inference:

Average cost of equity increases from 2007 until 2009 because of increase in debt (as investors expect more return

when company is more leveraged), thereafter the cost of equity decreased as the debt ratio decreases. For year

2008 the average cost of equity does not include calculations from Gordon and EPS model as the cost of equity is

less than cost of debt for both the models as well as for the average of CAPM, EPS and Gordon.

For year 2009, the average cost of equity declined due to a sharp decline in market price (impacted the EPS model

cost of equity) coupled with decrease in market return. 2010 saw a sharp decline in cost of equity due to substantial

rise in market price of share. In 2011, though the rise in market rise was substantiated by increase in market return,

hence resulting in a moderate increase in cost of equity.

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Dec '11 Dec '10 Dec '09 Dec '08 Dec '07



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12%

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24%




WACC (CAPM)

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4%

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12%

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20%




WACC (CAPM)

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Dec '10 Dec '09 Dec '08 Dec '07

Strides Acrolab : ROCE & ROE


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Opto Circuits



Interest 24.93 34.52 41.04 8.77 4.98


Tax 2.68 16.49 0.87 0.43 0.97






ROE (ROE) 22.99% 17.07% 34.81% 37.18% 34.17%




Adjusted EPS (Rs.) 13.11 8.04 8.67 12.61 11.71

EPS growth* 63.06% -7.27% -31.25% 7.69% 2.99%


EPS model 7.76% 3.43% 5.93% 4.12% 4.06%

BETA 0.79 0.77 0.66 0.56 0.56

Market Return (Rm)* 16.83% 17.84% 13.31% 12.18% 18.68%

Risk free rate (Rf)** 7.92% 7.92% 7.92% 7.92% 7.92%

CAPM 14.96% 15.56% 11.48% 10.31% 13.95%





Weight of Debt 0.25 0.10 0.27 0.07 0.05


WACC (EPS Model) 6.67% 4.68% 6.48% 4.53% 4.37%

WACC (CAPM) 12.06% 15.60% 10.51% 10.28% 13.74%



Total (in Rs. Crs) 5062.89 4443.32 4059.66 3975.67 9047.81


Weight of Debt 0.14 0.04 0.13 0.02 0.01


WACC (EPS Model) 7.14% 3.98% 6.19% 4.25% 4.09%

WACC (CAPM) 13.31% 15.58% 11.03% 10.30% 13.93%



Net Profit NA 279.63 363.1 260.74 392.27




15

Opto Circuits: Charts & Graphs

Inference:

For, 2011 the cost of equity has been calculated by CAPM approach as the average of EPS, Gordon and CAPM was

less than cost of debt which is unacceptable.

Since the ROE is continuously decreasing the cost of equity (DPS) decreases as the growth rate reduces which is

calculated using ROE.

Cost of debt has been fluctuating over the years due to sharp increase and decrease in debt levels over the year.

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WACC (CAPM)

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16%

20%

24%

28%




WACC (CAPM)

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8%

16%

24%

32%

40%

Mar '11 Mar '10 Mar '09 Mar '08

Opto Circuits : ROCE & ROE


16

Jubilant Life Science Ltd



Interest 70.63 122.64 76.65 21.76 (38.98)


Tax 17.05 96.17 12.29 67.64 68.08

Cost of debt pre tax 2.82% 5.41% 3.66% 1.33% -3.51%


Effective cost of debt post tax 2.66% 4.27% 3.49% 1.14% -2.71%



ROE (ROE) 12.97% 20.68% 19.19% 33.52% 25.92%




Adjusted EPS (Rs.) 17.56 22.87 17.67 26.83 16.14

EPS growth* 2.13% 23.79% 19.23% 40.74% 25.23%


EPS model 6.01% 11.84% 8.64% 12.23% 8.52%

BETA 0.79 0.77 0.66 0.56 0.56

Market Return (Rm)* 16.83% 17.84% 13.31% 12.18% 18.68%

Risk free rate (Rf)** 7.92% 7.92% 7.92% 7.92% 7.92%

CAPM 14.96% 15.56% 11.48% 10.31% 13.95%





Weight of Debt 0.54 0.56 0.61 0.58 0.55


WACC (EPS Model) 4.21% 7.57% 5.52% 5.77% 2.30%

WACC (CAPM) 8.36% 9.20% 6.63% 4.97% 4.72%



Total (in Rs. Crs) 6839.68 6517.67 5641.70 5517.80 10108.16


Weight of Debt 0.37 0.35 0.37 0.30 0.11


WACC (EPS Model) 4.79% 9.21% 6.73% 8.96% 7.29%

WACC (CAPM) 10.46% 11.63% 8.51% 7.60% 12.12%



Net Profit NA 279.63 363.1 260.74 392.27




17

Jubilant Life Science: Charts & Graphs

Inference:

Over the past five years, it is visible that WACC using EPS method in both market value method and book value

method is lower as compared to CAPM or Gordon’s Growth Model.

Given the lower book value of equity as compared to market value, WACC under market value method is higher for

almost all the years.

Except the marginal rise in debt levels between the ranges of the period, debt to equity structure has more or less

remained constant as per the book value method. However, with price erosion in the past 1-2 years, the ratio of

debt to equity as per the market value has increased and subsequently the WACC has seen a decline.

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Mar '11 Mar '10 Mar '09 Mar '08

Jubiliant Life Science : ROCE & ROE


pharama - 5 company analysis

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