Nestle: Pricing power

The company is well positioned to cash in on the growing spends on processed foods.

Foods major Nestle has again demonstrated how powerful a portfolio of brands it has with gross margins expanding 240 basis points to 52.2 per cent in the September 2009 quarter. Of course the fact that prices of key inputs, except sugar, remained more or less stable during the quarter helped bring down costs.

But the company was also able to improve its product mix and thereby earn better realisations, reflected in its top line, which grew 17.6 per cent to Rs 1,302 crore. Sales were driven by an 18 per cent growth in the home market, the 17th consecutive quarter of high-double-digit revenue growth.

However, increase in staff costs and higher spends on advertising and marketing meant that operating profit margins, at 20.3 per cent, expanded by just 160 basis points. A lower tax rate of just 27 per cent helped push up profit after tax by 38.7 per cent to Rs 182.8 crore.

With Indian consumers increasingly able and willing to spend on branded and processed foods, Nestle should continue to command pricing power given that there is limited competition for many of its products. Also, the company has been trying to increase penetration, especially in non-urban markets, by launching its brands at lower price points.

That, together with the growth of organised retail in bigger cities, should help Nestle sustain double-digit volume growth. In the current year to December 2009, the company is expected to grow revenues by just under 17 per cent to around Rs 5,100 crore, while net profits are estimated to grow 32-34 per cent over those reported in 2008.

Next year, though, profits are estimated to grow 18-20 per cent. The stock has had a great run and at Rs 2,663, trades at around 30 times estimated calendar 2010 earnings. Nestle has almost always commanded a big premium to peers in the FMCG space and that trend should continue.