food initiation[1]

7/31/2019 Food Initiation[1]

1/48

SectorUpdatIndustry: FMCG

Gautam Duggad ([email protected])+91-22-66322233

FMCG

FoodInitiation Itsjuststarted

Downloaded by in-kpmg1 from 115.114.13.162 at 2012-05-21 01:56:21 EDT. ISI Emerging Markets. Unauthorized Distribution Prohibited.


2/48

May 07, 2012 2

FMCG

CONTENTS

PageNo

GlaxoSmithKline Consumer Products ......................................................................... 7

Nestle India ............................................................................................................... 24

(AllpricesasonMay7,2012)



3/48

May07,2012

FMCG

FoodInitiation Its juststarted

Prabhudas Lilladher Pvt. Ltd. and/or its associates (the 'Firm') does and/or seeks to do business with companies covered in its research report s. As a result investors should be aware ththe Firm may have a conflict of interest that could affect the objectivity of the report. Investors should consider this report as only a single factor in making their investment decision.

Please refer to important disclosures and disclaimers at the end of the report

Gautam [email protected]

+91-22-66322233

Food segment continues to outperform HPC categories: Foods sector, whichcontribute ~45% of Indian FMCG industry, continues to outperform the HPC

(Home & Personal Care) category helped by favorable underlying macro

catalysts as well as increasing focus and investments of the players. Bigger piealso precludes the internecine competitive battles which, has been the hallmark

of HPC space in the past three years.

Underpenetrationoffersstronggrowthvisibility: Penetration of processed andpackaged branded food categories continue to remain low, both in urban as wel

as rural geographies, despite high teens CAGR in past five years. Consequently

the growth visibility still remains high vis--vis HPC space. Consumption spends

on Foods is expected to triple by CY20 and reach US$ 900bn.

Favorable underlying macro drivers: Rising affluence driven by highedisposable income, younger demographics, increasing awareness of health andhygiene factors, continued urbanization and rising proportion of working

women constitute some of the key catalysts which will drive the growth in

Branded Foods space.

Initiate on Nestle and GSK Consumer: We initiate coverage on two of thelargest Processed Foods players, Nestle and GSK Consumer with an Accumulate

and Buy rating with target prices of Rs3,200 and Rs5,015, an upside of 18% and

9.6%, respectively. Unparalleled dominance in the core categories, strong

pricing power and robust balance sheet as well as cash flow metrics underline

our positive investment hypothesis for both Nestle and GSK Consumer

Notwithstanding the premium valuations, especially on near term valuationmetrics, we expect the structural bias for high quality growth stories with

distinct and sustainable competitive advantages to drive the medium and long

term returns.

Exhibit1: ValuationSummaryCompany CMP(Rs) TP(Rs) Upside Rating

P/E(x) EPS(Rs) EPSCAGR RoE

FY12E FY13E FY14E FY11 FY12E FY13E FY14E FY1214E FY11

Nestle India 4,576 5,015 9.6% Acc 43.3 38.1 31.2 86.8 105.7 120.1 146.7 17.8% 95.0%

GSK Consumer Products 2,702 3,200 18.4% BUY 32.0 26.6 22.5 71.3 84.5 101.6 120.0 19.2% 32.2%

Hindustan Unilever 430 406 -5.6% Reduce 35.0 30.7 26.5 9.9 12.3 14.0 16.2 15.0% 79.3%

ITC 236 270 14.2% BUY 30.5 25.4 21.6 6.5 7.7 9.3 11.0 18.9% 32.4%Dabur India 108 120 11.5% Acc 29.0 25.5 21.0 3.3 3.7 4.2 5.1 17.5% 48.9%

Marico 177 190 7.3% Acc 33.3 27.3 22.9 4.3 5.3 6.5 7.7 20.8% 33.4%

Colgate Palmolive 1,124 860 -23.5% Reduce 34.1 29.8 25.9 29.6 33.0 37.8 43.3 14.6% 112.8%

Asian Paints 3,644 3,500 -4.0% BUY 38.6 30.2 25.2 85.5 94.4 120.8 144.4 23.7% 42.1%

Godrej Consumer Products 553 575 4.0% BUY 32.4 25.2 21.2 14.9 17.1 22.0 26.1 23.5% 35.9%

United Spirits 714 800 12.0% Acc 24.1 20.5 15.3 27.2 29.6 34.9 46.7 25.6% 8.6%

Source:CompanyData,PLResearch



4/48

FMCG

May 07, 2012 4

Exhibit2: ConsumptionexpenditureonFoodexpectedtogrow11%CAGR

135

328

895

0

100

200

300

400

500

600700

800

900

1,000

CY2000 CY2010 CY2020

(US$bn)

