SELECTED INDIAN PHARMACEUTICAL COMPANIES PERFORMANCE THROUGH EVA, A STUDY

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1 SELECTED INDIAN PHARMACEUTICAL COMPANIES PERFORMANCE THROUGH EVA, A STUDY Mamatha. Ellanti Assistant Professor, Sree Vidyanikethan Institute of Management. Tirupati (India) ABSTRACT The Indian Pharmaceutical Industry has grown in recent years to become a major manufacturer of health care products to the world, Globally, India ranks 3 rd in terms of Volume of Producing drugs and 14 th in terms of value. The domestic market is worth of US$13.8 billion as of 2013 and it is expected to reach US$49 billion by 2020.With this regard, this study throws a light on evaluating the performance of selected companies through Economic Value Added (EVA).In 1990 s EVA, A new financial devie was formulated to measure the firms s returns earned and benchmarked against cost of capital. In India also, several leading companies have adopted EVA as the metric for evaluating performance and they have also been successful for enhancing the wealth of their shareholders. EVA was trade marked by Stren and Stewart in the year (1991).It is a valued based measurement tool and is calculated by comparing a firm s Net operating profit After Tax (NOPAT) to the total cost all its forms of capital which includes debt as well. If NOPAT exceeds the Cost of capital, it gives Positive EVA and if NOPAT is less than the cost of capital, it gives Negetive EVA. Ashok Benarjee, IIM Lucknow, in his Research paper, explains the relationship between the two values based measures EVA and MVA (Market Value Added) Dr.Shipna putry in her research work, analyzed the EVA in the two sectors Power and IT. Three companies based on Market Capitalization were taken for this study, SUN PHARMA Large capitalization, CADILLA HEALTHCARE- Mid capitalization, AJANTHA PHARMA- Small capitalization. Economic profit (or) EVA was calculated for the three companies from the year (3 years).as per the analysis Sun pharma for the year is having more Eva than other two years, due to high debt taken from various sources. Cadilla is having Negative Eva for all the three years from Small Cap firm Ajantha Pharma is having a positive EVA when compared to all other Mid-Cap company (Cadilla Health care) and Large- cap company(sun Pharma) Key Words: EVA, NOPAT, Market Capitilization, Cost Of Capital I. INTRODUCTION The global economy has so far relieved on demand in advanced economies as it engine of growth. Central Statistics Organization and International Monetary fund surveys indicate that India is now the fastest growing major economy in the world. Financing pattern of India has been changing every day with Innovative financial instruments for their sustainability. These days, corporate India is concentrating on wealth maximization of its shareholders. Capital is 284 P a g e

2 still costly in the country and depends on the Debt and Equity invested by Retail Investors, Institutional Investors, FDI s and FPI s. The Investors are also concentrating on wealth creation of the corporate in India. The Investors cannot completely depends upon the traditional methods to measures like P/E ratio, ROI (Return on Investment), RONW(Return on Net worth ) etc.,. EVA(Economic Value Added) by stern, Stewart., recognized by so many companies to calculate Economic profit and Wealth creation of the shareholders.with this backdrop, This study attempts to measure EVA of selected pharmaceutical companies based on the market capitalization II. PHARMACEUTICAL INDUSTRY- AN OVERVIEW Indian Pharma Industry ranks 3 rd in the volume of sales and 14 th in terms of value. According to Price water coopers (PWC) in 2010, Indian pharma will reach the sales of US$ 50 Billion by 2020 and it will also join the league of top 10 global pharmaceuticals. The strengths of the Industry is the 20% of Global exports in Generics and it become largest service provider of generic medicines globally. The Industry is going to be spent US$200 Billion on Infrastructure by For the Fiscal year , recorded a growth rate 2.5% over the corresponding period of previous years Strengths: Cost of production in India is significantly lower than USA and almost half of that of Europe. Competent with skilled workforce as well as high Managerial and Technical expertise. Approval time for new facilities has been drastically reduced, due to liberalization of patents Act, Pharma companies have increased spending to tap rural markets and develop better Infrastructure; the market share of hospitals is expected to increase from 13.1% in 2009 to 26% in % FDI is allowed under government route. Make in India aimed to improve various manufacturing sectors in India including Pharmaceuticals. Total 175 companies are in pharma industry, and most of them are mainly operated as well as controlled by dominant foreign companies. Pharma Industry in India is competing with global companies with high Growth rate, Skilled Workforce, Government Initiatives, 100% FDI, Good Infrastructure and Technical Expertise. So, It is the responsibility of the Players in the Industry to maximize the wealth of the shareholders. With this backdrop, this study throws a light on finding of Shareholders wealth through EVA (Economic Value Added) of three Indian pharma companies listed in NSE and also based on its Market capitalization. III. EVA AN OVERVIEW One of the financial goals of every company is to improve shareholder s wealth. As well as the investors are also expect good Long-term yield on their investments, some of the performance measures like ROI (Return on Investment), EPS (Earnings per share), RONW (Return on Net worth) etc., and these measures should not correlate 285 P a g e

