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MAGGIE’S NESTLED COMFORT VANISHES
We initiate coverage on Nestle with a Sell recommendation
and a TP of Rs3,208. We believe entry of new players in the
hitherto-secure noodles segment challenges Nestle’s ‘cash
cow’. Further, we believe the premium enjoyed by the stock
vis-à-vis FMCG peers is unjustified and would correct.
Volume to drive growth
We believe stiff competition in most brands would force Nestle
to protect its turf and retain market share, which it would do
through higher volumes. Aggressive marketing efforts and
capex of ~Rs12-13bn over the next two years for expansion of
capacities are early pointers to this volume-driven growth. We
expect volume to grow at 20% CAGR during CY10-12e, led by
10%, 27% and 22% volume CAGR in ‘milk and nutritional’,
‘prepared dishes’ and ‘chocolates’ categories respectively.
Competition to impact pricing power in noodles
Competition threatens to challenge the fortified citadels of
Maggi, Nestlé’s cash cow and largest contributor to profit
(~35% of EBITDA) with ~88% market share. The entry of big
players would impact the pricing power of Maggi Noodles. We
expect higher investment would result in higher industry
growth and would help Maggi Noodles grow 32% over the next
two years. However, growth would largely be volume-driven
and lower price premium would impact profitability.
Profitability under pressure
We expect low pricing power coupled with higher SG&A would
result in 50bps and 60bps decline in EBITDA margin in CY11
and CY12 respectively.
De-rating imminent given a competitive environment
Nestle trades at ~48% premium over the FMCG sector on
robust earnings growth and high return ratios. In our opinion,
the high premium would narrow owing to the current
competitive business scenario. We argue that Nestle would
trade at a 25% premium (two-year average) considering lower
pricing power for key products and pressure on return ratios.
Accordingly, our target multiple stands at 30x 12-months
forward earnings. Hence, our TP derives at Rs3,208, implying
18% potential downside. We initiate coverage on Nestle with a
‘SELL’ recommendation.
Investment Argument
Volume-driven growth
We believe Nestle’s growth would be more volume driven since retaining market share would
be its strategy, in our view, given the stiff competition in most of its brands.
Aggressive marketing efforts, capex of ~Rs12-13bn over the next two years for expansion of
capacities, and ambitious growth plans of Nestle Plc (parent) for emerging markets are early
pointers to this volume-driven growth.
We expect volume to grow at 20% CAGR during CY10-12e, led by 10%, 27% and 22% volume
CAGR in ‘milk and nutritional’, ‘prepared dishes’ and ‘chocolates’ categories respectively.
High competition in most products would result in muted growth of ~1.5% in realizations
over the next two years.
Over dependence on Maggi – Intense competition will impact pricing
power
Maggi is Nestle’s cash cow and the largest contributor to profit. It has a coveted ~88%
market share in the noodles market. The recent launch of GSK Consumer’s Horlick Foodles,
HUL’s Knor Soupy Noodles, and ITC’s Sunfeast Yippee has changed the scenario for Nestle.
Maggi is unarguably the leader in this segment. However, entry of big players would certainly
impact the pricing power of Maggi Noodles.
We believe competition would be favorable for the noodles industry. Higher investment in the
category would result in higher industry growth. We expect the noodles industry to grow at
~38% CAGR in the next two years.
Better industry growth would help Maggi Noodles grow 32% over the next two years. It would
largely be volume-driven as we expect competition to impact the pricing power of Maggi
Noodles.
Exhibit 3 indicates our assumptions for Nestle’s key brands. Noodles are the largest revenue
contributor and the key driver of Nestle’s overall growth. Thus, losing pricing power in this
category would certainly impact Nestle’s profitability.
Imminent de-rating given the heating competitive environment
Nestle is one of the favorite stocks in the FMCG space. Its robust earnings growth and high
return ratios resulted in the stock trading at an average premium (on one-year forward
earnings) over the FMCG sector by 25% and 8% in the past two years and five years
respectively.
At CMP, this premium expanded to 48% on one-year forward earnings. This high premium in
the current competitive business scenario seems unjustifiable. We argue that the premium
would narrow down to 25% (past two-year average) considering Nestle’s lower pricing power
for key products and slower profitability growth. Accordingly, our target multiple stands at
30x 12-months forward earning. We initiate coverage on Nestle with a ‘SELL’
recommendation and a TP of Rs3,208, implying 18% potential downside from the current
level.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
MAGGIE’S NESTLED COMFORT VANISHES
We initiate coverage on Nestle with a Sell recommendation
and a TP of Rs3,208. We believe entry of new players in the
hitherto-secure noodles segment challenges Nestle’s ‘cash
cow’. Further, we believe the premium enjoyed by the stock
vis-à-vis FMCG peers is unjustified and would correct.
