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Nestle: Margins remain under pressure
Aug 12, 2014

Nestle India announced the second quarter results of calendar year 2014 (2QCY14). The company has reported a 9% YoY growth in sales and 6% YoY fall in net profits. Here is our analysis of the results.

Performance summary
  • Revenues grew by 9.4% YoY in 2QCY14 led by 9.7% rise in domestic sales. For 1HCY14, revenues have grown by 6.2% YoY.
  • Steep rise in input costs mainly milk clipped operating margin by 1.7% YoY in 2QCY14. Foe 1HCY14, the operating margin contracted by 2% YoY.
  • At the net level, margin has contracted by a mere 0.4% YoY due to steep fall in interest charges and lower depreciation. For 1HCY14, the net margin contracted by 0.8% YoY.

Financial snapshot
(Rs m) 2QCY13 2QCY14 % change 1HCY15 1HCY14 % change
Revenue  22,227 24,320 9.4% 44,781  47,535 6.2%
Expenditure 17,222.1 19,247.3 11.8% 34,351 37,450 9.0%
Operating profit (EBDITA) 5,005 5,072 1.3% 10,429 10,085 -3.3%
EBDITA margin (%) 22.5% 20.9% -1.7% 23.3% 21.2% -2.1%
Other income 154 231 50.1% 281 541 92.1%
Interest 85 38 -55.7% 164 140 -14.7%
Depreciation 887 842 -5.1% 1,708 1,681 -1.6%
Employee benefit expenses due to passage of time 139 164 17.6% 281 329  
Provision for Contingencies - -   207 250 20.3%
Profit before tax 4,048 4,260 5.2% 8,350 8,226 -1.5%
Exceptional income - -        
Tax 1,334 1,382 3.6% 2,846 2,756 -3.2%
Profit after tax/(loss) 2,714 2,879 6.1% 5,505 5,470 -0.6%
Net profit margin (%) 12.2% 11.8% -0.4% 12.3% 11.5% -0.8%
No. of shares (m)         96.4  
Diluted earnings per share (Rs)*         115.5  
Price to earnings ratio (x)*         46.0  
* On a 12-month trailing basis

What has driven growth in 1QCY14?
  • Nestle recorded a 9.4% YoY topline growth with the largest domestic segment posting 9.7% growth from better realizations. Export sales growth was muted at 4.1% as exports to affiliates mainly to Russia declined by 7.1% whereas third party exports grew by 35.8% YoY.
  • Steep rise in milk and its derivatives led to a 15% jump in input costs. As a result the cost of goods sold to sales ratio was up by 2.3% YoY during the quarter. This was only partially offset by a 0.6% YoY drop in other expense to sales ratio. The operating margin saw a 1.7% yoy contraction for the quarter.

    Cost break-up
    As a % of sales 2QCY13 2QCY14 Change in basis points
    Cost of goods sold 45.0% 47.3% 231.48
    Staff costs 7.9% 7.9% -2.46
    Other expenditure 24.6% 23.9% -62.98

  • However at the net level, the company managed to limit margin contraction to 0.4% due to 56% fall in interest charges. Nestle repaid USD$ 157 m from total External Commercial Borrowings (ECB) of USD$ 192 m during the June 2014 quarter. Even depreciation outgo was down by 5% for the quarter.
What to expect?
Nestle's profitability continues to remain under pressure due to high commodity inflation. Even volume growth continues to remain sluggish with growth coming mainly from realizations. However the redeeming factor is that the company has fully repaid its ECB of USD $ 192 m and is debt-free. This has led to significant reduction in interest charges. The company continued to launch innovative products such as low fat lassi, buttermilk with Ayurvedic herbs and spices and oats noodles.

At a price of Rs. 5351, the stock is trading at 31 times our estimated CY16 earnings. Armed with a diversified portfolio and strong brand equity, Nestle's long-term growth prospects remain bright. But at current valuations, the stock is overvalued and we re-iterate a SELL on the stock.

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