In this assignment, you will be reviewing the Berger Paints case (images of the case attached below). After reviewing the case documents, complete the following tasks:

1. Discuss the process and framework of equity valuation generally followed by financial analysts.

2. Discuss the various valuation methodologies used by analysts globally for estimating the value of an equity stock.

3. Discuss the concept of the dividend discount valuation model and its key steps and assumptions.

4. Determine the intrinsic fundamental valuation of Berger Paints (on a per share basis) using the multi-stage DDM. Clearly state all your assumptions and calculations including an estimation of cost of equity (for required returns).

5. Based on your analysis, as Rohit Bajaj, what recommendation would you make?

6. Does Berger Paints qualify as a potentially undervalued target? Should Rohit's clients invest in it?

Introduction On July 30, 2016, it was a Iate evening for Rohit Bajaj, senior advisor at a prominent wealth management company in Nariman Point, Mumbai. Rohit, who spearheaded the Indian consumer sector research for his firm, was examining the latest financial data from Berger Paints Ltd, one of India's leading paint companias headquartered in Kolkata, India. Rohis wondered whether Berger Paints would be a good investment for his existing clients - as well as new clents - who were looking to deploy funds in fundamentally strong but potentialy undervalued companies. Berget Paints dominant presence had ensured superior sales growth and robust profit margins in the past and it was poised to benefit significantly from the strong growth of the Indian paint industry on account of increasing incomes, higher discretionary spending, increasing penetration in terms of per oapita consumption of paint per household, strong construction activities, and robust growth in the auto and consumer durables industries. Given the current equity market value of around INR 14.000 crores 1 (at per share price of INR 199). Rohit wondered whether Berger Paints would turn out to be a potentialy undervalued investment target for his cients given its current valuation. To evaluate this problem, he decided to conduct fundamental analysis of Berger Paints using the traditional DDM on the basis of financial information available. Rohit had a lot to think about as he considered the proposed financial valuation of Berger Paints using the traditional DDM. Could Berger Paints be the high growth but undervalued stock that Rohit was looking for? Page 3 of 10 Eerger Paints: Dividend Dlecourt Valuaton \$SAGE buginetscases What would be the fair fundamental value of Berger Paints? How would he arrive at the cost of equity calculation for computing the discount rate? What would be the basis for calculating the terminal value? With all these questions in mind, Rohit decided to clear his desk of all other work and focus on the dividend discount valuation of Berger Paints. Indian Paint Industry The Indian paint industry, estimated to be around INR 40 billion (Business Standard, 2014) in terms of market size, has grown tremendously during the past decade on the back of increasing income levels, higher discretionary spending on repainting homes, robust construction activities, and strong housing demand. The growing demand and the scale of the paint industry in India is closely related to gross domestic product (GDP) growth rate and has grown on an average 1.5-2 times GDP growth rate since liberalization in 1991 (Paint Ex-Asia, 2017). In terms of per capita consumption of paint, the Indian paint market is underpenetrated with per capita paint consumption of around 2.7kgs, which is very low compared to the developed Westem nations (Berger Paints, 2016). Low per capita paint consumption, combined with India's favorable demographic profile, rising disposable income, urbanization, and development of rural markets, would spur strong demand for paint companies in near future. The Indian paint industry can be primarily classified into two major segments: (1) decorative paints; and (2) industrial paints. Decorative paints include higher end acrylic exterior and interior emulsions, medium range exterior and interior paints, low end distempers, wall putty, wood coatings, cement paints, primers, thinners and putties. Decorative paints account for more than 70% of the paint market in India and this segment is growing at a faster pace than industrial paints (Berger Paints, 2016). Demand for decorative paints generally stems from household painting, architectural and other display products, and it increases during the festive season (New Year), as compared to other times of the year. The main growth drivers for this segment have been shortening of the repainting cycle and increase in the number of new homes built each year, which reflects an including in-laws and grandparents, whereas a nuclear family includes only a couple and their children). The including in-laws and grandparents, whereas a nuclear family includes only a couple and their children). The industrial paint segment, on the other hand, includes paints used in automobiles, auto ancillaries, consumer for industrial paints is derived from demand from the auto and infrastructure sectors. The