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Nestle: Coffee price bonanza

Jan 1, 2001

The price of the coffee beans in the international and the domestic markets has been hovering near 30-year lows. Although, this indicates a bad year for coffee growers in the country, for Nestle India it is a win-win situation simply because it derives its revenues from branded coffee. Its brand ‘Nescafe’ enjoys premium positioning in the Indian subcontinent. Raw coffee contributed around 21% to total raw material consumption of the company in 1999. The coffee bean prices witnessed a sharp decline due to the increased coffee production in counties such as Brazil, Columbia, Vietnam and Indonesia in the recent years. This, coupled with the stagnant coffee consumption has resulted in prices hitting the rock bottom.

Raw material mix
Year ended December 1996 1997 1998 1999
Milk 34% 34% 34% 42%
Skimmed Milk Powder 4% 2% 0% 3%
Sugar 5% 4% 5% 6%
Raw Coffee 36% 36% 35% 21%
Chicory 1% 0% 1% 1%
Tea 4% 5% 8% 6%
Others 17% 17% 18% 22%
Total 100% 100% 100% 100%

Domestic coffee industry is facing severe competition from the imported coffee from Vietnam and Indonesia. Low priced Robusta coffee from these countries has found its way into Indian markets. Also, with the liberalization from April 2001, quantitative restrictions on imports as per WTO agreement will be eased. This could lead to major imports of cheaper Robusta coffee, which is used in making soluble coffee. Thus, Indian coffee will be exposed to tough competition from the world’s major coffee producing countries like Brazil, Colombia and Latin American countries.

The imported coffee will be in various forms like soluble, roasted, green beans and liquid coffee. Thus, to protect the domestic coffee industry, the Union Government has hiked the import duty on coffee from 15% to 35%. Also to meet the challenges the industry has to become competitive through consolidation and by means of other effective strategies. Favourable raw material prices is expected to improve Nestle India’s operating margins. But the company may have to face competition from cheap imports of soluble coffee since it derives more than 80% of its revenues from domestic markets.

Nestle has reported excellent profit growth of 53% during the nine months ended September 2000. Its revenues during the period grew by 10% fueled by a robust 35% jump in exports. Revival in the Russian coffee prices led to improvement in the coffee exports. We expect the company to maintain its performance for the quarter ended December 2000, since it is the peak period for chocolates and coffee sales.

At the current market price of Rs 552 Nestle is trading at a P/E multiple of 38 times its December 2000 projected earnings with a market cap to sales ratio of 3.2 times. Historically, the company has traded in the average P/E range of 40-45 times.

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