Report based on Capital Investment Plans

To analyze the capital investment plans of Hatsun Agro Products Limited (HAPL) we shall look at the capital expenditure of HAPL in the last five years, given in Table 1.

Table 1 : Capital Expenditure of HAPL in last 5 Years

In the last five years seeing the capital expenditure of the company, it has been constantly expanding its operations. In the year 2005, the company had 44 Crore capital expenditure in the year 2005. During this year HAPL entered into international markets. There was an overall increase in the capital expenditure due to the creation of additional infrastructure to support the international expansions. In the year 2008, the company has 34Crore capital expenditure to set up new plants. Some of the expansion plans the company carried on during the financial year 2008 are as follows.

1. Milk powder plant at Krishnagiri in Dharmapuri district of Tamil Nadu. With a capacity to produce 60mt milk powder every day.
2. The company also opened a new Honnali Dairy Milk processing unit, in Karnataka, with a capacity to process and packs one lakh litres of milk per day. This became operational at the end of FY 2008.
3. A processing facility at Madurai, with a capacity of one lakh litres of milk per day, was also opened in the year FY 2008.
4. The above expansions helped HAPL to expand its capacity near the supply chain in Tamil Nadu. Also Karnataka plant will help in reducing transport cost.

HAPL is engaged in processing and marketing of Milk, Ice creams & other Dairy products. The major business segments of HAPL comprises of two primary segments - Milk & milk products and Ice creams.  The Company's operating businesses are organized and managed separately according to the two segments representing a strategic business unit that offers different products and serves different markets. The below mentioned Table 2, gives the last five year split of capital expenditure of HAPL in their primary business segments.

Table 2 Primary Segment wise Capex of HAPL

The segment wise split clearly indicates the company is very aggressive in expanding its operations in its Milk processing business segment. Milk products contribute 90% of the revenue for HAPL. There had been recent high investment in their ice cream segment. This clearly indicates their new operations in Seychelles, Brunei and Fiji.

1. Expaniding its existing 600 Distribution centers to 900 by next financial year.

New Project

HAPL in the FY 2009, planned for a major capital expenditure plan. It has planned to open two milk processing units in Kangeyam and Kumbakonam district of Tamil Nadu.      These two plants will have a facility of milk processing and packaging centers with a capacity of each plant two lakh litres of a day.

The company intends to move milk relatively shorter distance from the dairy farm to processing plans and to consumers. The savings estimated would be about 40 paise a litre in milk transport because of the two plants. HAPL handles about 16 lakh litre of milk a day of which logistics cost works out to about 7% of the milk cost. Hence this capex project of HAPL would be a two pronged strategy:

1. Increase in capacity will help HAPL to help its fast growing domestic sales and export. The Compounded Annual Growth Rate of Sales over the last five years of HAPL is 22%.
2. Also a distribution cost reduction which will help in improving the profit margins for the company which has a present profit margin of around 2%.

HAPL has planned an investment of about Rs.120Crores in this setup of the two new plants. With a few assumptions we can analyze this Capex project of HAPL. Though this will not help in deciding the implementing the project this will help in identifying the potential of the project to the company and also the effect in the share price of the company.

Some assumptions made for the calculations.

1. Initial outlay or expenditure is Rs.120Crore inclusive of the opportunity cost, net working capital increase.  Terminal value is assumed to be zero as the plant would be outdated and requires complete replacement with no scrap value.
2. The both plants would run in its full capacity. Each plant has a capacity of 2 lakh litres per day and runs for 330 days in a year.
3. Also all the production capacity is sold in the market and hence sales volume for 330 days will be 4lakh litres per day.
4. Market price of per litre of milk is Rs.15 in Tamil Nadu at present. Hence the complete sales are made at this price. There could be other ways of calculating like the processed milk is not only sold as packaged milk, but sold as flavored milk or milk powder. Here for calculation it is sold at Rs.15 per litre.

HAPL's commissioned a plant at Seychelles which on May 2008 with a capacity of 3000 litres per day. Also a similar sized plant was also set last year in Fiji which manufactures their Ice cream brand. One of the reasons the company would have chosen these place is because of the lack of big enough markets for the Unilevers and Nestles to set up shop. This reduces competition and promotion costs.

