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Nestle India (Nestle) scrip has significantly outperformed S&P BSE Sensex since July this year, and touched its all-time high of Rs 6,144 on Monday before closing at Rs 6,049.
The company's renewed focus on innovations and new product launches along-with expectations of revival in discretionary spends as well as urban demand are key reasons for the street turning bullish on the company.
Notably, these trends are in contrast to the stock and company’s performance in the recent past. The company's focus on maintaining margins had impacted sales growth in the past six-eight quarters which in turn had kept the stock price under check. Weakening consumption demand in urban areas added further to Nestle's woes.
"Nestle's excessive focus on margins led to under-investment in brands (lowest advertisement and promotion spends among peers) and little investment in categories of the future. As a result, the sales CAGR halved to 10% over CY11-13, from 22% in CY06-11", says Sanjay Singh of Standard Chartered Securities.
What’s more, Nestle also lagged peers such as Hindustan Unilever, Dabur, GSK Consumer and Britannia on the sales growth parameter. However, the company managed to keep EBITDA margins in a narrow band of 21-22% aided by consistent price hikes.
But, things appear to be looking up for the company. Nestle India’s new managing director - Etienne Benet's strategy of investing in existing brands and new launches has excited the street. In fact, Nestle launched three new products in the June quarter itself, namely, low fat Nestle Sweet Lassi, Nestle Butter milk with ayurvedic herbs and spices and Maggi Oats noodles.
Maggi- Nestle's major brand in noodles segment is estimated to have lagged behind ITC's Yippie in recent times, say analysts. The launch of Maggi Oats Noodles in the quarter gone by (Madhuri Dixit features in the ad) marks the company’s entry into the oats-based noodle segment and gives it the first mover advantage. Extension of the strong Maggi brand to other variants to boost growth is a strategy the company has successfully adopted for several years now.
It has also scaled up advertising of EveryDay Dairy Whitener and roped in Bollywood actor Rahul Bose and Raima Sen for the ads. The two segments namely, prepared dishes & cooking aids and milk products & nutrition accounted for 76% of CY13 revenues.
Going forward, the company is also revamping Nescafe (coffee brand) to boost growth. Tough competition from HUL's Bru Coffee has seen Nestle lag in the past. While the success of these new launches as well as introduction of more new products are key for future growth of Nestle, analysts sound bullish.
They expect Nestle's EPS growth to improve from 8% in CY11-14 to 19% over CY14-16 on the back of higher sales growth.
"Nestle has stepped up innovations and has been investing aggressively. Its volume growth is likely to improve in the forthcoming quarters and earnings growth could gain traction", says Naveen Kulkarni of PhillipCapital. For the past several quarters, the company’s topline was largely driven by prices hikes while volume growth was muted, something the street was wary about.
Now, with its mega expansion plan also over and given the company's renewed focus, volumes should look up.
As per Bloomberg consensus data, Nestle's sales and earnings per share (EPS) estimates which were consistently revised downwards since January 2012, have also seen some upgrades since July this year, both for CY14 and CY15. Singh believes the earnings downgrade cycle is largely over for Nestle.
While this change in trend is positive, the recent gains in the stock suggest that upsides are limited. Out of the 30 analysts polled by Bloomberg since August 2014, 12 have a Hold, four a Buy with the rest a Sell recommendation on the stock. Their average target price stands at Rs 5,063, which is 16.3% lower than Monday's closing price of Rs 6,049.
Rich valuations of 40.6 times CY15 estimated earnings cap significant upsides from here on, believe analysts. Nestle scrip has historically traded at peak one-year forward price/earnings ratio of about 41-42 times. A good enough correction though could provide a reasonable entry point for a long-term investor.
Nestle enjoys strong brand equity (Maggie, Nescafe, Kit-Kat, Milkmaid and Lactogen) in India and is well positioned to benefit from growth of processed foods segment. Input cost inflation (milk, wheat flour, edible oils and sugar) and intensifying competition are key downside risks going forward.