3 theoretically with the shareholders value creation. With this Backdrop, Value based measures like EVA and MVA (Market Value Added) have revived a lot of attention in the recent years. This study concentrates on measuring EVA for selected pharmaceutical Companies.Stern, Stewart and co., developed EVA in the year They have been a number of studies investigating the relevance and importance. 160 adjustments can be done to EVA. Few of them are: 1. Research and Development cost 2. Deferred Taxes 3. LIFO reserves 4. Depreciation 5. Goodwill 6. Operating leases etc., EVA was trademarked by Stern and Stewart and Co., So, it is frequently referred to as Economic profit and provides a measurement of a company s Economic success or Failure over a period of time. Computation of EVA has done at the Research Methodology. Objectives of the Study: 1. To examine whether the selected pharma companies has been able to generate shareholders value using EVA. 2. To study which company based on Market capitalization generating maximum and minimum EVA. 3. To suggest what are the various reasons for the companies which are unable to provide better Economic profit. IV.LITERATURE REVIEW Stern (1990): A performance metric EVA was developed by stern, According to his study, EVA is a performance measure which is mostly closely linked to create shareholders wealth maximization. Eva also suggested to managers for decision making in Financial Management. He stated in his studies that, Eva is the best way of maximizing shareholders return is to offer incentives to managers for Decision making that boost long-term value. Stewart (1991): He studied the relationship between EVA and shareholder wealth (MVA) with market data of 618 US companies and presented the results in his book The quest for Value. He stated that EVA and MVA correspond with each quite well among selected US companies. He provided the first Empirical evidence of proximity of EVA and MVA with R2 of 0.97 between changes in Eva and changes in MVA for 25 groupings of firms over the period Lehn and Makhija (1996): Their study examined the effectiveness of MVA and EVA as measures of performance as signals of strategic development was conducted. They were found to be 114 European Journal of Economics, Finance, and Administrative services (2011). Resulted, Firms having greater focus in their business activities had higher MVA than less focused counterparts. 286 P a g e