Also the analysis of investments in fixed assets will give us some light on the major investment spending area. This analysis will help us in evaluating one of the future capital expenditure projects of HAPL, in assuming the depreciations. Table 3 lists major additions of important fixed assets of HAPL.

Table 3 Fixed Assets additions of HAPL

In the last two years the spending on plant and machinery has increased considerably for all the capacity expansion plans of HAPL. Seeing the Capex and depreciation in the last three years, in FY 2007 and 2008 the company has gone on aggressively into capital expenditure. The company uses straight line depreciation with the mentioned estimated life for every type of fixed assets.

Other Capex plans for the company are

1. The company is also doubling its dairy ingredients - milk powder and milk fats - production capacity to over 180 tonnes a day. The expanded capacity would be in place by February 2009, and the benefit would accrue from 2009- 10.
2. For financing the ongoing expansion plans the company's shareholders have approved a preferential issue of zero per cent compulsorily convertible preference shares to raise Rs 12 Crore which will be raised from promoters and associates.
3. Expaniding its existing 600 Distribution centers to 900 by next financial year.Doubling the capacity of the ice cream factory at Salem by end of March 2009 which would cut down costs by 6.5 Crores through reduction of distribution costs.

New Project

HAPL in the FY 2009, planned for a major capital expenditure plan. It has planned to open two milk processing units in Kangeyam and Kumbakonam district of Tamil Nadu.These two plants will have a facility of milk processing and packaging centers with a capacity of each plant two lakh litres of a day.

The company intends to move milk relatively shorter distance from the dairy farm to processing plans and to consumers. The savings estimated would be about 40 paise a litre in milk transport because of the two plants. HAPL handles about 16 lakh litre of milk a day of which logistics cost works out to about 7% of the milk cost. Hence this capex project of HAPL would be a two pronged strategy:

1. Increase in capacity will help HAPL to help its fast growing domestic sales and export. The Compounded Annual Growth Rate of Sales over the last five years of HAPL is 22%.
2. Also a distribution cost reduction which will help in improving the profit margins for the company which has a present profit margin of around 2%.

HAPL has planned an investment of about Rs.120Crores in this setup of the two new plants. With a few assumptions we can analyze this Capex project of HAPL. Though this will not help in deciding the implementing the project this will help in identifying the potential of the project to the company and also the effect in the share price of the company.

Some assumptions made for the calculations.

1. Initial outlay or expenditure is Rs.120Crore inclusive of the opportunity cost, net working capital increase.  Terminal value is assumed to be zero as the plant would be outdated and requires complete replacement with no scrap value.
2. The both plants would run in its full capacity. Each plant has a capacity of 2 lakh litres per day and runs for 330 days in a year.
3. Also all the production capacity is sold in the market and hence sales volume for 330 days will be 4lakh litres per day.
4. Market price of per litre of milk is Rs.15 in Tamil Nadu at present. Hence the complete sales are made at this price. There could be other ways of calculating like the processed milk is not only sold as packaged milk, but sold as flavored milk or milk powder. Here for calculation it is sold at Rs.15 per litre.
5. As tax calculation, costs are unknown we use the profit margin to calculate the cash flows. The profit margin in the year 2008 is 2% (Table 4), it would be 30 Paise per litre (2% of Rs.15). As this project will reduce the distribution cost by 40 Paise. In this cost reduction 30% would be going for tax and remaining 28 Paise would be adding to our 30 Paise per litre profit. Overall there would be 58 Paise per litre profit because of the project. That is 3.5% Profit Margin approximately.

Table 4 Profit Margins of HAPL

From the above assumptions cash flows can be obtained as calculated in Table 5.  The discounting rate for NPV was assumed to be 7%.  The ROA of HAPL in the year 2008 was approximately 7%

Table 5 Incremental Cash Flow for HAPL's new Project

The payback period of the project in gross without considering discounting rate is around 6.4 years but the internal rate of return in 9.28%. Hence for the above assumptions if the discounting rate anything below this IRR will result in a positive NPV for HAPL and hence the project will be a success for HAPL