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Nestle: Mixed performance - Views on News from Equitymaster
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Nestle: Mixed performance
Jul 31, 2006

Introduction to results
Processed foods major, Nestle India, announced its results for the second quarter and half year ending June 2006 on Saturday. The company reported a decent topline growth of 10.4% YoY for 1HCY06 supported by growth in most categories and across channels. While the bottomline has witnessed a decline in this quarter on the back of higher interest costs, the one time gain in other income in 2QCY05 has led to a fall in other income in this quarter.

(Rs m) 2QCY05 2QCY06 % change 1HCY05 1HCY06 % change
Net sales 6,158 6,812 10.6% 12,293 13,571 10.4%
Expenditure 4,778 5,428 13.6% 9,526 10,822 13.6%
Operating profit (EBDITA) 1,380 1,384 0.3% 2,767 2,750 -0.6%
EBDITA margin (%) 22.4% 20.3%   22.5% 20.3%  
Other income 80 44 -44.9% 149 95 -36.4%
Interest 0 2 475.0% 1 3 85.7%
Depreciation 149 161 7.9% 274 318 15.8%
Profit before tax 1,311 1,265 -3.5% 2,640 2,524 -4.4%
Miscellaneous items (59) (34) -42.6% (167) 91 -154.4%
Extraordinary item 4 - -100.0% 39 2 -94.9%
Tax 428 421 -1.6% 904 920 1.7%
Profit after tax/(loss) 828 810 -2.1% 1,608 1,697 5.5%
Net profit margin (%) 13.4% 11.9%   13.1% 12.5%  
No. of shares (m) 96.4 96.4   96.4 96.4  
Diluted earnings per share (Rs)*         33.0  
Price to earnings ratio (x)*         30.6  
* On a 12-month trailing basis

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 2QCY06?
Topline picture: The net sales for the quarter has increased by 10.6% YoY. This was mainly due to a 13.5% YoY increase in domestic sales supported by growth in most categories and across channels. However, export sales decreased by 9.2% YoY for the quarter mainly due to lower sales of beverages to Russia and Japan, which has been partially offset by growth in sales of other categories across geographies.

Lower margins: The operating profits for 2QCY06 remained flat. The margins also declined by 210 basis points. This decline in margins is mainly due to steep increase in prices of commodities, fuels, energy cost and higher operating costs associated with upgraded formulations and manufacturing processes of the ‘infant nutrition’ products to further enhance their quality. Going forward, the raw material prices are expected to rise.

Cost break-up
As a % of net sales 2QCY05 2QCY06 1HCY05 1HCY06
Total Cost of goods 44.5% 46.1% 43.7% 45.6%
Staff Cost 7.7% 7.9% 7.5% 7.8%
Other Expenditure 25.4% 25.7% 26.3% 26.4%

Bottomline: Lower operating profits aided by higher interest costs and lower other income led to a decline in the net profits for the quarter. Even the net profit margin fell to 11.9% as compared to 13.4% in 1QCY06.

What to expect?
At Rs 1,009, the stock is trading at 30.6 times its trailing 12-month earnings. Though the domestic performance has been good, exports remain a cause of concern. Also, with the rising input prices Nestlé’s margins are likely to get hit. Though the valuations of the company are not favourable currently, given its market leadership in key categories, Nestle has bright prospects going forward.

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