Nestlé India - Q1CY13: Volume concerns persist; margins surprise on the upside :JPMorgan

Nestlé India reported another quarter of subdued domestic revenue growth,
though margins continued to surprise on the upside. Company registered Net
Sales, EBITDA and adjusted PAT growth of 10%, 16% and 8% respectively for
Q1CY13. Volume growth continues to remain subdued given severe impact from
weak consumer sentiment (impacting discretionary spends on packaged foods),
aggressive pricing and portfolio/channel optimization. We remain constructive on
the company’s long term growth potential, but see near term top-line growth
challenges and current valuations at 37x CY13E and 32x CY14E P/E as limiting
upside potential. Volume growth recovery remains the key for stock performance
going forward. We expect volume growth rates to recover gradually in 2013
supported by new capacity commissioning, wider product base, enhanced
distribution reach and a bit more competitive pricing in some of the categories.
RM inflation outlook appears benign and that should help margins to hold out.
 Domestic sales growth subdued at 8%. Domestic sales growth remained
sluggish at 8% during Q1. We believe much of the growth has been led by
higher pricing and improved mix. Volume growth has been affected adversely
by challenging macro, portfolio/channel optimization and aggressive pricing.
Exports sales growth was however strong at 51% contributed largely by exports
to affiliates which rose 98% y/y. Exports to third parties grew by 9% y/y.
Management noted that they expect some volatility to continue throughout 2013
and while some categories are showing positive signals, some may take some
more time.
 Substantial margin improvement: Nestlé India continued to manage RM
inflation with strong pricing and improved channel/product mix leading to a
60bps y/y expansion in gross margins. EBITDA margins were further supported
by moderate increase in other expenses (+6% y/y) adding 80bp to margins.
Overall EBITDA margins expanded 140bp y/y and EBITDA grew 16% y/y.
Other financial income improved largely due to higher average liquidities,
though other operational income declined y/y due to lower realisation of export
incentives.
 Higher depreciation and interest costs weighed on earnings. The company
didn’t draw any new debt for capacity expansion during the quarter with total
debt outstanding at Rs 10.4bn (US$192mn). Depreciation cost increased 56%
y/y (flat q/q) due to significant capacity expansion undertaken over the past
year. Adjusted interest costs were at Rs79Mn (~3.5x y/y, -20% q/q) due to
higher debt y/y (taken for aggressive capex done over CY11/12).

�� -->

Price target and valuation analysis
We raise our EPS estimates for CY13/14 by 2-3% as we build in slightly
better margin assumptions. We also roll forward our price target
timeframe to Mar’14 (from Dec'13) and assign a new price target of
Rs4825 based on forward P/E multiple of 30x. Our target P/E multiple of
30x, is at a ~10% discount to its past five-year average considering slower
volume growth trends currently being registered by the company.

Key upside risks:
Any sharper than expected volume growth on the back of strong consumer
spending and/or substantial marketshare gains would be a key upside risk
to our sales and earnings estimates. Sharp decline in commodity costs
would also pose upside risk to our margins assumption and earnings
estimates.
Key downside risks:
Any adverse impact of inflation on consumer demand would significantly
impact our sales and earnings growth assumptions.
A sharp inflation in Milk/Sugar/Green Coffee/Wheat/Vegetable Oils
prices will significantly impact our margin assumptions and earnings
growth estimates.
Nestlé enjoys leadership position in most the categories it operates in.
However, any significant rise in competitive activity by existing players
and/or entry of new players could lead to higher A&P spends and impact
our margins/earnings assumptions