Nestle: Stopped in its tracks! - Views on News from Equitymaster

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Nestle: Stopped in its tracks!

Jul 28, 2004

Introduction to results
Nestle's bad run in 2004 continues. The company has reported a marginal dip in the June quarter topline. But significant pressure on its operating margins saw the company reporting a 36% dip in bottomline.

(Rs m) 2QFY04 2QFY05 Change 1HFY04 1HFY05 Change
Net sales 5,461 5,444 -0.3% 11,442 11,645 1.8%
Other Income 65 30 -53.5% 175 65 -63.1%
Expenditure 4,293 4,614 7.5% 8,961 9,606 7.2%
Operating Profit (EBDIT) 1,168 830 -29.0% 2,481 2,039 -17.8%
Operating Profit Margin (%) 21.4% 15.2%   21.7% 17.5%  
Interest 6 1 -76.4% 16 8 -51.2%
Depreciation 117 121 4.0% 230 243 5.6%
Profit before Tax & extraordinary items 1,111 737 -33.6% 2,409 1,853 -23.1%
Tax 358 255 -28.7% 790 594 -24.8%
Extraordinary items -83 -54 -34.7% -203 -188 -7.4%
Profit after Tax/(Loss) 670 428 -36.1% 1,417 1,072 -24.4%
Net profit margin (%) 12.3% 7.9%   12.4% 9.2%  
No. of Shares (m) 96.4 96.4   96.4 96.4  
Diluted Earnings per share (Rs) * 27.8 17.7   29.4 22.2  
Current P/e ratio (x)   28.5     22.7  
*(annualised)            

Has strong brands like Maggi, Nescafe, Cerelac
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.

Pipeline woes!
Sales:  What started out as a whimper in 1QFY05, is now threatening to become a deafening problem area for Nestle in 2QFY05. Throughout 2002 and 2003, the company remained largely untouched by the slowdown that had hit the overall branded FMCG sector. But 2004 is different! The company has reported just over 3% growth in domestic sales during the June quarter. This from a company that had grown its domestic business by nearly 12% in a slow year like 2003. The management has stated that the domestic sales has been impacted by a selective rationalisation of pipeline stocks.

Sales stats...
(Rs m) 2QFY04 2QFY05 Change 1HFY04 1HFY05 Change
Domestic sales 4,709 4,853 3.1% 10,032 10,470 4.4%
Exports 752 591 -21.4% 1,410 1,175 -16.7%
Total sales 5,461 5,444 -0.3% 11,442 11,645 1.8%

Moreover, exports business added to its woes, declining significantly during the quarter. While export sales in volume terms have increased by 6.5%, the same in value terms have declined by over 20% mainly due to the shift towards low realisation bulk coffee packs exported to Russia.

Margins:  Low export realisations, pipeline woes seem to have taken a toll on the company's operating margins. Virtually all cost heads saw an uptick as a percentage of sales. Gradual phasing out of export tax benefits also put pressure. Consequent to the staid topline performance and the pressure on operating margins, profits took a hit during the quarter. Lower other income was also responsible for this performance.

Cost break-up
as a % of net sales 2QFY04 2QFY05 1HFY04 1HFY05
Material cost 41.4% 44.3% 40.4% 43.1%
Staff cost 7.0% 7.6% 6.7% 7.1%
Other expenditure 30.2% 32.9% 31.2% 32.3%
Total expenditure 78.6% 84.8% 78.3% 82.5%

Over the last four quarters
Though Nestle grew in double digits during 2003 (11% topline and over 30% bottomline growth), both quarters in 2004 have seen domestic sales grow in lower single digits. Exports declined nearly 17% in the first half of 2004.

What to expect?
At Rs 505, the Nestle stock trades at nearly 23x annualised 1HFY05 earnings. The company has significantly underperformed our 2004 expectations on all parameters. As such, we will have to revise our EPS expectations downward. Though the management has attributed the slowdown in domestic topline to a pipeline correction, we believe, that this trend may be here to stay. If one remembers, even GSK Consumer has had to go through this phase of inventory correction, which lasted almost an year during 2002. Nestle has always got a premium valuation over peers owing to its superior growth and rich product profile. That premium may come under pressure if the trend reflected so far in 2004 continues. However, longer term prospects of Nestle remain enthusing owing to its strong product pipeline and folio of urban centric brands.

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