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Nestle India's stock price has gained almost 32 per cent from its low of Rs 4,648 on May 16, the day the Modi government was voted to power, outperforming the Sensex along with peers Hindustan Unilever (HUL) and Colgate.
Analysts say the rally is led by hopes of an economic recovery-led pick-up in consumer demand, especially from urban markets. However, there are no clear signs of a demand recovery yet, at least for Nestle, though peers such as HUL continue to report relatively better volume/revenue growth.
For the September quarter, too, Nestle’s volume growth remained under pressure. Motilal Oswal Securities (MOSL)’s analysts peg the domestic volume growth at 0-1 per cent. Management's cautious tone also implies that recovery in this metric is still some time away.
Analysts, thus, expect the company to post muted volume growth of one to two per cent in the near term, and are factoring in meaningful gains only from calendar year (CY) 2015. They peg volume growth at three to four per cent for CY15 and five to six per cent in CY16.
Though Nestle is taking steps to improve margins, increased competition across categories, continuous aggression in advertising spending and innovations will keep these in check, believe analysts. In this backdrop, most of them are neutral to bearish on the scrip.
“We remain negative on Nestle as we see a protracted recovery ahead, with no near-term respite visible. The valuations at 42.7 times the CY15 estimated earnings are rich, offering an unfavourable risk-reward," says Gaurang Kakkad of Religare Capital Markets.
Of the 20 analysts polled by Bloomberg since Tuesday, when the results were declared, 12 have a 'sell', six a 'hold' and two a 'buy' rating on the stock. Their average target price is Rs 5,344, a downside of 13 per cent from current levels. Though the stock jumped 3 per cent on Wednesday to close at Rs 6,129 on the National Stock Exchange, the gain might not sustain for long.
Nestle’s results for its third quarter (Q3), ending September, were broadly in line with Street expectations. Revenue was Rs 2,570 crore, up 8.9 per cent over a year and largely driven by price increases. In addition, grammage reduction in some brands and launch of new variants helped.
Domestic business was the key driver. At Rs 2,399 crore, domestic revenue was up 9.9 per cent over a year. While this is the second quarter of nine-plus per cent growth and suggests the management’s effort to revive sales growth is showing results, it is again short of peer HUL, which posted a fourth straight quarter of double-digit growth in packaged foods revenue (up 13.4 per cent). Nestle has posted 4.6 per cent and 2.9 per cent sales growth in the December 2013 and March 2014 quarters, respectively. Volume growth, too, remains muted.
Export sales declined 3.9 per cent to Rs 159 crore due to lower coffee exports and impacted overall numbers. Among key products, Maggi Oats noodles, Vegetable Atta noodles, Kit Kat, Nescafe, Milkmaid and Everyday had healthy growth.
On the cost front, high prices of milk and milk products impacted the gross margin (down 114 basis points to 53.9 per cent) indicating the price rises taken so far were inadequate. The Ebitda (earnings before inteerest, taxes, depreciation and amortisation) margin was down only 11 bps points year-on-year, to 20.6 per cent, with a 90 bps fall in other expenses to 24.8 per cent of sales and a 20 bps savings in employee costs to 8.1 per cent of sales. But, some of these might not be sustainable on a longer-term basis.
A sharp fall in interest expenses, coupled with a lower tax rate, more than compensated for the fall in other income. Thus, net profit grew 9.2 per cent to Rs 311 crore.
Road ahead
Revival in volumes is crucial if Nestle's growth rates are to pick up and for the stock to gain more ground. Though the company is well-placed to gain from any recovery in urban demand, it will have to invest significantly in new launches and advertising, believe analysts.
"Under the new leadership, innovations have stepped up, with interesting launches, including Nestle Oats. However, in our view, Nestle needs to further accelerate new launches," says Abneesh Roy, associate director at Edelweiss Securities.
“Revival of urban consumption dynamics is a key pre-requisite for Nestle to go back to high-teen sales growth. Our channel checks do not suggest any imminent revival in the same,” write Gautam Duggad and Manish Poddar of MOSL in a post-results note.
ITC's potential entry in the instant and filter coffee segments is also seen as a big threat for Nestle's Nescafe.
On the positive side, strong brand recall and parentage are among Nestle's key strengths. Its record has also been good, with average top line growth of a little over 20 per cent (except CY12 till date, when growth rates have slipped), lending hope. For now, analysts are pegging sales growth at 11-13 per cent for CY15 and profit growth at 17-20 per cent.
