Buy Nestle With Target Of Rs 3,208 by PINC Research

Buy Nestle With Target Of Rs 3,208 by PINC ResearchWe initiate coverage on Nestle with a Sell recommendation and a TP of Rs3,208. We believe entry of new players in the hitherto-secure noodles segment challenges Nestle’s ‘cash cow’. Further, we believe the premium enjoyed by the stock vis-à-vis FMCG peers is unjustified and would correct.

Volume to drive growth

We believe stiff competition in most brands would force Nestle to protect its turf and retain market share, which it would do through higher volumes. Aggressive marketing efforts and capex of ~Rs12-13bn over the next two years for expansion of capacities are early pointers to this volume-driven growth. We expect volume to grow at 20% CAGR during CY10-12e, led by 10%, 27% and 22% volume CAGR in ‘milk and nutritional’, ‘prepared dishes’ and ‘chocolates’ categories respectively.

Competition to impact pricing power in noodles Competition threatens to challenge the fortified citadels of Maggi, Nestlé’s cash cow and largest contributor to profit (~35% of EBITDA) with ~88% market share. The entry of big players would impact the pricing power of Maggi Noodles. We expect higher investment would result in higher industry growth and would help Maggi Noodles grow 32% over the next two years. However, growth would largely be volume-driven and lower price premium would impact profitability.

Profitability under pressure

We expect low pricing power coupled with higher SG&A would result in 50bps and 60bps decline in EBITDA margin in CY11 and CY12 respectively.

De-rating imminent given a competitive environment Nestle trades at ~48% premium over the FMCG sector on robust earnings growth and high return ratios. In our opinion, the high premium would narrow owing to the current competitive business scenario. We argue that Nestle would trade at a 25% premium (two-year average) considering lower pricing power for key products and pressure on return ratios. Accordingly, our target multiple stands at 30x 12-months forward earnings. Hence, our TP derives at Rs3,208, implying 18% potential downside. We initiate coverage on Nestle with a ‘SELL’ recommendation.