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Nestle India: Concerns over volumes

Analysts feel sales growth will be limited with Nestle focusing on pricing rather than volumes, pressure on margins likely due to higher overheads

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Nestle India, which declared its June quarter results on Friday (post-market hours), is trading nearly flat (up 0.3 per cent) since then, compared to the and that are up 2.4 per cent and 1.3 per cent, respectively. The stock is in the positive zone partly due to the 180 per cent interim dividend declared, say analysts. Otherwise, sales growth in the recently concluded second quarter, (Nestle follows January-December calendar year) has been disappointing. Net profit margin has come in flat due to a rise in interest and depreciation costs. However, operating profit margin has improved significantly helped by lower raw material costs, price hikes in the earlier quarters and better product portfolio/channel mix.

The company's management has expressed concerns about the future outlook. Says Antonio Helio Waszyk, Nestle India's, chairman and managing director: "As expected, 2012 is proving to be a very challenging year. We remain cautious thanks to persistent inflation, uncertain monsoons and economic volatility."

Analysts also echo this concern. They believe sales growth will be restricted given the change in Nestle's strategy of focusing on pricing rather than volumes. Margins are also expected to come under pressure, as major overheads trend higher. These risks aren't fully reflected in the stock's valuation at 31-times calendar year (CY) 2013 estimated earnings.
 

CY12: GROWTH CONCERNS
In Rs crore Q2’ CY12 CY2012E CY2013E
Net sales 1,993.4 8,648.0 10,644.0
Y-o-Y change (%) 12.7 15.1 23.1
Operating profit 431.0 1,865.0 2,287.0
Y-o-Y change (%) 25.4 21.4 22.6
Adjusted net profit 238.0 1,117.0 1,372.8
Y-o-Y change (%) 11.2 14.0 22.9
E: Estimates       Q2 is quarter ended June 2012      Source: Company, Analysts reports

June quarter: Slow growth
Growth in the domestic business (94 per cent of total sales) at 13.7 per cent year-on-year was disappointing but was steady compared to the previous quarter. Volume growth was impacted by an estimated 12 per cent price hike undertaken by the company over the last several quarters, analysts say. Notes Pritesh Chheda, analyst, in his post results note, "This is against our expectation of pick-up in volume growth due to Tahliwal factory." Even exports fell by 1.5 per cent, despite rupee depreciation.

Operationally, profit margins improved 218 basis points to 21.6 per cent, led by lower raw material prices in percentage to sales (down 404 basis points) and price hikes. These would have been better if employee (up on account of higher headcount) and advertising costs (due to focus on brand building) would have been under control. Higher depreciation and interest costs also restricted the net profit margin, which remained flat at 11.9 per cent.

Outlook
Nestlé's stock valuation is way above its five- and ten-year historical average of 28 times and 25 times, respectively. The stock at Rs 4,462 does not factor in the impending risks to volumes and margins, says an analyst at a domestic brokerage. While Nestle has commissioned new capacities, it remains to be seen how fast it can increase utilisation levels given the muted demand environment amid slowing economic growth, as well as its focus on pricing. Chheda of Emkay points out that volume ramp-up becomes imperative as favourable base for margin wanes. However, Abhijeet Kundu, analyst, Antique Stock Broking, is not so worried. "Volume growth would gradually recover over a period of six-nine months led by substantial ramp up in operations and subsiding of the impact of price hikes," he says in a post-results note.

Nevertheless, the trend in sales growth remains a key monitorable, going ahead, given the fact that Nestle derives 30-35 per cent of sales from the price sensitive rural market.

Given that Nestle is heavily dependent on agri commodities (wheat, milk and sugar, among others), deficient rainfall across the country could push raw material costs higher and hurt margins. Also, it could impact volume growth if Nestle resorts to further price hikes. The advertising expenditure is also expected to remain at elevated levels given the focus on brand building, product innovation and distribution strategy. Hence, developments on these fronts also need to be watched.

On the other hand, depreciation and taxation will continue to weigh on the back of Nestle's capacity expansion plans. In this backdrop, the risk-reward ratio is not favourable at the current levels. Existing investors may hold though fresh investments could be made on a significant correction, analysts say.

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