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Nestle: Signs of turnaround?

Mar 15, 2005

Introduction to results
Processed food major, Nestle India, has reported an encouraging 8% topline growth during the December quarter ended 2004. Easing of some of the commodity prices in the last quarter of 2004 and improved control over costs led to improved operating margins. Consequently, the company finished the quarter with a significant 68% bottomline growth YoY. The company reported over 4% revenue growth during the full year 2004.

(Rs m) 4QCY03 4QCY04 Change CY03 CY04 Change
Gross sales 5,666 6,122 8.0% 22,798 23,728 4.1%
Expenditure 4,843 4,805 -0.8% 18,374 19,242 4.7%
Operating profit (EBDITA) 824 1,316 59.8% 4,425 4,487 1.4%
EBDITA margin (%) 14.5% 21.5% 19.4% 18.9%
Other income 51 49 -4.9% 278 145 -48.1%
Interest (net) 1 -1 -300.0% 19 8 -59.4%
Depreciation 118 126 6.7% 463 491 6.2%
Profit before Tax 756 1,240 64.1% 4,221 4,132 -2.1%
Tax 170 351 106.4% 1,361 1,346 -1.1%
Extraordinary income/(expense) -132 -125 -5.3% -230 -267 16.2%
Profit after Tax/(Loss) 454 765 68.4% 2,631 2,519 -4.2%
Net profit margin (%) 8.0% 12.5% 11.5% 10.6%
No. of Shares (m) 96.4 96.4 96.4 96.4
Diluted Earnings per share (Rs)* 18.8 31.7 27.3 26.1
Price to earnings ratio (x) 23.9
*(annualised), CY = Calendar Year

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 has also 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 though 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 CY04?
Sales:Throughout 2002 and 2003, the company remained largely untouched by the slowdown that had hit the overall branded FMCG sector. But 2004 has left much to be desired. The company has reported just over 4% growth in CY04 revenues. Its domestic sales (nearly 90% of revenues) grew by just over 5% for the full year, though the growth rate was much better at 8% during the December quarter. This, from a company that had grown its domestic business by nearly 12% in a slow year like 2003. The management had stated in June 2004 that domestic sales have been impacted by selective rationalisation of pipeline stocks.

Sales stats…
(Rs m) 4QCY03 4QCY04 Change CY03 CY04 Change
Domestic sales 5,115 5,517 7.9% 20,227 21,293 5.3%
Exports 551 605 9.6% 2,572 2,435 -5.3%
Gross sales 5,666 6,122 8.0% 22,798 23,728 4.1%

The December quarter performance was aided by an improvement in the company's exports business, which grew by nearly 10%. In the June quarter, exports declined by a significant 21% mainly due to the shift towards low realisation bulk coffee packs exported to Russia. This has led to the company finishing with a 5% decline during the full year 2004.

Margins: The company was able to somewhat stabilise margins for the full year, which had shrunk in the June quarter owing to the export blues. However, low export realisations, pipeline woes did put some pressure on margins for CY04. Material cost as a percentage of sales were higher during the year, indicating strengthening commodity prices. Gradual phasing out of export tax benefits also put pressure. Consequent to the staid topline performance, lower other income and the pressure on operating margins, profits declined by 4% in CY04. However, if we take out the extraordinary items, then profit before tax declined by a marginal 2%.

Cost break-up
as a % of net sales 4QCY03 4QCY04 CY03 CY04
Material cost 40.8% 39.6% 40.5% 42.2%
Staff cost 7.5% 7.0% 7.0% 6.9%
Other expenditure 36.8% 31.7% 33.0% 31.9%
Impairment of fixed asset (net) 0.3% 0.3% 0.1% 0.1%
Total expenditure 85.5% 78.5% 80.6% 81.1%

Over the last few quarters
Though Nestle grew in double digits during 2003 (11% topline and over 30% bottomline growth), the first 3 quarters of 2004 have seen domestic sales grow in lower single digits. Only in the December quarter has the domestic performance picked up. Also, export performance continues to be inconsistent owing to the shift to bulk exports of coffee.

What to expect?
At Rs 624, the Nestle stock trades at nearly 24 times CY04 earnings and market cap to sales of 2.5x. Our 2004 estimates on both revenues and profits proved to be aggressive. Though we were on target on the operating margin side, our outlook on revenue growth was much more positive. We will have to re-look at our assumptions for future growth and update our numbers based on that. Though CY04 was largely un-enthusing, the improvement in performance during December quarter both in domestic and exports businesses is an encouraging sign.

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