Stock Review: Nestle India

Last week, Nestle India announced plans to almost double its capital expenditure (capex). While this indicates the management's confidence in business growth over the long-term horizon, it is likely to strain the company's financials in the near term.

Upping the capex trajectory

Nestle India is planning a capex for brown field projects at Samalkha (Rs 650 crore), Nanjangud (Rs 400 crore), Ponda (Rs 500 crore) and Bicholim (Rs 150 crore), apart from two greenfield projects, totalling 1,700 crore over the next fourfive years (Rs 550 crore in CY11). This is far higher than 920 crore spent in the last five years.

While the company's zerodebt position augurs well, it also generates cash flow of over `900 crore from operations annually. However, the incremental capex outlay will put pressure on free cash flow generation and on the dividend payout, which could fall down to 60-70 per cent versus 84 per cent in CY09. Nestle is likely to use a mix of internal accruals and debt to finance its capex.

In the interim, till the new capacities contribute to its financials, its interest expenses (due to incremental debt) and depreciation will increase and impact the company's bottom line. Analysts have trimmed their earnings estimates as much as 7 per cent for CY11 and 5 per cent for CY12 (EPS of `99 and `125, respectively).

Operating performance

Nestle has maintained strong growth momentum across segments (16.3 per cent yearon-year volume and 21.3 per cent value growth in nine months of CY10). Beverage growth rates are improving while the chocolate & confectionary and prepared dishes & cooking segments continue to be key growth drivers. Nestle has phased out non-strategic products and channel sales —exports, sales to canteen stores department and industrial channels, impacting milk products sales growth 4 per cent in the September quarter. However, these moves have helped it improve the sales mix and hence the margins.

It has lined up new launches in beverages, chocolates and milk products. While Maggi faces product substitution risk (from Knorr and Foodles), the spate of new launches in Maggi (four new variants) can help sustain current growth rates by increasing the consumption points.

Nestle SA's plans to set up an R&D centre at Manesar by 2012 is marginally positive for Nestle India as it already has access to the former's R&D facilities.

Meanwhile, though the volume growth is pegged at 19 per cent, sustained input costs and higher ad spends could keep operating margins under pressure, believe analysts.

Outlook

Nestle India has outperformed both the BSE FMCG index and the broader market, rising 4 per cent as against the near flat returns by each of the benchmark indices in the last one month. The company's plans for a higher capex and new product launches will help sustain healthy growth rates in the long run, but analysts think current valuations at around 36 times the CY11E and 32 times the CY12E P/E adequately capture the near-term growth prospects. These rich valuations suggest the near-term upsides are very limited. But, investors with a perspective of over one year could invest on dips for 18-20 per cent returns.