Nestle: Good performance, but fairly valued: HSBC

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Nestle India (NEST)
N: Good performance, but fairly valued
􀀗 3QFY10 results reinforce Nestle's ability to post robust sales
growth; PAT marginally misses due to cost inflation
􀀗 Competitive pressures increasing (on noodles) and cost
continues to be a challenge
􀀗 Remain Neutral; valued on PE multiple basis at INR3,400





Robust sales, PAT in line: Nestle surprised us on the topline, growing 25.7% vs our
expectation of 22%, and domestic sales growth was even more impressive at 27.8%. This
was due to a combination of volume growth (our estimate 18-19%) and price increases to
tackle input cost inflation. However, input cost inflation was steep, shrinking gross
margins by 128bp for the quarter vs our estimate of 20bp. Overheads increased by 23%
yoy (high ad spends but low employee cost) resulting in EBITDA margins going down by
76bp. PAT at INR2,186m (vs our estimate of INR2,273m and consensus at INR2,098m)
grew 19.6% yoy despite effective tax increasing by 126bp.

Competition, cost remain concerns: While Nestle has demonstrated robust sales growth,
competition is increasing, especially in its star category of noodles. Over the last year,
GSK Consumer has introduced Foodles, HUL has introduced Soupy Noodles and ITC has
introduced Sunfeast Yippee in this category. This could have an impact on the growth
rates of Nestle's Maggi Noodles over the mid to long term. Cost is another issue which is
of concern, with food inflation being much more resilient than earlier estimated. Milk
prices have inflated c25% over the last year. Moreover, coffee prices are expected to go
up due to delayed harvesting in India and weather problems in Brazil and Vietnam.

Valuation: We maintain our 12-month target price at INR3,400. We use a target multiple
of 28x Sept 2012e EPS. The forward multiple has averaged 25x over the past three years.
We believe the stock deserves a premium of c12% to its historical average to account for
robust volume growth and improved ROE. The stock is trading at 34x 12-month forward
EPS and 28x 2012e EPS and is fully valued; thus we are Neutral.