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Nestle: The exports kicker - Views on News from Equitymaster
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Nestle: The exports kicker
Aug 2, 2005

Performance summary
Processed foods major, Nestle India, recently announced its results for the second quarter and half-year ending June 2005. The company reported a decent topline and an enticing bottomline growth during 2QCY05. Bottomline outpacing topline by miles was mainly due to margin expansion by 720 basis points, higher other income and lower corporate tax rate.

(Rs m) 2QCY04 2QCY05 Change 1HCY04 1HCY05 Change
Net sales 5,444 6,158 13.1% 11,645 12,293 5.6%
Expenditure 4,614 4,778 3.5% 9,606 9,526 -0.8%
Operating profit (EBDITA) 830 1,380 66.3% 2,039 2,767 35.7%
EBDITA margin (%) 15.2% 22.4%   17.5% 22.5%  
Other income 30 80 166.1% 65 149 129.7%
Interest (net) 1 0.4 -69.2% 8 1 -82.5%
Depreciation 121 149 22.9% 243 274 13.1%
Profit before Tax 737 1,311 77.8% 1,853 2,640 42.5%
Tax 255 428 67.5% 594 904 52.2%
Extraordinary income/(expense) (54) (55) 2.0% (188) (128) -31.9%
Profit after Tax/(Loss) 428 828 93.5% 1,072 1,608 50.1%
Net profit margin (%) 7.9% 13.4%   9.2% 13.1%  
No. of Shares (m) 96.4 96.4   96.4 96.4  
Diluted Earnings per share (Rs)* 17.7 34.3   22.2 33.4  
Price to earnings ratio (x)         24.0  
*(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 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 2QCY05?
Sales stats...
(Rs m) 2QCY04 2QCY05 Change
Domestic sales 4,853 5,745 18.4%
Exports 591 781 32.2%
Gross sales 5,444 6,526 19.9%
Export revenues back on track:  Growth during the quarter was contributed by domestic as well as exports. Export sales saw a huge jump (up 32% YoY) due to higher realisations from instant coffee exports to Russia, arising from increased green coffee prices. Export volume sales increased by over 15% in the quarter. Domestic sales increased by over 18% YoY, mainly on account of a lower base in 2QCY04 along with improved volume and product mix. It must be noted that Nestle had increased prices of some of it brands during the quarter, which also aided domestic revenue growth. The company launched ‘Maggi Atta Noodles’ during the quarter, which further strengthened its product portfolio.

Cost break-up
as a % of net sales 2QCY04 2QCY05
Material cost 44.3% 44.5%
Staff cost 7.6% 7.7%
Other expenditure 32.7% 25.4%
Total expenditure 84.6% 77.6%
Lower other expenditure enhances margins:  As can be seen from the table below, material costs and staff costs were maintained as a percentage of sales during the quarter. However, it was other expenditure that clearly stole the show. This was due to lower spending on advertising and sales promotion. Factors like favorable commodity prices and change in method of inventory valuation also helped matters. It must be noted that during the quarter, the company implemented Nestle group’s worldwide initiative Global Business Excellence (GLOBE) that required a change in the method of valuation of raw materials. Investors have to remember that during 2QCY04, margins were hit due to higher commodity prices and lower sales. To that extent, the improvement in margins is magnified.

Other income kicker:  As can be seen in the first table, bottomline was also aided by increase in other income (166% YoY) that increased due to reversal of certain provisions written back as well as increase in investment income.

Over the last few quarters:  As can be seen from the graph below that highlights the YoY growth in domestic and export sales, the sharp spurt in sales in 2QCY05 is exaggerated to the extent of poor performance in the same quarter previous year. The domestic front continues to exhibit 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?
The stock currently trades at Rs 800 implying a price to earnings multiple of 18.9 times our estimated CY07 earnings and market capitalisation to sales of 2.8 times. We are enthused by the company’s performance in the quarter. However, it must be noted that a part of the growth has come in due to low base effect due to a bad 2QCY04. Following the implementation of Project GLOBE, we expect benefits to the company on margins.

We continue to view Nestle as one of the top FMCG companies in India, with strong growth prospects. We believe that there is a need to upgrade our earnings estimates for the next two years. But valuation is an issue. We suggest investors to adopt a ‘wait and watch’ approach and ascertain whether the export growth can really be sustained going forward.

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