major companies in the Indian paint industry include: Asian Paints; Kansai Nerolac Paints; Berger Paints; Akzo Nobel; Nippon Paints; and Shalimar Paints. The Indian paint industry is generally characterized by high raw material intensity with more than 300 raw materials involved in the manufacturing process. About 3035% of the raw materials of the paint industry is crude oil based. Titanium dioxide constitutes 20% of the total raw material cost and is also the major constituent in the manufacture of white shades (Moneycontrol, 2015). Since most of the raw materials are petroleum based, the industry benefits from softening crude prices. A sharp fall in crude prices tends to impact gross margins of paints companies favorably. Berger Paints Berger Paints, incorporated in 1923, is the second largest paint company in India with a consistent track record of being one of the fastest growing paint companies with a strong global presence across 4 countries (Nepal, Bangladesh, Poland, and Russia). With employee strength of more than 2800 and a countrywide distribution network of more than 25,000 dealers, Berger Paints has been acclaimed as a game changer in the sector with a vibrant portfolio of paints and tailor-made customer services in every paint segment (Berger Paints India, n.d.). In terms of revenue segmentation, in line with the trend in the country, the company's decorative business constitutes almost 80% of its overall sales. Berger Paints is the second-largest paint company in decorative paints in India and is aided by an extensive distribution network and consistent product launches such as Silk, Weathercoat All Guard, Easy Clean, Bison, Butterfly. Walmasta, and Luxol HiGloss. The company also has significant presence in industrial paints, which contributes around 12% to its overall revenues. The company is the market leader in the protective paints segment in the country and continues to be the preferred supplier for project related work in all sectors of the economy with well-established products such as chloro rubber, epoxies, inorganic zinc products, polyurethane, poly-siloxanes, high temperature resistant coatings, anti-carbonation coatings, road marking, airfield marking, concrete coatings, rebar coatings, heavy duty floor coatings, and green coatings. Financial Performance and Management Outlook To understand the current state of financial affairs at Berger Paints and management outlook for the future, Rohit looked up excerpts from the 'Director's Report' and the "Management Discussion and Analysis" section of the Berger Paints annual report for 2015-2016. During the financial year that ended March 31, 2016, the company registered a consistent performance across all parameters. While net revenue from operations showed a stellar growth of 8.57%, the profit before depreciation, interest, and taxes recorded an improvement of 26.2% vis-ad-vis the previous financial year. Likewise, profit before taxes and profit after taxes registered an increase of 38.8% and 39.7% respectively in the financial year 2015-2016 compared to previous financial year 2014-2015. In terms of retum ratios for shareholders, Berger Paints registered a return on equity of 23.5% in the financial year 2015-2016 compared to 20.5% in the previous financial year 2014-2015. The company has been reducing debt on its balance sheet over a period of a few years with a current debtlequity ratio at a minuscule 0.18:1, reflecting strong internal cash flow generation and superior profitability metrics. The company has also been reducing its dependence on crude oil-based raw materials and has started using water- or solvent-based paints derived from emulsion materials in the decorative and wood coating segments to keep a check on costs in order to maintain superior profitability. The company has also been a beneficiary of falling crude prices since 2014 as titanium dioxide and other key raw materials used in paint production are crude oil derivatives. With oil prices unlikely to rise significantly in the near future due to supply-side responses from US shale producers, Berger Paints should be able to keep costs under control. During the previous five years, while the company has grown its revenue and profit after taxes by a compound annual growth rate (CAGR) of around 14%, its market capitalization has grown at an outstanding rate of 35%, thereby reflecting strong investor interest. Given the stellar growth in revenue and profits, the company has been regularly distributing dividends to its shareholders with current dividend per share at INR 1.65 (in the financial year 2015-2016) compared to INR 1.25 in the previous financial year 2014-2015, thereby reflecting an increase of 32% in form of pay-outs. Through its dividend policy. Berger Paints intends to deliver sustainable returns to its shareholders, in consonance with the dynamics of a business environment. Looking ahead, the management envisions increasing demand for paints on the back of expected revival in rural consumption (which has been subdued for the past two years primarily due to poor monsoon and unfimely rains), setting up of smart cities by the government, revival of the rural employment schemes, One Rank One Pension Policy and the recommendations of