Nestle: Margin pressure likely to continue

Though March quarter performance largely in line with expectations, valuation seems steep

Nestlé India's stock has fallen 15 per cent in the past year, lagging behind the S&P BSE Sensex, due to the Maggi controversy. In fact, despite the re-launch of Maggi noodles five months ago and a healthy reception by consumers, the stock has continued to be under pressure. It has fallen 5.5 per cent in the past six months against a 0.7 per cent gain in the Sensex.

The weak stock performance is despite Maggi cornering over 50 per cent market share after re-launch and analysts expecting Nestlé to regain the pre-ban market share of 75 per cent. A key reason for this underperformance is the muted near-term outlook for the company, some of which is visible in the March (Q1) quarter numbers.

Nestlé's Q1 show was largely in line with subdued expectations. Although net sales fell 8.4 per cent year-on-year to Rs 2,296 crore and were ahead of Bloomberg consensus estimate of Rs 2,161 crore, Ebitda (earnings before interest, taxes, depreciation and amortisation) margin contracted 103 basis points to 23.3 per cent despite the savings on input costs. Weakness in revenue as well as higher employee costs were among key reasons for the fall in margins. This, along with higher tax rate and provision for contingencies, hit net profit, which fell 19.1 per cent year-on-year to Rs 259 crore, but came in line with estimates.

The worry stems from the likely continuation of margin pressure. Higher spends towards re-launch of remaining Maggi products as well as increased competition across categories, namely, noodles, coffee, chocolates, and infant nutrition, is expected to keep margins in check. Going by consensus Bloomberg estimate, Ebitda margin is likely to remain unchanged at 20.7 per cent in 2016 and inch up 50 basis points to 21.2 per cent in 2017. In its results release, the firm emphasised the focus to grow volumes via innovation across all its segments.

And there are reasons for it. By Nestlé's annual report, the company's milk products, beverages, and chocolates witnessed volume decline of three, 10, and 11 per cent, respectively, in 2015, indicating the stress extended beyond the Maggi portfolio (volume dip of 60 per cent in 2015). In contrast, most FMCG (fast-moving consumer goods) companies continue to show some increase in volumes across categories. Analysts at Citigroup have trimmed Nestlé's earnings estimates 12-25 per cent over 2016-2017.

At current levels, the Nestlé stock trades at an expensive 47 times 2016 estimated earnings.