Nestle India

Despite below-par results for the March quarter, that saw the stock take apause for the latter two weeks of April, Nestle's stock has once again started to outperform the markets. In fact, it scaled an all-time high of Rs 3,065 on Monday. The recent outperformance is not without reason.

A good monsoon and, hence, higher disposable incomes for farmers — coupled with declining input prices — should boost demand. This augurs well for Nestle.

Easing input pressure

Through early 2009, prices of inputs like sugar, wheat and milk had risen sharply. For Nestle, this meant major inputs like milk, milk powder, wheat and sugar accounted for 59.75 per cent of total costs of the raw material consumed (Rs 2,014.3 crore) in the calendar year (CY) 2009 — or 23.5 per cent of net sales of Rs 5,129.4 crore.

This was reasonably higher than 56.1 per cent and 22.5 per cent, respectively, in CY2008. While profit margins were stable in CY2009, the impact of high prices was visible in the March quarter. Since the company was unable to fully pass on these costs, its earnings before interest, taxes, depreciation and amortisation (Ebitda) margins shrank nearly 400 basis points to 20.5 per cent.

The good news is that input prices have eased recently. While malt, milk and milk powder prices have eased somewhat, sugar prices are down 36 per cent (and still falling) since the first week of January. Likewise, while wheat prices are also down over 13 per cent since early January, they are likely to remain soft consequent to the expected rise in production in the country. Hence, expect Nestle to gain on this count.

But given its inventories as of end December 2009, analysts expect the gains to be felt only from the September quarter this year. Also, they expect some of these gains could be offset by a likely increase in Nestle's ad-spend, consequent to the increasing competition in the foods business, which accounts for about a fourth of Nestle's revenues. While ITC and GlaxoSmithKline have forayed into the noodles category, HUL is also turning aggressive. In dairy products, too, while Amul, Britannia and Mother Dairy are Nestle's major competitors, French major Danone has forayed into the business and has launched products with prices in line with the market.

However, given Nestle's strong understanding of consumer tastes and preferences (especially in categories like noodles), competition is unlikely to make a dent in its market share. In the long-run, says an IIFL analyst: "Competition is unlikely to be a major issue.

Iexpect Nestle to do well, but some near-term pressure could be there."

Investment rationale

Nestle has a vast product portfolio, strong brands (like Nescafe, Maggi, Munch, Nestle, Kit Kat, Milkmaid and EveryDay) and extensive distribution reach. Nestle operates in large and fast growing categories (like processed foods, milk products and nutrition, etc) wherein penetration levels are low. It also enjoys large market shares in these.

Analysts say Nestle is now increasingly enhancing focus on Tier-II and -III cities and is introducing low-priced packs. IIFL's analyst says: "While the company has continuously innovated new products and variants, it has done a lot of work on the price point front. At present, about 30 per cent of its total revenues come from product-packs priced below Rs 10." All this, along with improving demographics and increasing disposable incomes, will help the company sustain about 20 per cent growth for the next couple of years. At Rs 2,983.05, the stock trades at aprice-to-earnings ratio of 29.5 times its estimated CY2011 earnings and can be considered on dips.