Nestle India -Impressive capex plans : Kotak Sec

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Nestle India (NEST)
Consumer products
Impressive capex plans. We believe Nestle India is planning an aggressive capex
program of >Rs20 bn—as much as its current gross block—in all categories except
beverages over the next two/three years. The quantum of capex has surprised us (it had
incurred a capex of Rs9 bn over CY2005-09, ~5% of sales) and we are puzzled
regarding its capacity constraints—unusual in an industry with high asset turns—and
the bunched-up capex program. At 35X FY2012E, the stock discounts most positives.




Key takeaways from the analyst meet
􀁠 Nestle India is planning an aggressive capex program in all categories except beverages over the
next few years. The company indicated that it would invest Rs17 bn in brownfield expansion
(Samalkha: Rs6.5 bn, Ponda: Rs5 bn, Nanjangud: Rs4 bn and Bicholim: Rs1.5 bn) in addition to
two greenfield plans. The company indicated that it would look to debt (domestic and foreign
currency) to finance the expansion.

Our view. The quantum of capex surprised us (it had an opening gross block of Rs17 bn in
CY2010; it had incurred a capex of Rs9 bn over CY2005-09, which is ~5% of sales) and we are
puzzled about the bunched-up capex program. This is particularly noteworthy in the context that
Nestle India had the option to expand capacity in an existing fiscal benefit unit in Pantnagar before
March 31, 2010 wherein the company could have got excise and income tax benefits for 10 years.
The management indicated that the current capacity utilization is at an all-time high—quite
surprising in consumer staples businesses in India which typically has high RoIC and high asset
turns.
􀁠 Nestle SA plans to set up an R&D center in India (in Manesar, Haryana; to be commissioned by
mid of CY2012) to further the ‘Indianisation’ of its legacy concepts (from the parent portfolio),
to develop locally relevant products and will focus on ‘Popularly Positioned Products’ (typically,
price-pointed packs).
Our view. The setting up of a R&D centre is positive though we believe it will have limited
incremental benefit for Nestle India as it already has access to Nestle SA’s R&D facilities (and it pays
royalty to parent company) and many of Nestle India’s products are developed in other R&D
centers like Germany (Pasta), Singapore (Masala magic cooking aid) etc.
􀁠 The company indicated its intention to focus on premiumisation in most categories—chocolates
and dairy, in our view.


Our view. Nestle is evaluating steps to unlock itself from the price-pointed strategy,
however, we would view this with caution given that in the past Nestle had attempted to
increase the retail price of its chocolate portfolio but had to subsequently roll it back due to
a slowdown in demand.
􀁠 The management highlighted that part of the growth in Maggi is due to the increase in
penetration (almost 50% of incremental growth) and that the new variants of Maggi
doing well. The management highlighted that atta (wheat flour with bran) Maggi and
Maggi pasta have received good response from customers and is meeting internal
expectations. Recently, it has launched a multi grain variety of Maggi.
Our view. We continue to believe that Maggi faces product substitution risk (from Knorr
and Foodles). However, the spate of new launches in Maggi (four new variants) indicates
that competition seems to have triggered higher activity levels in the industry, led by the
market leader. We note that this can potentially help Maggi maintain its current growth
rates by increasing the consumption points.
􀁠 The recent JV for marketing Nestea (ice tea in RTD format) with Coca Cola is at the parent
level and Nestle India has no stake in it.
􀁠 The company indicated that input cost inflation, particularly in milk products, is very high.
We recall a few points from the analyst meet of August 2010, indicating a likely favorable
input cost scenario, (1) specific management comment that ‘cost pressures are not
escalating’, (2) a good monsoon is likely to result in a flush season for milk production
and (3) liquid milk collection in Moga factory has increased in double digits in 2QCY10 (it
declined in 2QCY09). We are surprised at the significant change in view regarding input
costs in such a short span.
􀁠 Capacity constraints faced by Nestle India—quite unlike of Indian consumer companies, in
our view—and has phased out non-strategic products and channel sales—exports, sales
to Canteen stores department (sales to defence personnel) and industrial channels. This
has impacted milk products sales growth by ~4% in 3QCY10 (~1% at company level),
however, it has helped it improve sales mix and hence margins.

At 35XFY2012E, there is no room for execution risk. Retain REDUCE
We like the market opportunity for most of Nestlé’s categories, but look for better entry
points into the stock. We tweak estimates marginally, maintain REDUCE rating and maintain
TP at Rs3, 100. Key risks to our rating are (1) higher-than-expected sales growth due to
distribution gains and (2) better than-expected margin expansion.