Nestle India: Growth ahead

Nestle India sprang a hugely positive surprise when it announced a 68 per cent jump in net profit in the quarter ended December 2004.

As a result, the fall in profit in 2004, which was overall a tough year for the company because of higher commodity prices, was restricted to 4.2 per cent. In the nine months till September 2004, Nestle's net profit was 19.4 per cent lower on a year-on-year basis.

In the first nine months of the year, Nestle had suffered because of two main reasons. First, sales growth had tapered to low single-digit levels mainly owing to a drop in chocolate sales.

Secondly, commodity prices including those of milk solids were higher, hurting Nestle's profitability since it wasn't able to pass on the increase in cost. In the nine-month period, operating margin had fallen by as much as 320 basis points.

In the December quarter, the company saw an improvement on both fronts. Not only did cost pressures ease, but there was also an increase in chocolate sales. Overall sales growth jumped to 7.8 per cent last quarter, compared to just 2.8 per cent in the nine months till September.

Operating margin increased by a massive 740 basis points, thanks largely to a 500 basis points cut in other expenses. Analysts point out that this could be because of a cut in advertising expenses, which generally peak in the December quarter thanks to the festive season.

The better than expected results have led to a 3.6 per cent rise in Nestle's stock price in the last two trading sessions, against the declining trend in the markets. Over the past year, however, Nestle has underperformed the market as well as its peers.

Despite that, it still gets a rich discounting of around 20 times estimated CY05 earnings. Nevertheless, earnings are expected to jump this year, with chocolate sales having picked up, cost pressures having eased and with the company having taken some price increases towards the end of the previous year.

Nicholas Piramal

Nicholas Piramal India Ltd (NPIL) says that its rights issue, for a maximum of Rs 350 crore, will be used to strengthen its manufacturing facilities, its drug discovery efforts and for suitable M&A efforts.

The company has recently bagged three custom manufacturing contracts, and the target, according to analysts, is to ensure that its contract manufacturing business accounts for half its total sales by 2010.

The rights issue could be helpful in meeting the capex requirements for such deals, although analysts point out that the requirements for the deals already announced have already been tied up. NPIL is also due to commission its formulations plant at Baddi in Himachal Pradesh by April next year.

It also has plans to increase the scale of the recently acquired global Inhalation Anaesthetics (IA) business of Rhodia Organique Fine Limited (Rhodia), UK, and to manufacture the most recent IA products, which earn high margins.

It's also possible, as the company has said, that the company will use the proceeds of the rights issue to scout for new acquisitions in pursuit of its strategy in contract manufacturing or in its formulations business.

NPIL's business model is viewed as having lower risk compared to large generic players who are facing margin pressures in key export markets like the US.

Margins for contract manufacturing are typically pegged at 15-20 per cent. The NPIL stock currently trades at around Rs 267, around 18 times FY 06 earnings, having gained about 10 per cent over the last two months.

Of course, investor appetite for this rights issue will depend on the pricing worked out, but there is little doubt that NPIL's business model is proving to be a very robust one in a post-product-patent world.

Glaxo Smith Kline

Glaxo Smith Kline's long-awaited share buyback has finally materialised. The buyback will be done at a price not exceeding Rs 800, which will provide some support to the stock, which closed at a cum-dividend price of Rs 768 on Tuesday.

The buy-back size is for about a quarter of the total paid-up equity share capital and free reserves of the company. The market has been lukewarm to the offer, with the stock more or less unchanged.

Assuming the highest price, this offer is being made at a multiple of about 25 times estimated CY05 earnings of the combined entity. Other MNC pharma stock like Aventis India trade at about 17 times estimated CY05 earnings, while for Pfizer India (year ending November 2005) it is 24 times.

Glaxo has more than enough money on its books to be utilised for the buy-back process. Topline growth has been elusive for the company, but that's because of a conscious decision to downplay the DPCO component of its portfolio.

The vaccine initiative will, however, result in higher revenues going forward. Over the next few quarters, the company is planning to enter the high growth cardio-vascular and diabetes segments, but results in these areas will take time, because weaning away patients from existing products is not easy.

Also, VAT is going to be shortly introduced and the last time the government tried to introduce this measure, it resulted in slower offtake from dealers. In addition, the new MRP - based tax regime is anticipated to impose additional liabilities this year.

This stock has already gained about 11 per cent over the last two months, with the market more or less pricing in the anticipated growth in profit for CY05. Investors could well look at using the support provided by the buy-back to exit from the stock.

With contributions from Amriteshwar Mathur and Mobis Philipos