the Seventh Pay Commission. To cater to increasing demand for paints, Berger Paints plans to enhance capacity in phases, taking advantage of its multiple locations throughout india, introduce new products, strengthen servicing capabilities, and bolster logistics, distribution, and storage capability. Valuing Berger Paints: Dividend Discount Valuation The dividend discount valuation approach involves finding the present value of all future dividends during the forecasted period and then discounting it at the computed cost of equity to arrive at the intrinsic value of the stock. Projecting Future Data for Dividend Discount Valuation To perform the dividend discount valuation, Rohit needed to explicitly forecast the dividends of Berger Paints using the various financial data available in the annual report for the financial year 2015-2016 (see Iables 1 and 2). Rohit was confident that revenues of Berger Paints would grow in the high teens (close to 20\%) given the management's positive outlook, improving demand environment, and strong financial position of the company. As per the "India Paint Industry Outlook 2020 report, given rapid urbanization, increasing disposable incomes, and growing infrastructure, it is anticipated that the Indian paint market will grow with a CAGR of around 14% during 2015-2016 to 2019-2020 (Business Wire, 2015). Some of the other assumptions made by Rohit were as follows: - Cost of materials consumed (as \% of revenue) assumed to be in line with the current year (2015-2016) levels in the foreseeable future. - Employee and other expenses (as \% of revenue) was assumed to be in line with the current year levels (20152016). - Depreciation (as \% of revenue) assumed to be in line with the current year (2015-2016). - Finance costs were assumed to be the same as in the current year (2015-2016). - Dividend payout ratio was assumed to be at 60%, higher than the current year levels on account of the strong financial position of the company. - Tax rate to be assumed as 30%. Table 2. Berger Paints balance sheet (in crores). \begin{tabular}{|l|l|l|} \hline & FY 2015 & FY 2016 \\ \hline Equity and liabilities & \\ \hline Shareholders' funds & 1,293 & 1,510 \\ \hline \end{tabular} FY: Financial year. The final consideration for Rohit was determination of cost of equity to be used as a discounting factor. To compute the same, Rohit estimated the one-year beta for Berger Paints to be 0.7 and the average equity risk premium for India as 4%. For risk free rate data, Rohit referred to the central bank (Reserve Bank of India) website wherein govemment treasury securities prices and yields were traded. As per the Reserve Bank of India website, India's 10-year treasury yield as on 30 July, 2016 was 7.2% (RBI, 2016). With all this financial information in hand, Rohit set out to assess the fundamental value of Berger Paints using the dividend discount valuation methodology wondering whether the price he was about to calculate would be higher or lower than the market price as accordingly he needed to recommend the stock for his clients. Introduction On July 30, 2016, it was a Iate evening for Rohit Bajaj, senior advisor at a prominent wealth management company in Nariman Point, Mumbai. Rohit, who spearheaded the Indian consumer sector research for his firm, was examining the latest financial data from Berger Paints Ltd, one of India's leading paint companias headquartered in Kolkata, India. Rohis wondered whether Berger Paints would be a good investment for his existing clients - as well as new clents - who were looking to deploy funds in fundamentally strong but potentialy undervalued companies. Berget Paints dominant presence had ensured superior sales growth and robust profit margins in the past and it was poised to benefit significantly from the strong growth of the Indian paint industry on account of increasing incomes, higher discretionary spending, increasing penetration in terms of per oapita consumption of paint per household, strong construction activities, and robust growth in the auto and consumer durables industries. Given the current equity market value of around INR 14.000 crores 1 (at per share price of INR 199). Rohit wondered whether Berger Paints would turn out to be a potentialy undervalued investment target for his cients given its current valuation. To evaluate this problem, he decided to conduct fundamental analysis of Berger Paints using the traditional DDM on the basis of financial information available. Rohit had a lot to think about as he considered the proposed financial valuation of Berger Paints using the traditional DDM. Could Berger Paints be the high growth but undervalued stock that Rohit was looking for? Page 3 of 10 Eerger Paints: Dividend Dlecourt Valuaton \$SAGE buginetscases What would be the fair fundamental value of Berger Paints? How would he arrive at the cost of equity calculation for computing the discount rate? What would be the basis for calculating the terminal value? With all these questions in mind, Rohit decided to clear his desk of all other work and focus on the dividend discount valuation of Berger Paints. Indian Paint Industry The Indian paint industry, estimated to be around INR 40 billion (Business Standard, 2014) in terms