Nestle India: Strong 1QCY11 Results Citi Research

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Nestle India (NEST.BO)
Strong 1QCY11 Results
 In line revenues; Profit beats expectations — Revenue growth of ~22% Y/Y to
Rs18.1bn was healthy and in line with estimates, on the back of ~23% Y/Y growth in
the domestic business (volumes + price) and ~10% Y/Y exports growth. However,
reported PAT at Rs2.6bn (+27% Y/Y) was ahead of both our & Street estimates of
~Rs2.4bn – driven by 70bps EBITDA margin expansion Y/Y to 21.3%. Material costs as
% of sales decreased 100bps Y/Y – mgmt attributed this to improved product/channel
mix and reduction in free goods promotion.

 Sustenance of margins is key — Admittedly, we are positively surprised with the

strong margins, especially in light of last month’s analyst meet where mgmt spoke of
the many challenges in CY11, most prominent being volatility in input costs & other
cost inflation. Despite the good quarter, we do not see margin expansion to continue, in
the near term given: a) commodity cost inflation; b) increasing brand investments
especially in beverages & chocolates; and c) escalating power, fuel & distribution costs.
 Tweaking estimates — We raise our revenue estimates by 6-7% over CY11/12 driven
by strong domestic volume growth and pricing actions. However, the delta in profits is a
tad lower (6/4%), as we incorporate a) some margin pressures going forward and b)
higher tax rate (100% tax holiday at the Pantnagar factory drops to 30% from the
current month). We tweak our balance sheet assumptions factoring the higher capex in
line with recent mgmt commentary. Our dividend assumptions are lowered – we
assume DPS to remain flat (Rs48.50) over CY11-12 before an increase in CY13.
 Maintain Sell; target price of Rs3,345 — We increase our target price to Rs3,345
driven by a roll forward to Sept 12E EPS (Mar12E earlier), maintaining our 28x target
multiple – Nestle India’s long-term average forward P/E multiple. We think the company
has strong fundamentals and is well positioned to benefit from the long-term
opportunity in the branded foods & beverage space, but valuations at ~35x one-year
forward P/E are rich and capture the growth prospects.


Nestle India
Company description
Nestle India, a c61% subsidiary of Nestle SA, is the largest and most diversified
food and beverage company in India. The group has a dominant market position in
infant food, cereals, and instant coffee and culinary products, and is No.2 in the
chocolate market. Its product portfolio comprises some of Nestlé's best-known
global brands - Nescafe, Lactogen, Cerelac, Maggi and Kit Kat. The company has a
strong focus on adding value to basic commodities, and has an extensive
distribution network, covering most of the urban and semi-urban areas.
Investment strategy
We have a Sell / Low Risk (3L) rating on Nestle India shares. While we view Nestle
as the best play on urban consumption growth in the Indian consumer sector
universe, and it has in the recent past grown much ahead of the consumer sector
growth average, its valuations are capturing this growth premium, in our view. The
stock is currently trading at the higher end of the current trading range, and we do
not see any further re-rating triggers. Historically, Nestle has benefited on two
counts - on the demand side from its urban exposure, which was driven by high
service sector growth, and on the costs side through its agri-product exposure,
where raw-material prices remained soft over a long period. However, over the last
few years, raw material costs have been firming up, which has put pressure on
margins. While Nestle has been able to mitigate margin pressure through price
hikes, we believe that, if raw material costs keep firming, it will be difficult to hike
prices without sacrificing volumes. Additionally, like the rest of consumer universe,
ad spends are likely to increase in the near term, depressing operating margins.
Valuation
We value Nestle India using a P/E based methodology, given its steady growth
characteristics and non cyclical revenue streams. Our target price of Rs3345 is
based on a target P/E multiple to 28x Sept 12E. We peg the target multiple at the
middle of the current trading band. Our target multiple is at a premium to what we
ascribe to Hindustan Unilever, given Nestle India's superior growth profile,
benefiting from the recovery in urban consumption in India. The stock is trading at
relative P/E of 2.5x vs. the broader market – at the higher end of its historical band.
At current valuations of ~35x one-year forward, Nestle is trading at a ~25%
premium off its long-term P/E multiple; which we think is rich and leaves no room for
disappointment.
Risks
We rate Nestle shares Low Risk based on our quantitative risk-rating system, which
tracks 260-day historical share price volatility. The key upside risks that could
sustain the shares above our target price include: (1) better-than-expected revenue
growth; and (2) favorable agri-product prices. Key downside risks include: (1)
fluctuations in commodity prices could affect profitability prospects; (2) supply
constraints on raw materials, particularly milk solids, could stifle growth.