Launches key to Nestle's fortunes

Market has cheered company's renewed aggression on innovations and launches; current valuation could limit upside

Nestle India’s scrip has significantly outperformed the benchmark S&P BSE Sensex since July. It touched an all-time high of Rs 6,144 on Monday, before closing at Rs 6,049.

The company’s renewed focus on innovations and product launches, along with expectation of revival in discretionary spending and in urban demand, are key reasons for the Street turning bullish on the company. Notably, these trends are in contrast to the stock and the company’s performance in the recent past. The focus on maintaining of margins had impacted sales growth in the past six or eight quarters; this, in turn, had kept the stock price under check. Weakening consumption demand in urban areas added to its problem.

"Nestle’s excessive focus on margins led to under-investment in brands (lowest advertisement and promotion spends among peers) and little investment in categories of the future. As a result, the sales CAGR (compounded annual growth rate) halved to 10 per cent over CY (calendar years) 2011-13, from 22 per cent in CY06-11," says Sanjay Singh of Standard Chartered Securities.

Nestle also lagged peers Hindustan Unilever (HUL), Dabur, GSK Consumer and Britannia on sales growth. However, it managed to keep Ebitda (earnings before interest, taxes, depreciation and amortisation) margins in a narrow band of 21-22 per cent, aided by consistent price increases.

Things appear to be looking up. Its new managing director Etienne Benet’s strategy of investing in existing brands and new launches has excited the Street. Three new products were launched in the June quarter — the low-fat Nestle sweet lassi, Nestle buttermilk with ayurvedic herbs and spices, and Maggi oats noodles.

Maggi, its major brand in the noodles segment, is estimated to have lagged ITC’s Yippie in recent times, say analysts. The launch referred to earlier, in the quarter gone by (Madhuri Dikshit features in the advertisement), marks the company’s entry into the oats-based noodle segment and gives it first-mover advantage. Extension of the strong Maggi brand to other variants to boost growth is a strategy the company has successfully adopted for several years.

It has also scaled up advertising of EveryDay Dairy Whitener and got Bollywood actors Rahul Bose and Raima Sen for the ads. The two segments, prepared dishes & cooking aids and milk products & nutrition, accounted for 76 per cent of CY13 revenue.

The company is also revamping Nescafe (coffee brand) to boost growth. Tough competition from HUL’s Bru Coffee has seen Nestle lag in the past. The success of these launches and introduction of more new products are key for future growth.

Analysts sound bullish. They expect earnings per share growth to improve from eight per cent in CY11-14 to 19 per cent over CY14-16, on the back of higher sales growth. “Nestle has stepped up innovations and has been investing aggressively. Its volume growth is likely to improve in the coming quarters and earnings growth could gain traction,” says Naveen Kulkarni of PhillipCapital.

For several quarters, the top line was largely driven by prices rises, while volume growth was muted, something the Street was wary about. With its mega expansion plan over and the renewed focus, volumes should look up.

From Bloomberg consensus data, Nestle’s sales and EPS estimates, consistently revised downwards since January 2012, have seen some upgrades since July for both CY14 and CY15. Singh believes the earnings downgrade cycle is largely over.

Still, the recent gains in the stock suggest the upsides are limited. Of the 30 analysts polled by Bloomberg since August, 12 have a ‘Hold', four a ‘Buy’ and the rest a ‘Sell’ recommendation on the stock. Their average target price is Rs 5,063, which is 16.3 per cent lower than Monday’s closing price of Rs 6,049. Rich valuations of 40.6 times the CY15 estimated earnings cap significant upsides from here on, believe analysts. The scrip has historically traded at peak one-year forward price/earnings ratio of 41-42 times. A good enough correction, though, could provide a reasonable entry point for a long-term investor.

Nestle enjoys strong brand equity (Maggie, Nescafe, Kit-Kat, Milkmaid and Lactogen) in India and is well positioned to benefit from growth of the processed foods segment. Input cost inflation (milk, wheat flour, edible oils and sugar) and intensifying competition are key downside risks.