of market size, has grown tremendously during the past decade on the back of increasing income levels, higher discretionary spending on repainting homes, robust construction activities, and strong housing demand. The growing demand and the scale of the paint industry in India is closely related to gross domestic product (GDP) growth rate and has grown on an average 1.5-2 times GDP growth rate since liberalization in 1991 (Paint Ex-Asia, 2017). In terms of per capita consumption of paint, the Indian paint market is underpenetrated with per capita paint consumption of around 2.7kgs, which is very low compared to the developed Westem nations (Berger Paints, 2016). Low per capita paint consumption, combined with India's favorable demographic profile, rising disposable income, urbanization, and development of rural markets, would spur strong demand for paint companies in near future. The Indian paint industry can be primarily classified into two major segments: (1) decorative paints; and (2) industrial paints. Decorative paints include higher end acrylic exterior and interior emulsions, medium range exterior and interior paints, low end distempers, wall putty, wood coatings, cement paints, primers, thinners and putties. Decorative paints account for more than 70% of the paint market in India and this segment is growing at a faster pace than industrial paints (Berger Paints, 2016). Demand for decorative paints generally stems from household painting, architectural and other display products, and it increases during the festive season (New Year), as compared to other times of the year. The main growth drivers for this segment have been shortening of the repainting cycle and increase in the number of new homes built each year, which reflects an including in-laws and grandparents, whereas a nuclear family includes only a couple and their children). The including in-laws and grandparents, whereas a nuclear family includes only a couple and their children). The industrial paint segment, on the other hand, includes paints used in automobiles, auto ancillaries, consumer for industrial paints is derived from demand from the auto and infrastructure sectors. The major companies in the Indian paint industry include: Asian Paints; Kansai Nerolac Paints; Berger Paints; Akzo Nobel; Nippon Paints; and Shalimar Paints. The Indian paint industry is generally characterized by high raw material intensity with more than 300 raw materials involved in the manufacturing process. About 3035% of the raw materials of the paint industry is crude oil based. Titanium dioxide constitutes 20% of the total raw material cost and is also the major constituent in the manufacture of white shades (Moneycontrol, 2015). Since most of the raw materials are petroleum based, the industry benefits from softening crude prices. A sharp fall in crude prices tends to impact gross margins of paints companies favorably. Berger Paints Berger Paints, incorporated in 1923, is the second largest paint company in India with a consistent track record of being one of the fastest growing paint companies with a strong global presence across 4 countries (Nepal, Bangladesh, Poland, and Russia). With employee strength of more than 2800 and a countrywide distribution network of more than 25,000 dealers, Berger Paints has been acclaimed as a game changer in the sector with a vibrant portfolio of paints and tailor-made customer services in every paint segment (Berger Paints India, n.d.). In terms of revenue segmentation, in line with the trend in the country, the company's decorative business constitutes almost 80% of its overall sales. Berger Paints is the second-largest paint company in decorative paints in India and is aided by an extensive distribution network and consistent product launches such as Silk, Weathercoat All Guard, Easy Clean, Bison, Butterfly. Walmasta, and Luxol HiGloss. The company also has significant presence in industrial paints, which contributes around 12% to its overall revenues. The company is the market leader in the protective paints segment in the country and continues to be the preferred supplier for project related work in all sectors of the economy with well-established products such as chloro rubber, epoxies, inorganic zinc products, polyurethane, poly-siloxanes, high temperature resistant coatings, anti-carbonation coatings, road marking, airfield marking, concrete coatings, rebar coatings, heavy duty floor coatings, and green coatings. Financial Performance and Management Outlook To understand the current state of financial affairs at Berger Paints and management outlook for the future, Rohit looked up excerpts from the 'Director's Report' and the "Management Discussion and Analysis" section of the Berger Paints annual report for 2015-2016. During the financial year that ended March 31, 2016, the company registered a consistent performance across all parameters. While net revenue from operations showed a stellar growth of 8.57%, the profit before depreciation, interest, and taxes recorded an improvement of 26.2% vis-ad-vis the previous financial year. Likewise, profit before taxes and profit after taxes registered an increase of 38.8% and 39.7% respectively in the financial year 2015-2016 compared to previous