Nestle India's long path to recovery

Benign demand and expensive valuations could keep the stock price in check

At its analyst meet last week, Nestlé India management re-emphasised its focus on strong volume-led growth on the back of higher innovations. The company plans to introduce many new products in the premium segment to grow profitably.

However, the Street and analysts are not quite convinced. Be its June quarter (Q2) results on July 29 or the analyst meet on August 22, the Nestle’s stock has underperformed the BSE Sensex.

Nestle’s aggression on revenue growth has generated excitement but new launches are niche in nature and would be a drag on earnings in the medium term,” says Sanjay Singh, analyst at Axis Capital.

The nutrition, health and wellness (NHW) products, infant food, milk products and new categories it plans to enter, and premium chocolates, are some segments (besides Maggi) where it plans to focus. It has already launched 25 new products over the past two months to recover some of the ground it lost, not just in noodles (Maggi) but also in other categories.

The renewed focus on innovations will drive volumes and enable Nestlé to compete efficiently. It will also entail higher investments behind advertising & brand building. So far in the second quarter, advertising & sales promotion costs were up 14.8 per cent over a year (versus a 26.3 per cent decline in the first quarter). Thus, the company's aim of achieving profitable growth with healthy volumes may not come easily and will likely bear fruit only in the longer run.

“A weak market and intense competition in Nestlé’s categories will result in a much more gradual growth recovery than the market is currently factoring in,” write analysts at IDFC Securities in a recent report.

  The weak consumption demand environment and intensifying competition from peers such as Mondolez, etc are other potential hurdles in Nestlé’s road to recovery. Though Maggi has managed to garner healthy market share of 57 per cent after the controversy, management indicated consumer confidence in the noodles category has not recovered fully.

Despite Maggi controversy and slowing growth in other categories (chocolates, milk, baby food, beverages), the Nestlé scrip continues to trade at premium valuation of 54 times the 2016 estimated earnings.

Even as most analysts are positive on the new management's strategies, they are concerned about the scrip’s rich valuations. Of the 22 analysts polled by Bloomberg this month, only three have a ‘buy’, with 11 analysts having a ‘sell’ on the scrip. Unless Nestlé is able to surprise positively, the stock could remain under pressure.