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Nestle: Write-back saves the day
Apr 28, 2006

Introduction to results
Processed foods major, Nestle India, announced its results for the first quarter ending March 2006 late yesterday. While the company reported a decent topline growth for the quarter backed by growth in its domestic portfolio, margin contraction of 240 basis points resulted in the company posting a 2% dip at the operating level. However, an extraordinary gain helped matters, helping the company report a positive bottomline growth. Excluding this effect, bottomline has actually dipped by 11% YoY for the quarter.

(Rs m) 1QCY05 1QCY06 Change
Net sales 6,135 6,759 10.2%
Expenditure 4,748 5,394 13.6%
Operating profit (EBDITA) 1,387 1,365 -1.6%
EBDITA margin (%) 22.6% 20.2%  
Other income 69 50 -26.4%
Interest (net) 1 0 -70.0%
Depreciation 126 157 25.2%
Profit before Tax 1,329 1,258 -5.3%
Tax 476 499 4.8%
Extraordinary income/(expense) (73) 127  
Profit after Tax/(Loss) 781 886 13.5%
Net profit margin (%) 12.7% 13.1%  
Effective tax rate (%) 35.8% 39.6%  
No. of Shares (m) 96.4 96.4  
Diluted Earnings per share (Rs)*   33.2  
Price to earnings ratio (x)   38.8  
*(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 1QCY06?
Exports disappoint once again: Exports (7% of revenues) declined by 22% YoY during the quarter under review, mainly due to lower exports of beverages to Russia and Japan. On the other hand, domestic sales (93% of revenues) increased by 13.5% YoY, due to higher volume and better realisations backed by selective price increases. It must be noted that Nestle had increased prices of some of it brands in 3QCY05. Also, the launch of ‘Maggi Atta Noodles’ by the company in 2005 has helped strengthen its product portfolio.

Margins under pressure: Material costs during the quarter increased by around 210 basis points, mainly due to higher green coffee prices and a steep increase in milk solids along with energy costs. This was partially negated by the 40 basis points improvement in staff costs and a 20 basis points decrease in other expenditure.

Cost break-up
as a % of net sales 1QCY05 1QCY06
Material cost 43.0% 45.1%
Staff cost 7.2% 7.6%
Other expenditure 27.2% 27.0%
Total expenditure 77.4% 79.8%
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 profit for the quarter to the tune of Rs 6 m at the PBT level.

Bottomline outpaces topline: Despite a dip in operating profits, lower other income and a rise in depreciation charges, the net profit growth reported by the company was over 13% YoY. This was owing to the reversal of provisions created in the earlier years. Adjusting for the extra-ordinary item, the bottomline has actually declined by 11% YoY.

Over the past few quarters…
As can be seen from the graph below that highlights the YoY growth in domestic and export sales, 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?
At the current price of Rs 1,277, the stock is trading at a price to earnings multiple of 33 times our estimated CY07 earnings and market capitalisation to sales 4.5 times. Although we are enthused by the company’s performance during the quarter on the domestic front, exports remain our cause of concern. 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, but the current valuations is an issue.

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