Source:Industry,NSSO,PLResearchExhibit

3: ProportionofAspiringandAffluentHouseholdssettoincrease

50%28%

24%

30%

6%

6%

6%

13%

8%10%

4%5%

2% 8%

0%

20%

40%

60%

80%

100%

CY10 CY20

St rugglers Small Town Next Billion Large Town Next Billion Rural Aspirers

Urban Aspi rers Tradit ional Af fluent Professional Af fluent

Source:BCG,NCAER,PLResearchExhibit4: IncomeclassificationbycategoryCategory Incomeperannum(US$

Professional Affluent >18,500

Traditional Affluent >18,500

Urban Aspirers 7,400-18,500

Large Town Next Billion 3,300-7,400

Small Town Next Billion 3,300-7,400Strugglers


5/48

FMCG

May 07, 2012 5

Exhibit5: ProportionofavgmonthlyhouseholdspendonFood&Groceries

13% 13% 13% 13% 13% 15%9% 12% 9% 9% 10% 9%13% 14% 13% 13% 13% 13%

16% 16% 15% 16% 16% 16%

31% 29% 32% 32% 29% 29%

18% 16% 18% 17% 19% 18%

0%

20%

40%

60%

80%

100%

Professional Aff luent Traditional Aff luent Urban Aspirers Large Town Next

Billion

Small Town Next

Billion

Strugglers

Home & Personal Care Meat Packaged Food Dairy Vegetables & Fruits Staples

Source:BCG,PLResearchExhibit

6: FoodcategorySpendas%ofincome

42%

35%37%

31%

20%17%

0%

10%

20%

30%

40%

50%

Strugglers Small TownNext Billion

Large TownNext Billion

UrbanAspirers

TraditionalAffluent

ProfessionalAffluent

Source:BCG,PLResearch



6/48

FMCG

May 07, 2012 6

COMPANIES



7/48

GlaxoSmithKlineConsumerProducts

HorlicksisthesecretofGSKsenergy

May07,2012

Prabhudas Lilladher Pvt. Ltd. and/or its associates (the 'Firm') does and/or seeks to do business with companies covered in its research reports. As a result investors should be aware th

the Firm may have a conflict of interest t hat could affect t he objectivity of t he report. Investors should consider this report as only a single factor in making their investment decision.


Gautam Duggad

[email protected]

+91-22-66322233

Rating BUY

Price Rs2,702

Target Price Rs3,200

Implied Upside 18.4%

Sensex 16,913

Nifty 5,114

(PricesasonMay07,2012)Tradingdata

Market Cap. (Rs bn) 113.6

Shares o/s (m) 42.1

3M Avg. Daily value (Rs m) 67.8

Majorshareholders

Promoters 43.16%

Foreign 15.50%

Domestic Inst. 16.53%

Public & Other 24.81%

StockPerformance

(%)

1M

6M

12M

Absolute (1.6) 5.6 19.4

Relative 1.7 9.3 28.1

HowwedifferfromConsensus

EPS(Rs) PL Cons. %Diff.2012 101.6 99.7 1.9

2013 120.0 116.2 3.3

PricePerformance(RIC:GLSM.BO,BB:SKBIN)

Source:Bloomberg

0

500

1,000

1,500

2,000

2,500

3,000

3,500

May-11

Jul-11

Sep-11

Nov-11

Jan-12

Mar-12

May-12

(Rs)

DominantpositioningincoreMFDbusiness: GSK enjoys dominant market shareof ~70% (55% for Horlicks) in its core MFD business (category size of ~Rs35bn)

which is under-penetrated (22% penetration, 11% in rural) driven by strong

brand equity of Horlicks as well as growing awareness for Health and Nutrition

products which in-turn is catalysed by rising disposable income. We expect GSKto witness 9-10% volume cagr in MFD driven by distribution expansion

increased penetration in rural markets and GSKs successful sub-segmentation

strategy which is driving the premiumisation in core business.

NonMFD business remains a mixed bag: GSKs attempts to diversify therevenue basket have not yielded spectacular gains so far. While Biscuits has

remained confined to niche categories (


8/48

May 07, 2012 8

GlaxoSmithKline Consumer Products

InvestmentArgument

HorlicksisthesecretofGSKsenergy

GSK enjoys dominant market positioning in the Rs35bn MFD segment, with a market

share of ~70% (55% for Horlicks, 13% Boost). MFD forms the bulk of GSKs revenues

with ~95% salience. MFD category is under-penetrated with 22% overall penetration

(11% in rural, 40% in urban) and expected to perform well on the back of favourable

macro factors like rising disposable income, growing health awareness leading to

rising demand for health and nutrition foods and rising urbanisation. We expect GSK

to capitalize on its incumbent leadership position and benefit from the increased

MFD spending.

