Nestle India - Impressive 3Q:: Kotak Sec

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Nestle India (NEST)
Consumer products
Impressive 3Q; however, at 32XFY2012E, there is no room for execution risk.
Domestic sales growth of 28% led by >20% volume growth is impressive (albeit on a
relatively low base). Contraction in gross margins is disappointing in the face of 6%
price hike taken by it in 1HCY10. While we like the market opportunity for most of
Nestlé’s categories, we await demonstration by it in managing head-on competition—
most of its categories have been either a monopoly or duopoly, so far.


Impressive sales growth (albeit on a low base)
In 3QCY10, Nestle reported net sales of Rs16.4 bn (+26%, KIE Rs16.1 bn), EBITDA of Rs3.2 bn
(+22%, KIE Rs3.3 bn) and PAT of Rs2.2 bn (+22%, KIE Rs2.2 bn).
􀁠 Domestic sales increased 28% largely on the back of volumes (>20%) – impact of pricing
growth is ~6% (price hike effected in 1HCY10). Exports declined 3% as the company shifted
capacity to meet domestic demand (which has higher margins).
􀁠 Decline in gross margins by130 bps is surprising as the company has effected price hikes in
1HCY10, the full impact of which was expected in 3QCY10. Savings in staff cost was 110 bps
and other expenditure (including adspends) increased 50 bps. We believe that adspends would
have been at escalated levels during the quarter as the company has relaunched Nescafe
(with celebrity endorsement for the first time) and Kit Kat with a new marketing campaign.
What do we watch out for?
􀁠 Decline in gross margins is disappointing. We recall that the management commentary at
the analyst meet in August 2010 was indicative of gross margin expansion, (1) liquid milk
collection in Moga factory has increased in double digits in 2QCY10. Milk accounts for ~35%
of input costs, (2) good monsoons is likely to result in a good flush season for milk production,
(3) price increases of ~6% in 1HCY10.
􀁠 Competition in instant noodles. Competitive intensity for Maggi is increasing with ITC being
the latest entrant (after GSK Consumer and HUL) in this segment with Sunfeast Yippee. The
product has been launched at price point of Rs5 and Rs10 for 45gm and 90gm in Bangalore
and Coimbatore. We concede that it is early days in the product cycle of the new entrants;
however, Maggi faces the risk of product substitution, in our view (particularly from GSK’s
Foodles as competition is based on brand equity of Horlicks and healthy proposition).

􀁠 Potential JV with Coca Cola? Media reports suggest that Nestle India is in the process
of forming a joint venture with Coca Cola in the ready-to-drink tea segment (Nestle has
Nestea brand in tea category). We highlight that Tata Global Beverages has recently
entered into a 50:50 joint venture with Pepsi Co in the field of non-carbonated drinks.
While further details on this joint venture are not available yet, Tion (TGB’s fruit drink on
ice tea platform) may likely be part of this venture.
􀁠 Can Nestle manage competition? We highlight that most of the categories which
Nestle India operates in are either a near-monopoly or duopoly. We keenly await
demonstration by Nestle in managing competition in culinary effectively.
􀁠 Spate of relaunches/new launches augurs well. Nestle has made several new launches
and relaunches in the past few months—Bar-one chocolates and Nescafe relaunched,
(with new media support), Nestle Extrafino premium range of chocolates introduced,
Maggi Vegetable Multigrainz noodles rolled out nationally.

At 32XFY2012E, there is no room for execution risk. Retain REDUCE
We like the market opportunity for most of Nestlé’s categories, but look for better entry
points into the stock. We tweak estimates marginally, maintain REDUCE rating and maintain
TP at Rs3,100. Key risks to our rating are (1) higher-than-expected sales growth due to
distribution gains and (2) better than-expected margin expansion.