Nestle - Profitability over volumes—right strategy?? - HDFC Securities

Nestle exhibits tremendous growth opportunities in India on account of 1) low penetration of packaged food, 2) strong distribution reach (doubled in 3 years), 3) strong brand salience across categories, 4) strong parent portfolio and 5) doubled its capacities across categories except beverages thereby resolving capacity constraint issue. However, in mid-term, as the economic growth slows down and inflation remain at elevated level, consumers are reducing discretionary spends thereby packaged food category appears vulnerable (Nestle's volume growth in the past 3 quarters has been dismal). Also its entire product portfolio is facing severe competitive pressure. Recommend UPF with TP of INR 4,650.

Long term story remains intact

The company has doubled its capacities across categories (Nestle has spent INR22.7bn on capex) except beverages thereby resolving capacity constraint issue. This combined with strong distribution reach (doubled to ~4 mn outlet in 3 years) will aid the company in growing faster. Also, large product portfolio gap (bottled water, cornflakes, oats, desserts, cream, ice cream, juice, health drinks, ready to cook, ready to eat- non veg, frozen foodnon veg, sandwiches) with the parent provides opportunity to customize those to Indian taste and launched in domestic market.

No product category is spared

Nestle's product portfolio is facing severe slowdown blues since past three quarters. 1) Milk Product: Significant price hikes and sustained inflation has led moderation in growth. 2) Infant Nutrition: Category will continue to witness muted growth (as compared to potential) due to advertisement ban. 3) Maggi: Increased competitive pressure from ITC (10% market share). 4) Chocolates: Limited innovation. Cadbury's growing at high double digit. 5) Beverages: HUL has pipped Nestle India to gain volume leadership in the branded instant coffee sector in India.

Earnings growth to remain under duress

We anticipate muted volume growth for next 2 quarters and sustained RM pressure (Commodity Basket Price Index has gone up from 138 in CY11 to 148 in YTD CY12). As new manufacturing plant comes on stream (capex INR 22.7bn), depreciation and interest outgo would surge impacting earnings and return ratios. At CMP, the stock is trading at 37.3x CY13E and 31.6x CY14E and appears fairly valued over the near term. Recommend UPF with TP of INR4,650/share (30x CY14E earnings in line with 5 year average valuation).

Source : Equity Bulls

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