Nestle: Dreaming big...

While Indian FMCG sector was plagued by the economic slowdown, one company's performance in the past year seemed like FY02 was a boom year for the industry. We are talking about Nestle India, one of India's largest processed foods company. While the overall FMCG sector was struggling to find growth, the foods major logged in over 14% topline growth in FY02. More importantly, it finished the year with a significant 46% bottomline growth. The management attributed this growth to lower sales base in FY01 (the pipeline inventory was adjusted during the year), as also to the buoyant export growth, which stood at nearly 17% in FY02. Increased sales and favourable commodity prices helped the company in maintaining its operating margins and consequently, improve profitability. What is creditable is the fact that Nestle India managed to maintain its operating margins despite entering comparatively low margin businesses like bottled water, milk and chilled products (dahi, butter).

Nestle business break-up

Segments	Brands	FY01 sales	FY02 sales
Milk Products & nutrition	Everyday Dairy Whitener, milk powder, Milkmaid, Milk, Dahi, Butter	7,375	8,159
% growth			10.6%
Beverages	Nescafe, Milo, bottled water like Pure Life etc.	4,903	5,627
% growth			14.8%
Prepared dishes & cooking aids	Maggi (noodles, pickles, soups, sauces)	2,310	2,764
% growth			19.7%
Chocolates & confectionery	Munch, KitKat, Bar One, Classic, Choco Stick, MilkyBar Choo	2,179	2,646
% growth			21.5%
Total Sales		16,768	19,197
% growth			14.5%
*(figures in Rs m)

Nestle divides its business into four segments i.e., milk products & nutrition, beverages, prepared dishes & cooking aids and chocolates & confectionery. That FY02 was a dream year for Nestle can be gauged from the fact that milk products & nutrition business (which contributes nearly 43% to turnover) grew by a healthy 11% YoY (in value terms). And mind you, this growth rate was the lowest among all of NestlE's categories. Infact, it was chocolates & confectionery business that saw a significant 22% YoY value growth during FY02.

What's more, Nestle's growth engine did not slowdown post FY02. Infact, in the first quarter of FY03 (March quarter) the company romped home with over 17% YoY growth in topline and a huge 55% bottomline growth. In volume terms, Nestle actually recorded a 22% growth YoY during the quarter, but pressure on realisations resulted in lower value growth. Its milkfood business saw an 18% volume growth, noodles grew nearly 35% YoY and chocolates at 40% plus. Favourable commodity prices helped the company expand its operating margins thus resulting in this huge growth in bottomline.

Going by this performance, one would have expected the company's stock price to hit the roof. However, the Nestle India stock is actually down marginally on a YoY basis. The reasons for this are not hard to find. For one, even at the current valuations the stock trades at over 28x its FY02 earnings. However, if you annualise the first quarter FY03 earnings, then the valuations reduce to 20x annualised earnings. Considering the downturn in the economy as well as the sector, these valuations are not really on the lower side.

The company management's cautionary statements suggesting that this growth may not continue are also dissuading investors. And the management does seem to have a point. As mentioned earlier, the growth in topline has come in not only because of a lower base in FY01 but also as a result of buoyant exports. This is not a situation that will continue. Also, the company has a smaller base in new areas like bottled water, chilled dairy products and milk. So volume growth will be robust in initial years.

Secondly, a lot of the expansion in operating margins has come in the wake of weak commodity prices. Coffee prices were at one point of time trading at 16-year lows. Nestle India has benefited from the low price cycle, but when the prices take a U turn, it will be affected likewise. Let's not forget that it was the low commodity prices that helped cushion the lower margins of new businesses that Nestle has entered. The concern is that if the material prices do strengthen, then owing to the lower margins of its other businesses Nestle India may face a fall profits going forward.

Another issue that may be keeping the stock price range-bound is the management's plan to hike their stake from the previous 54% to 64%. The company makes no secret of its plan to go the Cadbury way, i.e. delist from the Indian bourses.

The growth so far... (Rs m) FY93 FY02 CAGR Sales 4,902 19,210 16.4% Operating profit 607 2,950 19.2% Net profit 227 1,732 25.3% OPM (%) 12.4% 15.4%   NPM (%) 4.6% 9.0%

However, to the management's credit, they have always been cautious and given the right perspective of their business going forward. Also, despite the concerns mentioned above, there is no doubt that the company has been successful in its strategy to expand its folio. The company's balance sheet is clean and is strong enough to take on new initiatives. The new businesses it has entered will give it the volumes to expand its size, and its beverages and milkfood businesses are likely to bring in the profits. In the long term, Nestle India is definitely a stock to have in one's folio. A look at the company's historical growth table will vouch for that.

If you had invested Rs 10,000 in 1992 (10 years back) in Nestle India (at the year high price of Rs 360), your investment would have been worth approximately Rs 26,544 currently (CAGR of 11.5%). What's more, that investment would have raked in Rs 3,355 as dividends too. In the past decade the company has had 2 bonus issues (in 1993 and 1996).