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Nestle: Bad quarter, decent year… - Views on News from Equitymaster

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Nestle: Bad quarter, decent year…
Mar 7, 2006

Introduction to results
Processed foods major, Nestle India, announced its results for the fourth quarter ending December 2005 and full year late yesterday. The company reported a decent topline growth for the quarter backed by growth in its domestic portfolio. However, inspite of higher other income and lower extraordinary expenses, the bottomline was down on a comparable basis, mainly due to margin contraction of 400 basis points. Further, barring the extraordinary effect from both the quarters, bottomline is actually down by over 12% YoY, making the picture even bleaker. However, the company closed its books for the year with over 11% revenue growth YoY and a healthy 23% YoY growth in bottomline.

(Rs m) 4QCY04 4QCY05 Change CY04 CY05 Change
Net sales 5,720 6,228 8.9% 22,276 24,769 11.2%
Expenditure 4,404 5,047 14.6% 17,789 19,543 9.9%
Operating profit (EBDITA) 1,316 1,181 -10.3% 4,487 5,227 16.5%
EBDITA margin (%) 23.0% 19.0%   20.1% 21.1%  
Other income 49 58 17.8% 145 263 81.9%
Interest (net) (1) 0   8 2 -73.1%
Depreciation 126 154 21.7% 491 584 18.9%
Profit before Tax 1,240 1,084 -12.6% 4,132 4,903 18.7%
Tax 351 305 -13.0% 1,346 1,595 18.5%
Extraordinary income/(expense) (125) (38) -69.8% (267) (212) -20.4%
Profit after Tax/(Loss) 765 742 -3.0% 2,519 3,096 22.9%
Net profit margin (%) 13.4% 11.9%   11.3% 12.5%  
Effective tax rate (%) 28.3% 28.1%   32.6% 32.5%  
No. of Shares (m) 96.4 96.4   96.4 96.4  
Diluted Earnings per share (Rs)*         32.1  
Price to earnings ratio (x)         36.6  
* (Trailing 12-months)

What is the company’s business?
Nestle India is the third largest FMCG company in India after Hindustan Lever and ITC. Nestle dominates the culinary (Maggi) and the hot beverages (coffee - Nescafe) segments in India. It also has a significant presence in baby foods and has emerged as a strong No. 2 in dairy segment (after Amul) and chocolates (after Cadbury’s). In each of the segments, the company has been growing through new product launches and new price point presence. In the last couple of years it has emerged as the fastest growing food FMCG company. In the past 5 years, Nestle’s topline and net profits have recorded a CAGR of 15% and 24% respectively.

What has driven performance in 4QCY05?
Exports continue to disappoint: Exports (8.3% of revenues) declined by 8% YoY during the quarter under review, mainly due to lower exports of instant coffee to Russia and also lower sales in Nepal due to the current political unrest. On the other hand, domestic sales (91.7% of revenues) increased by over 11% YoY, due to higher volume and favourable product mix, coupled with selective price increases. It must be noted that Nestle had increased prices of some of it brands during the previous quarter. The launch of ‘Maggi Atta Noodles’ by the company earlier in the year helped strengthen its product portfolio.

Margins: While material costs during the quarter increased by around 30 basis points, mainly due to higher green coffee prices, this was negated by the 40 basis points improvement in staff costs. However, it was the higher other expenditure that did the damage (up 390 basis points). Seemingly, other expenditure has increased due to increased advertising costs in order to push its new and existing products.

Cost break-up
as a % of net sales 4QCY04 4QCY05
Material cost 42.3% 42.6%
Staff cost 7.5% 7.1%
Other expenditure 27.2% 31.3%
Total expenditure 77.0% 81.0%
It must be noted that during the second quarter of the year, the company had implemented Nestle group’s worldwide initiative, Global Business Excellence (GLOBE), which required a change in the method of valuation of raw materials. Thus, the company changed its method of raw and packaging materials, which resulted in higher consumption value and lower profit for the quarter to the tune of Rs 15 m at the gross level.

Over the last few quarters: As can be seen from the graph below that highlights the YoY growth in domestic and export sales, the sharp spurt in sales in 2QCY05 is exaggerated to the extent of poor performance in the same quarter previous year. Domestic revenues continue to exhibit relative consistency, led by new product launches. However, volatility on the export front is a concern. We expect exports to grow at a steady rate going forward in line with its expansion in South East Asian markets and to that extent, the current dependence on CIS countries will reduce.

What to expect?
The stock currently trades at Rs 1,156, implying a price to earnings multiple of 30 times our estimated CY07 earnings and market capitalisation to sales of 4.1 times. Although we are enthused by the company’s performance during the year, the quarter was a bit of disappointment. Following the implementation of Project GLOBE, we expect the company to reap benefits on the margins front.

We continue to view Nestle as one of the top FMCG companies in India, with strong growth prospects. We believe that there is a need to upgrade our earnings estimates for the next two years. But despite this, stock valuation is an issue.

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