Nestle: Still a good LT story, but valuation now unattractive: Nomura

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 Action
While Nestlé India remains a pure play domestic consumption-driven story, where
the longer-term opportunity remains attractive, in our view, we believe valuations
will hold back share price performance from these levels. We are downgrading the
stock to REDUCE from Buy, although our price target moves higher to Rs3,525
from Rs3,230, as we roll forward by six months.


 Catalysts
Increased competition and rising milk prices in the domestic market are likely to
put incremental pressure on margins.

Anchor themes
Food remains an attractive opportunity in urban India and Nestlé India is a play on
the same, with a strong market share in milk & milk products, confectionery and
chocolates. Potential to leverage on the parent’s strong portfolio should help it
deliver above-average revenue and earnings growth in the medium term.


Still a good LT story, but valuation
now unattractive
 Stock up on delisting speculation
Nestlé India shares rose +8.4% yesterday (vs the Sensex’ 0.4% gain),
on unconfirmed newsflow about minority shareholders being bought
out by the parent company and a possible delisting of the shares.
However, Nestlé India management denied any knowledge of such a
possibility, as per a story on Dow Jones newswires (9 November).

 Delisting possibility unlikely and very expensive
We see little likelihood of minority shareholders being bought out, with
Nestlé’s parent trading at 16.4x CY11F (Nomura estimate) and Nestlé
India at 37.1x. With an average daily traded value of < $4.5mn, the
premium needed to be paid to buy out minority shareholders could be
40-50% from these levels, based on our estimates.

 Attractive long-term opportunity, but not at these prices
Nestlé India offers strong long-term earnings growth and visibility, in
our view, among the most attractive across the FMCG space in India.
However, current valuations are not supportive of a Buy case, and we
see the share price performance being muted from these levels.

 No changes to our estimates
We have not changed our estimates for CY11F and CY12F. Rising
input costs are likely to exert pressure on margins over the next few
quarters. Increased competition remains a concern across categories.

 Downgrading to REDUCE
We are downgrading Nestlé India to REDUCE from Buy, after a
recent strong run from mid-August (Nestlé +44.8%; Sensex +16.0%;
FMCG index +14.8%). Our PT moves higher to Rs3,525 as we roll
forward by six months. Valuation methodology is unchanged at 27x
one-year forward earnings.