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Aarati Krishnan

SLIPPING profits and a rich valuation have held down the Nestle India stock over the past year. The stock has been left out of the re-rating bestowed on others in the FMCG space such as Procter & Gamble Hygiene, Dabur India and Marico Industries.

However, investors can now hold Nestle India, as there are signs of acceleration in sales and profit growth in the last quarter of 2004.

The parent's decision to increase dividends and initiate a buyback programme also raises the possibility of a more liberal distribution policy by the Indian arm.

Full year lacks froth

Nestle India has closed the year 2004 with uninspiring numbers, with net profits shrinking by about 4.2 per cent on the back of a 4.1 per cent expansion in net sales.

An inflationary input price environment, which saw prices of key inputs such as milk and coffee spiral sharply, played a key role in trimming the company's operating profit margins.

Sales growth also slowed, as pricing pressures took a toll on value growth and businesses such as chocolates and infant foods were impacted by external events. The export business was negatively impacted by a shift in exports of coffee to Russia, from retail to bulk packs. Retail sales offer higher margins and realisations than bulk sales.

But latest quarter shows promise

However, the numbers for the December quarter were distinctly superior to those for the preceding nine months. Net sales growth for the quarter accelerated to 7.8 per cent from 2.8 per cent in the first nine months. Profits, before non-operational items and taxes (this number is more relevant for Nestle than the reported net profits because of a slew of provisions), expanded by 62 per cent. Savings in raw material costs and a cutback in "other expenditure" drove profit growth, though exceptional charges made by Nestle in the final quarter of 2003 also played a role in pepping up profit growth.

Both domestic and export sales picked up pace. In the domestic market, the impact of one-off events that took a toll on Nestle's performance in the first half of 2004, appears to be wearing off. Coffee sales, for instance have accelerated in the last quarter of 2004, after posting sluggish growth rates in the first half. With the industry tackling the worm infestation controversy through better packaging, chocolate sales too appear to have picked up. Nestle's initiatives in the processed foods segment, such as the re-launch of Maggi noodles, also appear to have helped sales growth. In the case of export sales, the base effect of the change in sales mix appears to have receded and exports are back on a growth track.

Challenging climate

There have been signs of an expansion in consumer spend on FMCGs over the past six months, with many FMCG categories improving their growth rates. However, Nestle India will continue to face a fairly challenging environment in some of the segments where it operates.

Competition is intensifying in many of the categories Nestle operates in. In coffee, Hindustan Lever has made market share gains on the back of aggressive brand-building efforts in instant coffee.

In health drinks, Milo is under siege from newly re-launched brands such as Maltova, Boost and Bournvita. Amul too has made an entry into this segment with the launch of Amul Shakti.

The ban on advertising of infant foods could also temper growth in the infant food supplements business, until Nestle establishes an alternate model for promoting sales in this segment.

Relief on profits

However, even if sales growth does not move into a higher trajectory, Nestle India's profits could. Prices of milk solids, which took a toll on margins in 2004, have receded from their peaks.

Coffee prices are now in a sharp uptrend. But with processors around the world taking a significant price hike on their branded products, Nestle too should be in a position to pass on part of this price increase to its consumers.

Also, investors in the Nestle India could probably look forward to a more generous dividend policy going forward, in line with that of its parent.

In fact, Nestle has recently announced a special dividend of Rs 4.5 per share in addition to the dividend of Rs 20 per share paid out for 2004.

Despite a stiff price earnings multiple of about 24 times its trailing earnings, the Nestle India stock trades at a dividend yield of about 3.6 per cent, offering a higher yield than the market.

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