Nestle India: Hold/buy at declines

Recommendation: Hold/buy at declines

Aarati Krishnan

A FAVOURABLE input price scenario, a revival in coffee exports to Russia and the healthy growth in domestic product categories such as chocolates and coffee helped Nestle India report a good financial performance in the first nine months of 2000.

The stock markets have noticed this. The stock price surged from a low of Rs 292 in March to the current Rs 526. The recent surge in the stock price limits the scope for further appreciation in the near-term. But the stock can be picked up at declines in price in line with the broad market by investors with a two-to-three year investment horizon.

The stock now trades at a price earnings multiple of around 37 times the annualised nine-month earnings for 2000, which is on par with the valuation accorded to other FMCG companies of comparable size. However, at a time when poor agricultural performance and contracting rural disposable incomes are a concern, Nestle's urban focus could stand out as an advantage. This, and the healthy growth in the product categories targetted by Nestle, could make it a desirable investment within the universe of FMCG stocks.

Nestle India has traditionally derived its revenues from four major product categories -- coffee both domestic and exports (major brands being Nescafe Classic, Nescafe Select, Nescafe Sunrise), beverages, chocolates and confectionery (Milo, KitKat, Munch, Charge, Polo), milk products and baby foods (Cerelac, Lactogen, Nestum, Everyday dairy whitener, Milkmaid) and food products (Maggi Noodles and Ketchup).

While milk products and instant coffee are businesses in which Nestle India is firmly entrenched, competition is intense in chocolates (from Cadbury), culinary products (from Indo Nissin Foods, Hindustan Lever and Dabur). Nestle is broadbasing its portfolio by entering the packaged liquid milk and purified water. Given that both are highly competitive categories in India, investments in these businesses in the initial years are likely to run ahead of returns.

The decline in instant coffee exports to Russia has been the key problem area in Nestle India's performance since 1998. Here, the signs of revival in the Russian economy and the resumption of exports to the country helped Nestle pep up its sales performance over the past two quarters, with exports growing 50 per cent in March-September 2000. But given that export realisations carry a high linkage to green coffee prices, the margins from this business are unlikely to reach the pre-1998 level for the present.

However, Nestle India has managed to pep up domestic sales growth to compensate for lost export revenues. The growth in the domestic sales, which averaged 7 per cent in 1999, improved to 18 per cent in the third quarter of 2000. Nestle India slashed the prices of some of its coffee and chocolate brands in 2000 and this appears to have paid off in the form of additional sales volumes.

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Sharp declines in the prices of key inputs such as cocoa and green coffee helped the company sustain double-digit growth in post-tax profits. Growth in post-tax profits, which slowed to 10 per cent in 1999, picked up to 28 per cent in the first nine months of 2000.

Given that both the global cocoa and coffee markets are still in surplus, this advantage will remain with Nestle India for the time being. Since the last quarter of the year has traditionally been the peak period for chocolate and coffee sales, the company can be expected to sustain this level of performance in the final quarter of 2000. This points to satisfactory prospects for Nestle India in the near future.