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Nestle: Exports spoil the party

Oct 28, 2005

Introduction to results
Processed foods major, Nestle India, announced its results for the third quarter ending September 2005 yesterday. The company reported a decent topline and a relatively staid bottomline growth during the quarter, mainly due to an extraordinary expense. Without taking this into consideration, bottomline has actually outpaced topline and has grown by 23% YoY. Also, other income and lower corporate tax rate have aided bottomline, without which it would have been even bleaker.

(Rs m) 3QCY04 3QCY05 Change 9mCY04 9mCY05 Change
Net sales 5,600 6,248 11.6% 17,245 18,541 7.5%
Expenditure 4,469 4,970 11.2% 14,075 14,496 3.0%
Operating profit (EBDITA) 1,131 1,278 13.1% 3,170 4,046 27.6%
EBDITA margin (%) 20.2% 20.5%   18.4% 21.8%  
Other income 31 57 80.6% 96 205 113.6%
Interest (net) 1 0 -75.0% 9 2 -81.5%
Depreciation 122 156 27.5% 365 431 17.9%
Profit before Tax 1,039 1,179 13.5% 2,892 3,819 32.1%
Tax 395 386 -2.5% 989 1,290 30.4%
Extraordinary income/(expense) 45 (47)   (142) (175) 22.8%
Profit after Tax/(Loss) 689 746 8.3% 1,760 2,354 33.8%
Net profit margin (%) 12.3% 11.9%   10.2% 12.7%  
Effective tax rate (%) 38.1% 32.7%   34.2% 33.8%  
No. of Shares (m) 96.4 96.4   96.4 96.4  
Diluted Earnings per share (Rs)* 28.6 30.9   24.3 32.6  
Price to earnings ratio (x)         24.6  
*(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 3QCY05?
Exports revenues disappoint: Growth during the quarter was contributed only by domestic sales. Export sales saw a decline of over 7% YoY, mainly due to lower volumes of instant coffee and also lower sales in Nepal due to the current political situation. On the other hand, domestic sales increased by over 14% YoY, due to improved volume and product mix. It must be noted that Nestle had increased prices of some of it brands during the previous quarter. The company’s launch of ‘Maggi Atta Noodles’ has further strengthened its product portfolio.

Sales stats…
(Rs m) 3QCY04 3QCY05 Change
Domestic sales 5,306 6,071 14.4%
Exports 656 607 -7.4%
Gross sales 5,962 6,679 12.0%

Cost break up
as a % of net sales 3QCY04 3QCY05
Material cost 46.4% 45.1%
Staff cost 7.0% 7.6%
Other expenditure 26.4% 26.8%
Total expenditure 79.8% 79.5%
Margins: Material costs during the quarter reduced by around 130 basis points. However, higher staff costs and other expenditure offset a huge chunk of this benefit. In our view, other expenditure has increased due to increased advertising costs in order to push its new ‘Maggi’ product. It must be noted that during the previous 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. Also, the company changed its method of raw and packaging materials, which resulted in higher consumption value and lower profit for the quarter to the tune of Rs 20 m at the gross level.

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 875, implying a price to earnings multiple of 24 times our estimated CY07 earnings and market capitalisation to sales of 3.0 times. We are enthused by the company’s performance in the quarter on the domestic revenues front. 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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