Nestle - Attack on the nest eggs - Ambit

Nestlé's leadership position in chocolates, baby foods, noodles and premium coffees has historically been unchallenged; however, the company has been facing increasing competition over the past 18 months from Ferrero and Cadbury's in the chocolates segment, from HUL in the premium coffee segment, and from ITC and HUL in the noodles segment. Nestlé will NOT be able to defend its market share against this threat given its willingness to sacrifice volumes for EBITDA margins. Also, Nestlé's biggest cash cow, the baby foods segment, faces risk of market share loss from the increasing market presence of Danone and Mead Johnson in the future. The stock is currently trading at 43x CY13 P/E. We initiate coverage with a SELL stance.

Market share loss across categories: Nestlé is facing intense competition from Ferrero and Cadbury's in the chocolates segment, from ITC and HUL in the noodles segment, and from HUL in the premium coffees segment. Nestlé did not face any competition in these categories over the past decade. Moreover, Nestlé's focus on maintaining high EBITDA margins despite a loss of sales growth momentum has meant that the company has reported volume decline of 5% in milk products, 5% in beverages and 9% in chocolates in CY12. Given the high competitive intensity, we expect the market share loss for the company in these categories to continue in the future as well even if macro-economic conditions are stable.

Competition to intensify in the baby foods segment over the long term: The baby foods portfolio has been the biggest cash cow for Nestlé given the low advertising spends and weak competition until now. Whilst Nestlé, Mead Johnson and Danone dominate the global baby foods market, in India, the market has historically had only two key players—Nestlé and Wockhardt (brand Farex). However, in the coming months/years, Danone (targets to double sales in three years through the Wockhardt acquisition) and Mead Johnson (organic growth) are likely to expand their presence in India, given the high birth rates and low penetration of baby foods in India.

Valuation: Nestlé has a dominant presence in some of the fastest-growing categories in the sector. Whilst this characteristic deserves a premium rating for Nestlé as compared to its peers, the stock currently trades at a 26% premium to the sector average on P/E multiples. Given the headwinds highlighted above across its portfolio both in the near term as well as the long term, a smaller premium rating vs peers is justified. Our DCF-based valuation generates a TP of Rs. 4,389/share (17% downside), an implied CY13 P/E multiple of 35.6x and CY14 multiple of 29.4x.

Source : Equity Bulls

Keywords