Wednesday, May 2, 2012

>NESTLE INDIA: Grammage reduction in noodles and chocolates segment

Expensive valuations

We believe Nestlé India’s revenue CAGR of 19.8% over CY11-14E will be ahead of other non-food companies driven by high market share, low penetration in high growth categories across baby food, dairy whiteners, noodles and chocolates. We are also bullish on the food processing sector in the country and believe leaders including Nestlé would benefit the most with changing consumer behavior. But, high capex driven debt could impact profitability in the near term. At current valuation we believe volume growth risk is not priced in the stock and there is little room for earnings disappointment. Hence we initiate coverage with a HOLD
rating on the stock.

 Volume growth to bounce back: We expect volume growth to bounce back to CY10 levels after it posted a meagre 6.8% in CY11, the lowest since CY06. Volume growth dipped further in Q4CY11 to mere 1.5% on the back of de-growth of11% in chocolate & confectionary and 3.7% in milk products as thre was a ban on exports of milk products. Grammage reduction in noodles and chocolates segment due to raw material price increase and deliberately discouraging sales in the éclair segment due to its low margin profile also affected growth. Sales to CSD channel were low and high milk cost impacted volumes in the milk segment.
Addition of new capacities in each segment would help in launching new products and increase supply of premium products. Widening distribution reach would also help in
volume growth going forward.

 Financials: We expect revenue to grow at a CAGR of 19.8% over CY11-14E to Rs128bn in CY14 on the back of ~16% volume growth while operating profit is set to grow at a CAGR of 19.5% over CY11-14E to Rs26.52bn in CY14E on the back of steady gross margins and operating margins. RoCE is expected to moderate significantly as the company raised Rs9.7bn debt to fund its capex. It raised ECBs loan of $136Mn from its parent Nestlé S.A. for a 5-year period. Due to high capex, the company has capped its dividend at Rs48.5/share over past three years; however this is expected to increase from CY12.

 Stretched Valuations: Nestlé India’s current valuation is expensive as it trades on a one-year forward rolling P/E of ~33x, which is high compared to its long-run 10 year average of 25x, 5 year average of 28x and 3 year average of 32x. Relative to Sensex the stock is trading at 160% premium compared to 10 year average of 65% premium. At 40x and 33x CY12E and CY13E PE, we believe risks are not priced in the stock and there is little room for earnings
disappointment. We initiate coverage with a HOLD rating and a target price of Rs4,428 based on 31x CY13E EPS of Rs142.8 which is at 20% premium to long term average and 100%
premium to Sensex PE. 

 Key risks: i) Premium pricing can impact volumes; ii) Competition intensifies to reduce market share; iii) High cost inflation to impact margins