4 Padgett (1996): Commented on a study conducted by Stern, Stewart and company of top 100 US banks. The study resulted a dissatisfactory situation because maximum banks reported Negative EVA. Rajeswar (1997): Resulted EVA is not only a measure of financial performance of organization, But it is also be used as a device for shareholder s communication and Managers Incentive system. Saxena (1998): Elucidating that there is no one method of measuring financial performance that is totally perfect. EVA is a measure that evaluates investment center managers, because it considers goal congruence between shareholders and Managers. Bhattacharya and Phani (2000): Explained the concept of EVA is gaining popularity in India. It concluded that through EVA does not provide additional information to Investors, but also useful for adapting as a corporate philosophy for motivating and educating employees to differentiate between value creating and value destroying activities. Bhatnagar (2004): Study conducted on 56 companies for 10 years ranging from ( ) to ( ), resulted the EVA to be single variable, which was significantly related to MVA, and EVA is the most significant measure of corporate financial performance. Shurveer.s.Bhanwat (2009): Conducted a study on Shareholder value creation in the Indian Banking Industry by using EVA and Karlpearson s correlation. BSE listed public and Private sector Banks were taken for the study and revealed that, Indian banks including Public and Private sector are not creating shareholder value. Debdas Rakshit (2006): Developed a case study on EVA based performance measurement at Dabur India Limited. He calculated WACC based on Market value and Book value and also he did comparison of Traditional performance measure ROI (Return on Investment) with EVA in the case study. Comparatively EVA is less than ROI every year. R.Satish, Dr.SS.Rao (2009): Studied awareness and adaptability of EVA added concept in the Indian Banking sector, resulted 74% of the respondents make a clean breast about the good future of EVA in Indian Banking majority finds it is a strategic tool for decision-making and the overall inference gives that most of the banks are aware about the concept and respecting EVA to be a true indicator of Performance. Shipra pruthy and Rajbir Kaur hara (2013): Research paper on comparison between EVA and MVA of Top 10 NSE listed IT sector companies in India, Study concentrates on Ranking the EVA of IT companies, HCL Tech ranks 1 followed by Think soft and Tech Mahindra got last. According to MVA, TCS got rank 1 followed by Wipro and Polaris tech got last rank. And also defined that there is positive relationship between MVA and EVA of the companies, among all Polaris tech, Wipro, Tech Mahindra are the top 10 wealth destroyers. 287 P a g e

5 Shipra pruthy (2013): Conducted the study of comparing EVA and MVA between the Power sector companies in India. Indian Oil Corporation ranked 1 in EVA and Reliance Power got last. Reliance India got 1 st rank in MVA and Bharath Petroleum got last. Methodology of the Study: Sample size: Three companies listed in National Stock Exchange, based on its Market Capitalization taken for this study, they are S.N Market Capitalization Name of the company 1 Large Cap Sun Pharmaceuticals Pvt Ltd. 2 Mid- Cap Cadilla Healthcare Pvt Ltd. 3 Small - Cap Ajantha Pharmaceuticals Pvt Ltd. Sources of Data: This study is purely based on secondary data. Data has been taken from Audited and Published Annual reports of the companies. Market return has been taken form NSE Historical data for the above company stocks. V. METHODOLOGY Step-1: Calculation of NOPAT According to Stewart, EVA is a residual return measure the subtracts the cost of invested capital from NOPAT. It is the simplest form and can be calculated by using the formula. EVA= Nopat (WACC * IC) Where, Nopat = Net operating profit after taxes WACC = Weighted Average cost of capital IC = Invested Capital Company will create Shareholders wealth if EVA is positive, and also Nopat is more than cost of financing, If Nopat is less than cost of financing denoting that EVA is negative and the company is destroying the wealth of the shareholders. Step-2: Calculation of Weighted Average Cost of Capital We can use the below formula for calculating WACC WACC = wd *cd (1-t) + we*ce Step-3: Calculation of Cost of Equity Cost of Equity (Ke) is calculated by using the CAPM model. 288 P a g e

6 Ke= RF + Beta (Rm-Rf) Where, Ke = Cost of Equity, RF = Risk free rate of return Rm = Market return Beta can be calculated by using the formula Market return = current day closing price of Nifty Previous day closing price of Nifty Security return = current day closing price of stock previous day closing price of stock Regression formula has been used to check the dependency of security return on market return which is called Beta. Step 4: Calculation of Cost of Debt It can be calculated by using Total Interest expenses *(1-effective tax rate) Analysis of the Study: Table 1 Nopat calculation (Rs in Millions) Period Sun pharma Cadilla Healthcare Ajantha Pharma * Source- Based on Data Analysis Table 2 WACC (%) Period Sun Cadilla Ajantha pharma Healthcare Pharma * Source- Based on Data Analysis 289 P a g e

7 Table 3- Invested Capital (Rs in Millions) Period Sun pharma Cadilla Healthcare Ajantha Pharma , ,301 11, , , * Source- Based on Data Analysis Table 4 EVA Calculation Period Sun pharma Cadilla Ajantha Healthcare Pharma * Source- Based on Data Analysis Chart showing Economic value Added of three companies: 290 P a g e

