Saturday, February 27, 2010


Source of opportunity
We downgrade Nestle India to Sell and add it to our Conviction List, from Neutral, on valuation grounds and revise our 12-month target price to Rs2,376 from Rs2,362. We believe Nestle India’s current valuation is expensive as it trades on a one-year forward rolling P/E of about 29X, which is high compared with its long-run average of 25X. Although Nestle India remains structurally well positioned to deliver strong 19% topline CAGR in FY09-FY12E given its exposure to low-penetration processed food categories and urban skew, we forecast flat gross margins in FY10E driven by a spike in raw material costs.

Expensive valuation overshadows strong topline; down to Sell

Nestle India’s current absolute P/E and 35% P/E premium relative to our India consumer staples coverage are both about one standard deviation above their long-run trends. With EPS CAGR moderating from 28% in FY06-FY09 to 22% in FY09-FY12E given a high base and limited margin expansion, we expect mean reversion of its P/E. We also believe Nestle India would need to continue investing in brands to maintain its high topline growth.

We revise our 12-month target price to Rs2,376 based on 26X March 2011E time-weighted EPS (from Rs2,362 based on 26X December FY10E EPS previously) in order to capture earnings 12 months ahead. We also lower FY10E-FY12E EPS by 2%-4% post FY09 results. Moreover, our target price is backed by Director’s Cut analysis that indicates Nestle India is currently trading above the sector trendline despite a trajectory of moderating CROCI.

Key risks
Upside risks include significantly better top-line growth than our forecasts on the back of strong domestic demand, increased penetration, new launches and higher exports; a fall in input costs that could result in much better margin expansion than we estimate.

To read the full report: NESTLE INDIA