Nestle India Ltd. With Target Of Rs 3208

Nestle India Ltd. With Target Of Rs 3208Nestle’s Q1CY11 numbers were better than our expectation on margin surprise. Net sales growth of 22% was slightly ahead of our 21% growth expectation. Gross margins expanded by 93bps on better product mix and partial offset of promotional offers. Staff cost and other expenditures grew by 21% and 24% respectively and resulted in 64bps jump in EBITDA margin. Depreciation cost was lower than our expectation and translated in 27% growth in the net profits to Rs2.6bn.

We expect stiff competition in noodles would force Nestle to protect its market share. Noodles are the largest profitable product (~35% of total EBITDA) and loosing the price power on that would impact the overall profitability. We maintain our SELL recommendation with a TP of Rs3,208.

Volume driven growth

The sales growth of 22% was on the back of 23% growth in domestic market and 10% growth in exports. We believe this growth was based on high double digit volume growth. We expect 19-20% volume growth in next two years on aggressive marketing efforts and strategy of retaining volume market share.

Strong profitability in Q1CY11

Net profit growth of 27% was on 64bps jump in EBITDA margin and lower depreciation. We expect slower profit growth of ~19-20% in next two years on the back of pressure on EBITDA margin as well as higher depreciation and tax spending.

Capacity expansion on track

Nestle’s ambitious Rs18-20bn capex plan in next two-three years is on the track. Nestle has already set up new Maggi plant in Nanjangud and the production has started during Q1CY11.

VALUATIONS AND RECOMMENDATION

We expect new players in the noodle segment would change the game for Nestle. The competitive outlook and Nestle’s high capex on capacity addition would force Nestle on retaining the volume market share. Nestle trades at a ~40% premium over FMCG sector and we argue to narrow down this premium owing to the current competitive scenario. We peg 30x (~25% premium on FMCG sector) on 12-months forward earnings and derive our TP of Rs3,208. It implies 17% potential downside hence we maintain our SELL recommendation.