NESTLE- Sales rebound; margins likely to follow suit::Edelweiss

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􀂃 Strong momentum in volumes
Nestle’s Q3CY10 revenues increased 25.7% Y-o-Y to INR 16.37 bn (ahead of our
estimate of INR 15.62 bn). The rise was on back of volume growth as price hike
during the quarter was minimal. While domestic sales surged 27.8% Y-o-Y,
export sales were negatively impacted by diversion of capacity to domestic
demand and appreciation of the rupee. PAT increased 29.6% Y-o-Y to INR 2.18
bn (in line with our estimate of INR 2.19 bn).

􀂃 EBITDA swells, but margins dip
The company’s EBITDA rose 21.8% Y-o-Y to INR 3.2 bn against INR 2.6 bn in
Q3CY09. COGS jumped 128bps to 49.1% of sales and other expenses rose
47bps Y-o-Y. This was, however, partially offset by 113bps Y-o-Y reduction in
staff expenses. Hence, EBIDTA margins declined 63bps Y-o-Y in Q3CY10.

􀂃 Competitive intensity increasing
GSK Consumer, ITC, and Hindustan Unilever (HUL) have entered the fast
growing noodles category. Hence, Nestle will have to increase A&P spend to
maintain market share, which will exert pressure on margins in coming quarters
in the noodles segment. However Nestle’s margin are not likely to be impacted
due to softening of prices of major inputs.

􀂃 New products to drive growth
Nestle has enhanced its focus on consumer understanding and R&D. This led to
roll out of Nestlé KITKAT at lower price (INR 10), MAGGI Vegetable Multigrainz
Noodles and Nestlé EXTRAFINO Milk and Dark chocolates in the premium range.
The company relaunched Nestlé BARONE with 60:40 taste superiority and added
Nestlé Milk Half Fat and Romantic Capsica to its product portfolio.

􀂃 Outlook and valuations: Fairly valued; maintain ‘HOLD’
The company has achieved buoyant sales growth and we believe this momentum
will continue in the coming quarters with increased focus on new product
launches. Also, a good monsoon and softening in prices of major inputs such as
wheat, milk, sugar are likely to benefit Nestle, which may result in margin
expansion. Foreign promoters increasing stake in the Indian subsidiary reinforces
their confidence in and focus on the same. However, we believe the stock is
fairly valued over the near term and maintain ‘HOLD’ recommendation. On
relative return basis we rate it ‘Sector Underperformer’.