Stock Review: Nestle India

Nestle India's market leadership, diversified presence and lower competitive intensity in the under-penetrated foods and beverage (F&B) category helped it post robust sales growth of 26 per cent year-on-year (y-o-y) to 1,641 crore in the July–September quarter.

However, the company had to grapple with rising input costs and higher ad spends to maintain its market share, especially in the noodles segment, which led to a 27 per cent rise in total costs. Consequently, the operating profit margin slipped by 80 basis points, to around 20 per cent, and the net profit margin by 67 bps to 13.3 per cent.

The instant noodles market, Nestle's mainstay, recently witnessed the entry of new and large companies such as ITC (Sunfeast Yippee), Hindustan Unilever (Soupy Noodles) and GlaxoSmithKline Consumer Healthcare (Foodles). Analysts are cautious about the rising competition and the expected pricing pressure Nestle will face in the times to come. It will have to gear up on ad spending to maintain market share (currently above 80 per cent).

On the other, input costs (mainly wheat, sugar and milk) are on the rise and high inflation is expected to keep raw material costs firm, despite good monsoons. Nestle now plans to focus on lowpriced products and penetration in rural areas, especially in Tier-II and Tier-III cities. All these factors will put margins under further pressure.

Any action on the company's intention of domestic acquisitions and expanding product portfolio in the packaged foods category, including breakfast cereals, will be a major positive move. Considering margin pressures amid rising competition, the stock, trading at 35 times calendar year 2011 estimated earnings, seems to be in an overbought zone. However, current valuations factor in the near-term growth potential, leaving no room for any negative surprises, say analysts at Angel Broking.

Entry of new players in the company's key business segment is likely to challenge its market leadership and cap margins