Nestle India’s steep price hikes in response to rising raw material costs and sacrificing sales growth provided little respite as profitability still got affected in September 2012 quarter (Q3). Analyst do not expect any improvement in financial performance for the coming few quarters until volume growth picks up or there are no further price hikes (unlikely).
Q3: Growth in single digits
Nestle India missed analysts’ expectations on all major parameters and reported single digit growth in net sales, operating profit and net profit. Sales growth, affected by volumes and single digit growth (7.6 per cent) in domestic business (95 per cent of total revenues), has been lowest in past 18 quarters (read: historical low). Analysts had expected 13.3 per cent growth in revenues. Says Antonio Hello Waszyk, chairman and managing director (CMD), “Domestic sales growth has been adversely affected by portfolio/channel optimisation and pricing for value in certain products.” Anand Shah, analyst, Elara Securities estimates a sharper volume decline of 3-4 per cent in Q3 versus 1 per cent decline in first half of calendar year 2012.
While raw material prices remained stable or benign, increase in headcount or employee base (with increased capacities) and other expenditure (which includes advertising and promotions to support new campaign for Maggi, innovations like MilkMaid Creations, Munch Rollz and re-launch of Nescafe Classic) led to flat operating profit margin of 20.9 per cent but mostly on expected lines.
Despite 48 per cent jump in other income and reversal of exchange differences (expensed in earlier periods) adjusted under interest costs, net profit margin dropped 73 basis points (bps) to 12.6 per cent as depreciation costs galloped to form 3.5 per cent of sales (up 146 bps) thanks to near completion of Rs 2,500 crore manufacturing expansion.
Concerns and Challenges
Volume growth continues to be an issue for the company. Says Waszyk, “2012 is proving to be a challenging year. While some actions like portfolio rationalisation, channel prioritisation, focussed innovations and Nestle Continuous Excellence implementation have started to yield results, other corrective actions on demand generation in specific categories will take some time.”
Margin expansion also looks unlikely as outlook for prices of wheat, milk, sugar and coffee is up, which will put upward pressure on input costs, while on other hand, Abneesh Roy, analyst, Edelweiss Securities, said in his preview note that competitive intensity remains high in coffee, noodles and chocolate (major contributors to revenue).
Hence, valuation of 41 times calendar year 2012 estimated earnings do not justify the growth challenges and margin expansion concerns. Gautam Duggad, analyst, Motilal Oswal is neutral on the stock as he feels valuation appear expensive given the context of sub-par volume growth.
Says Shah of Elara Securities, in his post result note, “We highlight, management’s strong focus on margins (driven by pricing) vs. volumes is clearly hurting the latter in near-medium term and could potentially drive consumer’s away from Nestle portfolio, in our view. We find Nestlé’s premium valuations demanding given that earnings growth is volatile in view of volume uncertainty and high depreciation/interest costs, both payouts and return ratios have dropped significantly and likely consensus earnings downgrades and consequently P/E de-rating.”