Nestle - valuations expensive but long term story intact; visit note;Edelweiss

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Nestle (NEST IN, INR 3,562, Hold)

n  All segments continue to perform well

Nestle’s millionaire brands (Maggi, Nescafe, Kitkat, Nan, Cerelac, Everyday, Eclairs, Munch, Sunrise, Lactogen, Milkmaid) continue their high growth trajectory. However, milk’s growth suffered. This can be attributed primarily to Nestle’s strategy of phasing out non-strategic channels to optimally utilise its stretched capacity and also improve margins. Its volume growth in milk would have been ~11% instead of ~7%, had it not done this planned phase out.

n  Set for higher capex cycle

Nestle is positive on India’s economic environment and also its progressive population. Consequently, the company plans to significantly step up capex over the next few years to meet the growing demand of its products, launch new products and maintain market leadership in India (existing plants are operating at maximum capacity utilisation). The company is planning capex for brownfield projects at Samalkha (INR 6.5 bn), Nanjangud (INR 4 bn), Ponda (INR 5 bn), and Bicholim (INR 1.5 bn), apart from two greenfield projects.

n  Capex funding: Debt-free balance sheet augurs well

Nestle is likely to use a judicious mix of internal accruals and debt to finance its capex. It plans to raise INR 17 bn for the above-mentioned capex over the long term; as of now, it will raise ~INR 5 bn. Nestle could consider dividend payout and foreign currency debt financing strategies. As a reminder, the company’s credit ratings are top notch - Nestle India (locally AAA) and Nestle SA (AA).

n  Managing raw material costs a significant challenge

Nestlé’s Commodity Basket Price Index has increased from 138 in CY09 to 155 in YTD CY10. Milk continues to remain the biggest worry and its prices are unlikely to correct, primarily due to demand-supply mismatch. However, with sugar prices having softened and Nestle having good pricing power, we believe margins are likely to remain stable.

n  Outlook and valuations: No near-term triggers; maintain ‘HOLD’

We are enthused by Nestle’s plan for higher capex cycle to meet the growing demand of its products and launch new products, which is likely to benefit it in the long run. However, we believe the company is expensive at current valuation and maintain ‘HOLD/Sector Underperformer’ on it.