Nestle India gets 'sell' rating, any green shoot in haystack Deutsche

Updated: Jan 20 2014, 15:59pm hrs
More of the same. Nestls preference for profits over volumes is intact: Our recent focus has been on stress-testing our long-standing negative view (and of consensus, of late) on Nestl. Ears to the ground views: (i) Alpino chocolate is c.1% of sales in key markets in <6 months of launch; (ii) Nestl is piloting a distribution project to improve beat-efficiency (salesman productivity); (iii) distributor ROIs (return on investment) have declined to <20% (>25% earlier) on higher stock holding; (iv) it has launched Muah confectionary at R1 SKU (stock keeping unit); (v) ITC has >20% market share in noodles in large markets (differentiated product/variants); Nestls endeavor to uptrade noodle consumers to R15 price-point has met with limited success.

Distressed distributors, low ROIs, no visibility on new launches: Distributors are disappointed, as ROI has declined to <20%. The reduction in ROI is because of a higher stock holding period, likely due to lower secondary sales and lower asset turns (distributor inventory holding is c.30 days now, vs. 15 days in 2012).

Underperformance of Maggi Hungroo: Lack of a well-thought-through strategy, rather than stickiness to the R10 price point, is the reason for the lower-than-expected success of the R15 Maggi Hungroo pack, in our view. ITC, through its successful launch of the Yippee Chinese variant at a 50% premium to the normal variant, has demonstrated that, instead of grammage jugglery, a value-based proposition can be more successful. Read on to find out (i) why grammage changes (as a pricing tool) need to be handled smartly (examples of ITC, Frito Lays, Cadburys), (ii) MD change at Nestl India is being taken positively by investors (we humbly disagree, though).

Management change at Nestl India: Some investors believe that the management change at Nestl India is positive, which, in our view, is a simplistic assumption (Etienne Benet took over as MD from Antonio Helio Waszyk in Q4CY13). However, we do see a pattern where an MD/CEO is appointed by an MNC company with a specific mandate.

Antonio Helio Waszyk is from a technical background (holds a Bachelors degree in Pharmacy and a Masters degree in Food Biochemistry). He was the head of R&D centres prior to his India stint. It is rare for an R&D head to be appointed as an MD, particularly in consumer companies. Etienne Benet (new MD) has been in general management since 1997. It is quite likely that Antonio Helio came to India with a mandate to expand capacity, in our view.

Moreover, Antonio Helio Waszyk continues as a non-executive Chairman of Nestl India (which is a rarityhis predecessors had moved to global roles with Nestl after their India stints). The pattern appears to be similar to Doug Baillies stint in HUL a few years ago (2006-08). He was the first foreign CEO of HUL in around 50 years.

Our concern is Nestls excessive focus on margins: Our long-standing concern on Nestl has been its lack of demonstrated positive intentthat, despite near-all-time-high operating margins, there were (are) no material actions to prop up short-term volumes (through higher promotions), for relaunches (medium-term benefit) or for incubating multiple new categories (long-term).

At the analysts meeting in July 2013, the management said that it had cleansed the portfolio by weeding out low value-add propositions. Essentially, it has exited many mass-market low-unit packs that were not meeting the required margins. Its philosophy is higher sales growth is required for loss in profit margins. This may be construed as operating with target margins, in our view.

While we agree that a market opportunity exists, execution is important. Nestls current strategic direction appears very similar to HUL's in the early 2000s. With ITCs likely entry in dairy (where Nestl has lost market share due to excessive price increasesper management), we believe that, by H2FY14, it will face a serious competitor that has demonstrated a willingness to incubate brands and stay invested. Sell.

Maintaining Sell with a target price of R4,800: We value Nestl at 31x rolling 1-year forward earnings, implying a 15% discount to its three-year average one-year forward PE (price-to-earnings ratio), given the poor quality of growth (price-led sales growth unsustainable). Key risk: better-than-expected sales growth.