financial year 2014-2015. In terms of retum ratios for shareholders, Berger Paints registered a return on equity of 23.5% in the financial year 2015-2016 compared to 20.5% in the previous financial year 2014-2015. The company has been reducing debt on its balance sheet over a period of a few years with a current debtlequity ratio at a minuscule 0.18:1, reflecting strong internal cash flow generation and superior profitability metrics. The company has also been reducing its dependence on crude oil-based raw materials and has started using water- or solvent-based paints derived from emulsion materials in the decorative and wood coating segments to keep a check on costs in order to maintain superior profitability. The company has also been a beneficiary of falling crude prices since 2014 as titanium dioxide and other key raw materials used in paint production are crude oil derivatives. With oil prices unlikely to rise significantly in the near future due to supply-side responses from US shale producers, Berger Paints should be able to keep costs under control. During the previous five years, while the company has grown its revenue and profit after taxes by a compound annual growth rate (CAGR) of around 14%, its market capitalization has grown at an outstanding rate of 35%, thereby reflecting strong investor interest. Given the stellar growth in revenue and profits, the company has been regularly distributing dividends to its shareholders with current dividend per share at INR 1.65 (in the financial year 2015-2016) compared to INR 1.25 in the previous financial year 2014-2015, thereby reflecting an increase of 32% in form of pay-outs. Through its dividend policy. Berger Paints intends to deliver sustainable returns to its shareholders, in consonance with the dynamics of a business environment. Looking ahead, the management envisions increasing demand for paints on the back of expected revival in rural consumption (which has been subdued for the past two years primarily due to poor monsoon and unfimely rains), setting up of smart cities by the government, revival of the rural employment schemes, One Rank One Pension Policy and the recommendations of the Seventh Pay Commission. To cater to increasing demand for paints, Berger Paints plans to enhance capacity in phases, taking advantage of its multiple locations throughout india, introduce new products, strengthen servicing capabilities, and bolster logistics, distribution, and storage capability. Valuing Berger Paints: Dividend Discount Valuation The dividend discount valuation approach involves finding the present value of all future dividends during the forecasted period and then discounting it at the computed cost of equity to arrive at the intrinsic value of the stock. Projecting Future Data for Dividend Discount Valuation To perform the dividend discount valuation, Rohit needed to explicitly forecast the dividends of Berger Paints using the various financial data available in the annual report for the financial year 2015-2016 (see Iables 1 and 2). Rohit was confident that revenues of Berger Paints would grow in the high teens (close to 20\%) given the management's positive outlook, improving demand environment, and strong financial position of the company. As per the "India Paint Industry Outlook 2020 report, given rapid urbanization, increasing disposable incomes, and growing infrastructure, it is anticipated that the Indian paint market will grow with a CAGR of around 14% during 2015-2016 to 2019-2020 (Business Wire, 2015). Some of the other assumptions made by Rohit were as follows: - Cost of materials consumed (as \% of revenue) assumed to be in line with the current year (2015-2016) levels in the foreseeable future. - Employee and other expenses (as \% of revenue) was assumed to be in line with the current year levels (20152016). - Depreciation (as \% of revenue) assumed to be in line with the current year (2015-2016). - Finance costs were assumed to be the same as in the current year (2015-2016). - Dividend payout ratio was assumed to be at 60%, higher than the current year levels on account of the strong financial position of the company. - Tax rate to be assumed as 30%. Table 2. Berger Paints balance sheet (in crores). \begin{tabular}{|l|l|l|} \hline & FY 2015 & FY 2016 \\ \hline Equity and liabilities & \\ \hline Shareholders' funds & 1,293 & 1,510 \\ \hline \end{tabular} FY: Financial year. The final consideration for Rohit was determination of cost of equity to be used as a discounting factor. To compute the same, Rohit estimated the one-year beta for Berger Paints to be 0.7 and the average equity risk premium for India as 4%. For risk free rate data, Rohit referred to the central bank (Reserve Bank of India) website wherein govemment treasury securities prices and yields were traded. As per the Reserve Bank of India website, India's 10-year treasury yield as on 30 July, 2016 was 7.2% (RBI, 2016). With all this financial information in hand, Rohit set out to assess the fundamental value of Berger Paints using the dividend discount valuation methodology wondering whether the price he was about to calculate would be higher or lower than the market price as accordingly he needed to recommend the stock for his clients