Volume to drive growth
We believe stiff competition in most brands would force Nestle
to protect its turf and retain market share, which it would do
through higher volumes. Aggressive marketing efforts and
capex of ~Rs12-13bn over the next two years for expansion of
capacities are early pointers to this volume-driven growth. We
expect volume to grow at 20% CAGR during CY10-12e, led by
10%, 27% and 22% volume CAGR in ‘milk and nutritional’,
‘prepared dishes’ and ‘chocolates’ categories respectively.
Competition to impact pricing power in noodles
Competition threatens to challenge the fortified citadels of
Maggi, Nestlé’s cash cow and largest contributor to profit
(~35% of EBITDA) with ~88% market share. The entry of big
players would impact the pricing power of Maggi Noodles. We
expect higher investment would result in higher industry
growth and would help Maggi Noodles grow 32% over the next
two years. However, growth would largely be volume-driven
and lower price premium would impact profitability.
Profitability under pressure
We expect low pricing power coupled with higher SG&A would
result in 50bps and 60bps decline in EBITDA margin in CY11
and CY12 respectively.
De-rating imminent given a competitive environment
Nestle trades at ~48% premium over the FMCG sector on
robust earnings growth and high return ratios. In our opinion,
the high premium would narrow owing to the current
competitive business scenario. We argue that Nestle would
trade at a 25% premium (two-year average) considering lower
pricing power for key products and pressure on return ratios.
Accordingly, our target multiple stands at 30x 12-months
forward earnings. Hence, our TP derives at Rs3,208, implying
18% potential downside. We initiate coverage on Nestle with a
‘SELL’ recommendation.
Investment Argument
Volume-driven growth
We believe Nestle’s growth would be more volume driven since retaining market share would
be its strategy, in our view, given the stiff competition in most of its brands.
Aggressive marketing efforts, capex of ~Rs12-13bn over the next two years for expansion of
capacities, and ambitious growth plans of Nestle Plc (parent) for emerging markets are early
pointers to this volume-driven growth.
We expect volume to grow at 20% CAGR during CY10-12e, led by 10%, 27% and 22% volume
CAGR in ‘milk and nutritional’, ‘prepared dishes’ and ‘chocolates’ categories respectively.
High competition in most products would result in muted growth of ~1.5% in realizations
over the next two years.
Over dependence on Maggi – Intense competition will impact pricing
power
Maggi is Nestle’s cash cow and the largest contributor to profit. It has a coveted ~88%
market share in the noodles market. The recent launch of GSK Consumer’s Horlick Foodles,
HUL’s Knor Soupy Noodles, and ITC’s Sunfeast Yippee has changed the scenario for Nestle.
Maggi is unarguably the leader in this segment. However, entry of big players would certainly
impact the pricing power of Maggi Noodles.
We believe competition would be favorable for the noodles industry. Higher investment in the
category would result in higher industry growth. We expect the noodles industry to grow at
~38% CAGR in the next two years.
Better industry growth would help Maggi Noodles grow 32% over the next two years. It would
largely be volume-driven as we expect competition to impact the pricing power of Maggi
Noodles.
Exhibit 3 indicates our assumptions for Nestle’s key brands. Noodles are the largest revenue
contributor and the key driver of Nestle’s overall growth. Thus, losing pricing power in this
category would certainly impact Nestle’s profitability.
Imminent de-rating given the heating competitive environment
Nestle is one of the favorite stocks in the FMCG space. Its robust earnings growth and high
return ratios resulted in the stock trading at an average premium (on one-year forward
earnings) over the FMCG sector by 25% and 8% in the past two years and five years
respectively.
At CMP, this premium expanded to 48% on one-year forward earnings. This high premium in
the current competitive business scenario seems unjustifiable. We argue that the premium
would narrow down to 25% (past two-year average) considering Nestle’s lower pricing power
for key products and slower profitability growth. Accordingly, our target multiple stands at
30x 12-months forward earning. We initiate coverage on Nestle with a ‘SELL’
recommendation and a TP of Rs3,208, implying 18% potential downside from the current
level.
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