Standard Chartered Securities downgrades Nestle India to Underperform

ACT - Nestle India (downgrade to UNDERPERFORM): The nest becomes a little uncomfortable

Highlights of the report:

- We downgrade Nestlé to Underperform with a revised 12-month price target of Rs4,135 (based on 28x forward P/E).

- We expect volume moderation and margin pressure to slow EPS CAGR to 14% over CY11-14E vs 25% over CY06-11.

- We cut CY12/13/14 EPS estimates by 2/8/13%, lowering our CY13/14E EPS 8/10% below consensus, respectively.

- Given declining dividend payout, lower RoEs and moderate EPS growth, we believe P/E of 36x is unjustified.

- We initiate U/P ACT call on Nestlé; we expect it to U/P the BSE Sensex/FMCG Index by 10% in the next six months.

Triggers: 1) muted sales and EPS growth of 13% and 7% in 2H12; 2) entry of Danone and Abbott into infant nutrition.

- Downgrade to Underperform. We downgrade Nestlé to Underperform as we believe current valuations are unjustified given: 1) significant moderation in sales growth (from 22% over CY06-11 to 15% over CY11-14E); 2) decline in profitability due to higher overheads, increased A&P and sharp rise in depreciation and interest costs; and 3) lower dividend payout and RoEs. The recent spike in soft commodity prices could also soften the gross margin in the near term.

- Sharp moderation in sales growth, going forward. Lower sales growth in 1H CY12 was partly due to changes in the channel/product mix. Even from a low base, we expect sales growth to moderate (15% CAGR over CY11-14E) as a result of: 1) slower category growth (in noodles and chocolates); 2) lagging competition in innovation and marketing (in coffee and chocolates); 3) price point-led problems (in chocolates and noodles); and 4) the risk of new competition (in baby food).

- Increased capacity + lower demand = EPS downgrade. Capex over CY10-12 is likely to be Rs31bn - 3x the total capex in the previous 10 years - leading to a sharp increase in depreciation, interest and overheads. With no commensurate increase in volume growth, these expenses are likely to lower profitability. High capex should lead to a lower dividend payout (from 90% in CY08 to 52% in CY12E) and RoE (from 125% in CY08 to 71% in CY12E). Given moderate sales growth and lower profitability, we cut CY12/13/14E EPS by 1.5/8.1/13.2%.

- Valuations expensive. Given moderate EPS CAGR of 14% over CY11-14E, lower dividend payout and RoE, it is difficult to justify forward P/E of 36x. We value Nestlé at forward P/E of 28x (earlier 30x), leading to a revised price target of Rs4,135 (earlier Rs4,782). While its long-term prospects remain bright, expensive valuations and lower EPS growth could lead to some price correction and prolonged time correction in the stock.

Source : Equity Bulls

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