Nestle: Good show

Nestle has turned in reasonably good top line growth of 13.7 per cent in CY06 to Rs 2,816 core.

Driven by fairly strong sales growth of 14.4 per cent in the domestic market, Nestle has turned in reasonably good top line growth of 13.7 per cent in CY06 to Rs 2,816 core. That's a clear improvement over the 11.2 per cent that it posted in CY05.

However, pressure from higher input costs has resulted in the operating profit margin shrinking by nearly 200 basis points to 19.1 per cent.

Thus, the operating profit has increased by just 3 per cent to Rs 538.5 crore. Moreover, because of a one-time provision of Rs 10 crore, the profit after tax has risen only marginally to Rs 315 crore.

The numbers suggest that despite being able to sell good volumes, Nestle is not able to fully pass on the higher costs of raw materials because of the keen competition.

The management, however, says it has taken some price increases. Raw materials to sales rose around 200 basis points to 45.9 per cent""and other expenses including spends on advertising and promotion have also seen an increase during the year.

The management is confident that the company is moving to an accelerated growth path. It says it has invested in 'structural' areas to take advantage of the opportunities in the industry.

However, given the competition, it is unlikely that the company can take significant price hikes and better last year's growth, at least in the near term. In fact, revenue growth could taper off in the next couple of year if inflation persists and consumer spending suffers.

Moreover, prices of commodities remain high which mean input costs would continue to rise. Also, the company would need to maintain spends on advertising as it launches new products and variants as also to nurture its brand portfolio. That would continue to keep operating margins under pressure.

The stock has underperformed the BSE FMCG index over the past year. At the current price of Rs 900, the stock trades at around 23 times CY07 and just under 20 times CY08 expected earnings. The market appears to have priced in near""term growth.

RSWM: Stronger wicket

RSWM's (earlier Rajasthan Spinning & Weaving Mills) acquisition of Bangalore-based Cheslind Textiles, a 100 per cent cotton yarn EOU, will be good for the latter's shareholders.

RSWM's open offer at Rs 25, will be at about 40 per cent premium to the stock price 26 weeks prior to the announcement. Even if shareholders are not able to exit through the open offer entirely, the new management should be able to improve the company's lacklustre financials.

After posting a net profit of around Rs 10 crore in FY03 and FY04, Cheslind made a loss in FY05 as it was adversely impacted by a markdown in its inventory due to a fall in selling prices and unstable export markets.

In FY06, the company turned around due to a better product mix and more control on raw material prices. But its net profit of Rs 3.52 crore that year was nowhere close to its performance in FY03 and FY04. In the first nine months of FY07, its profits are at the same level as in the previous corresponding period.

RSWM, on the other hand, has been on a stronger wicket "" its net profit had marginally declined in FY05 over FY04, but in FY06, it went up 47 per cent. This acquisition will add 20 per cent plus, or 65,000 spindles to RSWM's spindle capacity.

According to RSWM, it is acquiring Cheslind at Rs 15,500 per spindle against a cost of Rs 25,000 in a greenfield project. The RSWM management also adds that Cheslind's products will be complementary and include super fine count cotton yarns.

Cheslind also provides RSWM a foothold in the international market. Cheslind's financials will improve as RSWM will bring in sourcing synergies and better operational capabilities. The RSWM management has not spelt out whether it plans to merge Cheslind with itself.

Looking at its recent history, the group does have a preference for consolidation""it has merged Jaipur Polyspin, which it had acquired in November 2004 and processing unit Mordi Textiles with itself.

The cost of the acquisition including the open offer works is small at Rs 39.3 crore, and RSWM will not have any problem generating it from internal accruals. In the first nine months of FY07, RSWM's sales increased 10.5 per cent while operating margins improved by 114 basis points to 10.1 per cent. The RSWM stock trades at about 5-6 times estimated FY07 earnings.