Nestle’s future not so sweet

While analysts expect good sales growth, rising competition and capacity expansion will, they think, limit an increase in profit

 

 

Even as Nestle India reported a better-than-expected performance at the operating level and strong rise in export sales for the December 2012 quarter, the Street wasn’t impressed. The disappointment is on account of only 10 per cent revenue growth, despite higher realisation and favourable product mix. Analysts expected 11-15 per cent; the  nine months till end-September showed 11.5 per cent growth.

Since the near- to medium-term prospects also don’t appear exciting and stock valuations are rich, most analysts have a hold or sell rating on the stock. They believe profit growth will be slower than top line growth in calendar year 2103 due to the expected increase in selling expenses and interest costs; besides, the domestic business might only see single-digit volume growth.

December quarter
Volumes, expected to grow in single digits (around five per cent) in the quarter, might have slipped more than expected or remained flat, thanks to price increases (eight per cent). Says Naveen Trivedi, analyst, Karvy Stock Broking, “A consistent price hike, focus on the high-value segment, slower consumer spending on discretionary items, along with the rising competition in most categories, have been impacting Nestlé India’s volume growth in the past five to six quarters.”

 

  Domestic business (95 per cent of sales) has grown in single-digit at 9.6 per cent to Rs 2,041 crore but the growth of 20.9 per cent in exports was impressive, given the high base of 23 per cent in the same quarter last year.

However, the company has surprised positively on the profitability front. Operating profit margin, expected to remain at 20.6 per cent (seen in the year-ago quarter) or decline, has jumped to 22.6 per cent (up 220 basis points year-on-year), the highest in the past 16 quarters, due to savings in costs across overheads. This also helped the company to report double-digit growth of 12.5 per cent in net profit, compared to the single-digit expected by analysts. This is despite interest costs tripling (Rs 9.9 crore) and depreciation jumping 86 per cent to Rs 83.5 crore. Hence, the net profit margin improved 28 basis points year-on-year (partly helped by a lower tax rate), unlike the decline witnessed in the past three quarters.

The company ended calendar year 2012 on a satisfactory note. While the top line growth of 11 per cent might be disappointing, the operating profit margin of 21.8 per cent has improved the most in the past seven years (up 135 basis points).

Outlook, valuation
While the company is confident of sustainable and profitable growth, it is cautious in the short term, given the uncertain environment, said Nestlé India Chairman and Managing Director A Helio Waszyk, in a statement. Analysts, too, remain cautious on this count. Says Amrita Basu, analyst, Kotak Institutional Equities, “Even as the company has now taken care of the capacity-crunch challenge, the recent slowing in discretionary F&B (food and beverages) categories does not bode well for revenue acceleration in CY2013.” Besides the pressure on volume growth due to price increases, competition remains high in milk, coffee, noodles and chocolates.

Thus, some analysts feel the company will have to step up its advertising spends. Trivedi of Karvy feels the operating margin recorded in the December quarter is not sustainable, owing to the expectation of higher marketing efforts and limited scope for further price rises. He expects a 100 basis points decline in margin in CY13. “To achieve better volume growth, Nestlé would have to sacrifice profitability,” he adds.

For the stock, an underperformer for quite some time, most analysts have a sell or hold rating, as valuation at 37 times CY13 and 31 times CY14 estimated earnings appear stiff, especially when slower volume growth and ongoing capacity expansion have affected the return profile. Says Ritesh Gupta, analyst, JP Morgan, “We see near-term challenges and current valuations as limiting the upside potential.”