Nestle: Valuations ignoring profit pressures

Stock could fall further as analysts trim estimates

The Nestle India stock has under-performed the benchmark BSE Sensex in the past few trading sessions, falling 15 per cent owing to rising concerns on sales of its key brand, Maggi noodles, after several state governments temporarily banned the product.

While the jury is still out on whether the lead and monosodium glutamate content in Maggi is within permissible limits, given the mixed views of different states, Nestle’s woes seem to have only begun. Channel checks by analysts indicate Maggi sales volumes have fallen already. This will put downward pressure on the company's premiumisation drive, given the unexpected significant investments to protect market share of Maggi. Once Maggi gets a clean chit from the food regulators, Nestle will have to launch damage control measures to restore consumer confidence. The product is key, as the prepared dishes segment forms about 30 per cent of Nestle’s sales, while Maggi noodles contribute 22-25 per cent of the company’s total revenues, estimate analysts.

Additionally, this row provides an opportunity for key competitor ITC (Yippee noodles) to step up market share. Currently, Maggi enjoys 72 per cent volume  share in the noodles segment. This could impact  the Ebitda (earnings before interest, taxes, depreciation  and amortisation) margin over two-three quarters, believe analysts.

Nestle had recently accelerated its innovations. However, given the unprecedented events, it could take a back seat, which in turn can put further pressure on overall volume growth in the near term. Apart from noodles, Nestle offers a range of products such as sauces, pasta and spices under the Maggi brand. Volume growth of these products, too, can come under pressure. However, its  confectionery, milk, beverages and  infant food brands might remain relatively unaffected.

Analysts from Edelweiss and ICICI Direct have reduced the 2015 earnings estimates by 11-18 per cent to factor in falling Maggi volumes and the margin headwinds. After considering the trimmed consensus earnings estimates, Nestle trades at 40 times 2015 price/earnings ratio, still at a 30 per cent premium to its historical average one-year forward price/earnings ratio of 31 times. The stock valuations, thus, are at risk to increasing negative news flow. Of the eight analysts polled by Bloomberg in June, two have downgraded the stock to ‘Sell’ post this development; two have a ‘Buy’ rating and the rest are divided equally between ‘Neutral’ and ‘Sell’ recommendations.