Earnings downgrade likely for Nestle

For the quarter, its sales grew 2.9% over March 2013 quarter to Rs 2,313 cr and net profit fell 7.1% to Rs 259 cr

Nestle India put up a dismal performance in the March quarter, with net profit declining for the first time in 8-10 quarters while sales growth, too, was the slowest in nearly two years on a year-on-year basis. The numbers missed street expectations on revenues as well as profits. While weakening domestic and export demand impacted sales, net profit was hit by higher milk (its key raw material) prices as well as higher advertising spends.

For the quarter, its sales grew 2.9 per cent over March 2013 quarter to Rs 2,313 crore and net profit fell 7.1 per cent to Rs 259 crore. Both these numbers were well below Bloomberg consensus estimates of Rs 2,431 crore on sales and Rs 316 crore for net profit. The Ebitda margin too contracted 135 basis points to 22.7 per cent and was marginally ahead of consensus estimates. Most analysts are likely to trim their CY14 earnings estimates for the company after this.

Says Abneesh Roy, associate director, institutional equities, research, Edelweiss Securities, "We will make some cuts to our CY14 earnings and target price given Nestle's weak performance on both sales as well as margins. Nestle's volumes have been under pressure for more than two years due to weak demand and rising competition."

At Tuesday's closing price of Rs 4,851, Nestle trades at 34.6 times CY14 estimated earnings which is expensive in light of the near term pressures facing the company. Most analysts remain bearish on Nestle. Their average target price stands at Rs 4,798 for the next 12 months. However, this could be revised downwards after latest results. Pick-up in urban demand remains key to Nestle's growth prospects.

Nestle has been hit by slowing demand given that most of its brands (Maggi, Nescafe, Lactogen, KitKat, Milkmaid, etc) are discretionary in nature. This has been impacting its domestic volume growth in most segments. The growth in domestic business was slowest in many years at 3.4 per cent. Adds Roy of Edelweiss, "Most of the sales growth is driven by price hikes in domestic market and we estimate domestic volumes have fallen."

  Notably, export revenues were growing at a higher pace than domestic revenues for the company in recent quarters. However, this trend too reversed in this quarter as the exports revenues fell 4.4 per cent and compressed overall sales growth. Analysts believe, slowing demand trends along with poor stream of innovations and new launches by the company are key reasons for falling top-line growth.

"Nestle's strategy of aligning resources behind its high margin portfolio is a long-term positive but impacts near-term volumes. Despite a weak base, we do not expect material improvement in volume growth (channel checks suggest continued weakness). Reversal of urban sentiment, pick-up in the pace of innovation/new launches could boost Nestle's prospects," says Gautam Duggad , FMCG analyst at Motilal Oswal Securities.

Surge in raw material costs (up 664 basis points as a percentage of sales to 49.7 per cent), other expenses (which includes ad spends by 126 basis points to 24.8 per cent) coupled with weak sales performance impacted the Ebitda margin in the quarter. The company though has managed to keep this metric in a narrow band of 21-24 per cent over the past couple of years. A two-fold growth in other income (due to higher yields on investments) to Rs 31 crore restricted the fall in net profit. However, given the volatile and non-core nature of this income stream, these numbers may not be sustainable. Demand recovery will be key in driving margins and overall profitability. The company's ability to pass on higher input costs is also limited given the weak demand and heightened competition.