One of the country's largest FMCG marketers, Nestle India, a 52 year old Indian subsidiary of the Swiss conglomerate (the parent holds 63% of the outstanding equity) continues to belt out the high notes, showing no signs of any slack whatsoever. Net sales excluding other income was up 22% in 2010, while the pre-tax profit was a tad higher at 25%. With the tax man not able to get to a larger percentage slice of the pretax cake, the net after tax profit grew at the same pace as the pretax profit. The increase in sales was on the back of both increased volume production of its four broad product classifications, and higher volume purchases of milk and nutrition products, a superb funds flow management situation occasioned by its ability to sell cash down, while squeezing creditors for material purchases. It helps immensely that the company is also debt free. It boasts of a surfeit of cash at its disposal, with the company at a total loss on how to extract the best returns from this largesse. It has separately invested Rs 1.5 bn in debt securities. On a paid up equity capital of Rs 964 m, the reserves and surplus ratcheted up to a humungous Rs 7.6 bn. Very clearly then, bonus shares are not a part of its purview, though a sizeable 76% of its paid up capital comprises of bonus shares. To make up for this anomaly the dividend payment is sumptuous and amounted to Rs 5.4 bn in 2010, or 67% of the post tax profit.
Spending on capital assets
There was quite some spending on capital assets too in the last three years. The gross block was richer by some Rs 6.5 bn in capital assets, of which Rs 4.8 bn was expended in 2010. The latter spend however led to only a marginal increase in the installed capacity of just two of its product lines - Milk Products and Nutrition business, and Prepared Dishes and Cooking Aids. Their capacities increased by 3% and 7% respectively to 147,546 MT and 205,017 MT. The production is fanned out to its 7 factories spread out across the states of Goa, Punjab, Karnataka, Tamil Nadu, Haryana and Uttarakhand. Not an even spread in geographical terms, but a spread of sorts nevertheless.
The factories for the 2 major product lines-Milk Products and Prepared Dishes are humming at full speed with capacity utilization at very near installed capacity levels. (It may be noted however that about 15% by volume of milk products that was sold was outsourced, and may have accounted for as much Rs 4.1 bn in gross sales in 2010, on a rough reckoning, against Rs 3.05 bn previously). The production of Chocolates and Confectionery on the other hand far exceeds that of the installed capacity. In 2010 it produced 54,285 MT of chocolates etc against an installed capacity of 32,769 MT. This is indeed a feat worthy of emulation, and the company may like to inculcate this work ethic in other manufacturers too, on how to extract infinitely more bang for the buck. It is only in the Beverages segment that the company is producing at a little over 50% of capacity.
How the sales add up
The milk products division is the biggest contributor to the sales kitty accounting for 43.5% of all sales. This is followed by Prepared Dishes with 27%. Next in line is the Chocolates division with 15.3% and last in the pipeline is Beverages bringing in 14% of all sales. Since the company does not provide division wise breakup of sales and profits, it is impossible to hazard a guess on which divisions bring home the value added bacon. The company's claim that its business activity falls within a single primary business segment and hence such disclosures are not applicable does not quite wash. The fact of the matter is that the sale price of its individual products is based on cost elements separately quantitified in-house, which is the onerous task of the cost accountant. Hence the profit margin on each product line is separately available to the company. Or do established businesses resort to some other methodology when pricing their products in the retail markets? Baloney! The gross margin that its outsourced sales could have generated is also inestimable, due to the muddled accounting that the company has chosen to adopt in this respect. This appears to have been deliberately orchestrated. But given the increased emphasis on outsourcing especially in the Milk Products segment, it proves that this modicum of affecting sales is becoming a game changer.
As stated earlier, gross sales increased 22%, while the consumption cost of materials including outsourced goods rose 27%. But the interesting catch here is that the consumption cost of materials where the quantity consumption details are also available have been well contained barring the cost of sugar and skimmed milk powder, among the major items of consumption. The item of expenditure that ran riot is clubbed under 'Others' and accounts for 14% of all consumption. The consumption cost of this item rose a phenomenal 57% over that of the preceding year. What was it that prevented the company from exercising similar cost controls on this omnibus item? It appears to keep an arm's length too in the sourcing of materials from its fellow subsidiaries (there are 84 of them according to the annual report) and merely sourced finished products worth Rs 163 m from them in 2010. On the contrary, the company sold finished goods worth Rs 1.9 bn to several fellow subsidiaries in 2010, against Rs 1.6 bn previously. However, the margins if any that it earns on this latter exercise are not specified either.
Some interesting asides
But the single most interesting aspect of the company's working is that it was able to contain employee emoluments to just Rs 4.3 bn in 2010, the same payout as in the previous year. This is amazing situation, especially in the context that the company is on an expansion mode on the one hand, and on the other employee payouts have built in increments each year. What exactly was the magic mantra here? There were two other expense items of significance which were out of sync with the increase in the turnover - expenditure on Freight and Transport which accelerated 29% to Rs 3.1 bn and that of Power and Fuel which jumped a cool 38% to Rs 2.2 bn.
Though the subsidiary and the parent do not have any apparent inter-se dealings, the parent collects its tithes all right. During 2010, the subsidiary forked out a 'gross' sum of Rs 2.5 bn to the parent, with the payment being labeled as General Licence fees. The neat trick that was resorted to here is that this payment also includes the tax on the general licence fees that it paid to the parent-- amounting to Rs 334 m! In effect therefore, the parent got away scot free and tax free. So who is complaining anyway? In all probability this payment is nothing more than royalty fees disguised under an innocuous heading. In the preceding year the payout was a slightly lower Rs 2 bn. Separately it also paid a distinguished sum of Rs 437 m to its Australian fellow subsidiary for a rather high sounding item of expenditure called Information technology and management information systems. This too is an annual tithe. What exactly is this high priced Information technology service that the Australian sibling parts with annually, and which the Indian sibling cannot develop in-house?
The cash flow statement that the company has furnished does not exactly reveal the full extent of the change in the status of some of its assets. The investment schedule for example has undergone a considerable change during the year with the purchase/ sale of debt securities. But the company has not specified the positive or negative effect arising from these transactions if any, and merely stating the year-end balance.
Its R&D centre
The parent it appears has kindly consented to the request of the Indian subsidiary to set up an R&D centre in India, which will operate as a wholly owned subsidiary of the parent when it becomes operational in 2012. How kind on the part of the parent to accede to such a request! Or is it pure business sense that resulted in the setting up this unit? It also appears in the realm of possibility that an R&D centre of sorts was probably already operating out of India, sporting the name of Specialty Foods India Ltd, and which has now been renamed as Nestle R&D Centre India Pvt Ltd. But nevertheless it is supposed to be some sort of a feather in the Indian company's cap given that only three other such research centers operate in the Asian domain, two in China and one in Singapore (based on the information culled from the annual report).
Gung ho on the future
The directors' report is gung ho on the company's future prospects. The report states that the company is accelerating investments in capacities to provide consumers a wide product range, and some significant investments have already been initiated. Additional capital investment commitments of around Rs 6,800 m already existed at year end. Current plans for-see a further acceleration in 2011 and beyond. It will go into expanding facilities at its factories at Goa, Punjab, Karnataka and such like. Besides, a new green-field plant at Himachal Pradesh for the manufacture of Maggi products is being initiated. The Maggi brand has finally begun to yield results.
Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio management scheme
This column Cool Hand Luke is written by Luke Verghese. Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.