8 Findings: Sun pharma has positive EVA in the year , and then it goes to Negative in the years and The capital invested of the company is also became more times than comparing to previous years i.e., ( ) in the year and (2746.2) in the year The sun pharma is investing huge funds from the year 2013 to till now; It acquired Ranbaxy from Daichin Sankyo with great deal. According to the study, Eva calculations reveals that sun pharma is not performing well comparing to the previous years and it is not concentrating on the maximization of Investors Economic profit. Coming to the Eva calculation of Medium capitalized company Cadilla HealthCare, Its Net operating Profit was increasing every year i.e., Rs millions to Rs. 12,683 millions. And its weighted average cost of capital is reduced in the year Moreover the capital Investment is also reducing every year. Cadilla s Investments are less comparing previous years, NOPAT is moving high. The cost of capital is going on increasing every year. Ajanta Pharma NOPAT is increasing year by year from (130.7) to (299.67), as well as weighted average cost of capital is reducing from 6.12 in the year to 1.73 in the year Anyway the capital invested is coming down but the EVA is showing positive in the year i.e., (182.26). The company is having negative EVA in the previous years and it is turning its Negative into Positive in the recent years. This Analysis shows that the small capitalization company Ajanta Pharmaceuticals is performing more than the other companies. It is also creating the wealth of the shareholders than other companies. Cadilla is negative for all the three years and sun pharma is positive for the year and Negative for the recent years. Suggestions Companies may get good ROI (Return on Investment) but it should disclose the EVA, a real performance metric to the Investors. So, this study highly recommends to all the companies that it should disclose the EVA to the interested shareholders and other stakeholders of the company. Cadilla Healthcare and Sun pharma should select good portfolio of projects for getting high returns and EVA can be increased. Eva should be linked with performance of the Managers. The Debt and Equity ratio should be optimum, companies can go for alternative sources of funds which can reduce cost of capital, especially in the case of Sun pharmaceuticals. 291 P a g e

9 Limitations 1. Stern Stewart, who is the father of EVA was given 160 adjustments to calculate EVA, the Economic profit will be true if we did all the 160 adjustments. 2. This study is based on valuation concepts. 3. Performance of the companies under consideration has been taken for the year VI. CONCLUSION Investors are investing their hard earned money in the companies. It is the responsibility of the company management to increase their wealth. Stern Stewart suggested a real and true performance metric to find out the economic profit of the company. It is least popularized in India. So, No company is disclosing its EVA in Annual reports. Because, the market price of the shares depends on the profit of the company. But if the companies calculate EVA and deduct the cost of Equity from profit the value would be less as equity cost is the highest cost instead of other component of capital cost. It has found that so many companies have enough profit but these companies are showing negative EVA (or) less EVA due to high cost of Equity. Companies should invest wisely in different projects. It should be mandatory for every company to disclose EVA, in its annual reports. So that Investor can check true profitability of the company while investing. REFERENCES 1. Stern Stewart & Co.[1997], The Stern Stewart Performance 1000: Introduction and Documentation, Stern Stewart Management Services Inc. 2. Sharma, K. A. & Kumar, S. (2010). Economic value added literature review and relevant issue. International Journal of Economics and Fiancé, 2(2). 3. Debdas Rakshit,(2006).Eva based performance measurement: A case study of Dabur India Limited,Vol.11,Vidyasagar university journal of commerce. 4. R.Satish and Dr.S.S.Rao. (2009). A study on awareness and adaptability of Economic value added concept in Indian Banking sector. Journal of contemporary research in Management, July September Lehn, K. & Makhija, A. K. (1996). EVA and MVA: as performance measures and signals for strategic change. Strategy & Leadership, 24, Phani, B.V & Bhattacharya, A. (2000). Economic Value Added: In search of Relevance. Decision, 27(2), Dr.Anil.ksharma and Satish Kumar (2010), Economic value Added (EVA) Literature Review and Recent Issues. International Journal of Economics and Finance, vol.2, No.2, Shipra pruthy (2013) A comparative study of EVA and MVA of power sector companies in India. Journal of commerce and Accounting Research, Vol.2, Issue.3, P a g e