Stock Review: Nestle India

 

Consistent growth and a robust demand for products should make Nestle a surefire bet for investors. But rising competition in noodles, a key segment, needs to be tracked

 

   Nestle India is one of the most promising bets in the consumer goods sector on the bourses. The foods company has grown consistently over the last several quarters, and its stellar performance in the latest quarter ended March offered further testimony to the strength of its business and brands.

Strong brands in the packaged products segments like noodles and sauces (Maggi), baby foods (Cerelac), dairy whitener (Nestle) and instant coffee (Nescafe) have given the company market leadership in these categories. Nestle also has the second-largest market share in case of health soups and is a leading player in chocolate and confectionery.

GROWTH DRIVERS

The demand for the company's products continues to remain robust, and is one of the major growth drivers. The company is leveraging its distribution network to reach out to the masses in the hinterland and the low-income groups. It has consistently and innovatively worked at reinforcing the consumer's association with most of its flagship products like Maggi, Nescafe and Kitkat. Nestle is also looking at growing its premium product portfolio. It has improved its product and channel mix and is expanding manufacturing capacities for the Maggi range of products. Nestle has proposed a capex plan of 1,800-2,000 crore over the next two-three years. A new Maggi plant in Nanjangud (Karnataka), started production in the first quarter of 2011.

FINANCIALS

Nestle has the strong balance sheet of a classic consumer goods company characterised by zero debt and strong cash flows. The company's net sales have grown at a compound annual growth rate (CAGR) of 20% to 6,255 crore for the year ended December 2010. Net profit has grown at a CAGR of 21.5% during the same period to 818.6 crore. Nestle has been consistently paying dividends with average payout ratio being 77% of net profit for the last three years.

Raw materials typically make up 47-48% of the company's net sales. The calendar year 2010 was difficult for the company in view of the inflationary trend in commodities like milk, sugar, coffee, wheat etc. Input costs make up 49-50% of the sales during the first three quarters of 2010. The company manages to offset the rise in input prices through timely price increases on its products.

CONCERNS

With commodity prices starting to cool off, pressure on Nestle's bottom line is likely to ease. Commodity price volatility, nevertheless remains a key concern for the company.

Competition has also been building up steadily for Nestle. HUL, ITC and GSK Consumer Healthcare are the latest entrants in the instant noodles category besides the private labels of retailers. Instant noodles — under the well-established brand Maggi — is the most profitable segment of the company's business, contributing one-third of its net profit. The growing competition in this segment is therefore a threat to the company. But investment in brand and brand innovations to strengthen the recall factor could help the company to stave off competition.

VALUATIONS

Nestle's stock is trading at a price to earnings multiple of 44 and is valued at more than six times its annual sales. These valuations are at a significant premium to its peers. The P/E of ET FMCG Index is 32.4. In return for these high valuations, investors can expect consistent performance, steady growth in capital returns and regular dividend income. But investors should keep an eye on the impact of rising competition on the company's noodles segment. Any adverse impact in that segment may hit the bottom line of the company.