Nestle India's advantage lies in its presence in the under-penetrated foods market, while FMCG peers battle it out in soaps, skin-care, shampoos and detergents. Nestle has a strong brand portfolio spanning diverse segments — Cerelac, in baby foods, Maggi, in prepared dishes, and Nescafe, in instant coffee, to name but a few, which aid in pricing power. That has helped the company maintain operating margins at around 20 per cent.

The prepared dishes segment has registered the strongest growth for the company, supported by both prices and volumes. But in its other segments of milk and nutrition, confectionery, and beverages, Nestle has managed minimal volume growth, with sales expansion coming in primarily from price increases.

Overall sales and profit growth for the company has been steadily decelerating over the past several quarters.

Prices of key inputs have not begun to abate, which could prompt more product price hikes. Also, consumers continue to feel the pinch of inflation. This may cause the squeeze on consumer spending on FMCGs to intensify. Besides, competition is increasing in both dairy products and prepared foods.

Therefore, Nestle may find it difficult to meet the expectations demanded by the stock's current price earnings multiple. At Rs 4,509, the stock trades at 45 times trailing twelve month earnings, a premium to FMCG peers. With limited room for upside in stock prices, investors can pare exposure to the stock.

Diversified portfolio

Nestle has a wide and deep product portfolio, with strong brands in each. The biggest segment is milk and nutrition which contributes 45 per cent of revenues. Within the segment, offerings range from infant foods to dairy whiteners.

Prepared dishes such as noodles, soups and pasta have been showing good volume and price growth, and form the next biggest sales contributor at 28 per cent. Here, Nestle has a strong brand in Maggi; it has extended this brand into related avenues too such as masalas.

Chocolates and beverages form the remaining segments for the company, at 14 per cent and 13 per cent respectively.

Demand pressures

While FMCG demand is rather resilient, the persistently high inflation and interest rates are beginning to tell on consumer spending, especially in urban areas. Should the monsoons fall short of expectations, a poor kharif season on top of a muted rabi crop will pinch rural demand.

Price of milk, the largest input for Nestle, is on a steady rising trend. In the past year alone, milk price as measured by the WPI index has increased 17 per cent. The beverages segment is dominated by coffee, whose prices are on a similar uphill climb.

Nestle does have the ability to pass on cost increase through higher product prices. But volume growth in milk and nutrition has already been impacted by earlier price hikes.

The beverages and confectionery segments have seen flat volumes in the past few quarters. With more price hikes imminent, demand could take a further hit.

Meanwhile, other FMCG companies are intensified attention on the foods segment, given its scope for growth and relative under-penetration.

ITC's Sunfeast Pasta and Sunfeast Yippee, GSK Consumer's Foodles and HUL's Knorr are making fast inroads into the segment, for so long Nestle's domain.

Similarly, while competition in the dairy segment is limited to the offerings of Amul and Britannia, the two companies have been stepping up on introducing new products in curds, flavoured milk, yoghurt, and so on.

Slowing growth

Compounded annual growth rate of sales and net profits was 20 per cent and 22 per cent over the past three years. However, sales and net profit growth for Nestle has been slowing down for well over a year now. Sales expanded by 13 per cent in the March 2012 quarter when compared to the year-ago period. That's well below the 22 per cent year-on-year growth seen in the March 2011 quarter.

Similarly, net profits expanded just 9 per cent in the March 2012 quarter; growth in the March 2011 quarter stood at 27 per cent.

The lower net profit growth is also due to a reduction in the tax benefits enjoyed by the company at its Pantnagar plant in the March 2012 quarter.

Raw material cost as a proportion of sales has hovered between 46 to 48 per cent of sales in the past few quarters. Though prices of wheat and sugar have stabilised, that of milk and coffee are rising, limiting operating margin expansion. Higher competition in the prepared dishes segment could also necessitate more adspend.

comment COMMENT NOW