Exhibit

1:

GSK

controls

70%

of

MFD

market


Exhibit

2:

MFD

segment

dominates

revenue

mix

disproportionately

MFD

94.0%

Biscuits

4%

Noodles

1%

Others

1%


Exhibit3: LowMFDpenetrationoffersgrowthvisibility

11%

22%

40%

5%

15%

25%

35%

45%

Rural All India Urban


Exhibit4: VolumegrowthinMFD

9.1%

7.1%

9.1%

17.1%

10.0%

13.3%

9.0%

10.5%10.5%10.0%

5.0%

8.0%

11.0%

14.0%

17.0%

20.0%

CY05

CY06

CY07

CY08

CY09

CY10

CY11

CY12E

CY13E

CY14E


Horlicks

54%

Boost

13%

Bournvita

16%

Complan

11%

Viva

2%

Maltova

1%

Others

3%



9/48

May 07, 2012 9


KeystrengthsandgrowthdriversforGSKsMFDsegment

Apart from the well documented favourable macro factors (rising middle class

urbanisation, young demographics and increased media exposure), following are the

key growth drivers for GSKs MFD business:

Portfoliostrength;subsegmentationapproachcaterstovarietyofconsumers: GSK

has a broad basket of offerings under its Horlicks (mega) brand which caters to a

specific consumer segment. This sub-segmentation approach has enhanced Horlicks

brand equity and helped GSK in driving premiumisation, in our view. For example

GSKs offering Horlicks Gold (available at a 30% premium to base variant) is

contributing 3% of Horlicks sales. GSK has launched several variants under the

Horlicks brand Mother,Women,Junior,Lite,Gold to drive its penetration over the

years. Success of GSKs sub-segmentation strategy is reflected in the rising salience

of its value-added variants from 16% in 2007 to 23% in 2011.

Exhibit5: Newvariantsnowform23%ofHorlickssales

84% 77%

16% 23%

0%

20%

40%

60%

80%

100%

2007 2011

Base Extension and new formats


Exhibit6: Horlicksrevenuesplit

Base

73%

Chocolate

7%

Junior

10%

Women

3%

Gold

3%

Mother

2%Lite

2%


Exhibit7: BarringBiscuits,NonMFDportfoliosperformancehasnotshownexpectedtraction




10/48

May 07, 2012 10


Exhibit8: Subsegmentationatplay


Competition has tried and failed: Given the attractiveness of the MFD category

GSKs competitors have tried making inroads in the category but have largely

remained unsuccessful. Nestle entered the category with Milo in 1997 but withdrewin 2007 as it failed to gain critical mass. HUL also forayed in the segment in 2008

through Amaze Brain Food but did not extend after test launch in three southern

states. It has again entered the market with Kissan Nutrismart (currently in tes

launch) but is priced at premium v/s Horlicks. Dabur has also been present in the

market since 2007 (Chyawan Junior) but its a differentiated offering with

Chyawanprash as the base. Amul has recently entered the malted beverage space

with its offering Amul Pro. So far, despite deep pockets and distribution reach o

its competitors, GSK managed to retain its leadership status. This, in our view

underscores the strong brand equity of Horlicks.

Exhibit9: CompetitionhasntposedachallengeasyetCompetitor

Brand

Year

Remarks

Nestle Milo 1997 Withdrawn in 2008

HUL Amaze 2007 Withdrawn in 2009

Dabur Chyawan Junior 2007 Launched to leverage equity of Chyawanprash

Amul Amul Pro 2012 Launched at a discount to MNC brands


Exhibit10: Lowunitskusforruralpenetration




11/48

May 07, 2012 11


Exhibit11: PricepointsofGSKandotherbrandsintheMFDandMilkAdditivesspaceCompany Brand Grammage Price(Rs) Price/Gm

GSK

Horlicks 200 80 0.400

Horlicks 1000 300 0.300

Horlicks Chocolate 500 158 0.316

Horlicks Chocolate 1000 285 0.285

Horlicks Gold 500 200 0.400

Horlicks Women's 330 180 0.545

Horlicks Mother's 500 260 0.520

Horlicks Lite 500 190 0.380

Horlicks Junior 123 200 90 0.450



GSK

Boost 450 162 0.360

Boost EnVita 180 75 0.417



Kraft

Bournvita 5 Star Magic 500 163 0.326

Bournvita (Oreo Biscuits worth Rs48 free) 1000 295 0.295

Bournvita (plastic container) 500 171 0.342



Bournvita (pouch) 80 25 0.313Bournvita Little Champs 200 105 0.525

Bournvita Little Champs 500 205 0.410

Heinz

Complan Kesar Badam 175 108 0.617

Complan Pista Badam 175 112 0.640

Complan Pro Growth Natural 200 89 0.445

Complan Pro Growth Chocolate 200 109 0.545

Complan Chocolate (container) 200 117 0.585

Complan For Growth 500 173 0.346

Complan For Growth Caramel 500 198 0.396

Complan for Growth Kesar Badam 400 218 0.545

Complan For Growth (Mango, Strawberry) 500 +50(free) 210 0.382

Complan For Growth Chocolate 1000 416 0.416

Complan Nutrigro (Strawberry) 175 102 0.583

Complan Nutrigro (Badam Kheer, Premium Chocolate) 175 108 0.617

Complan Nutrigro 400 213 0.533




12/48

May 07, 2012 12


Exhibit12: PricepointsofGSKandotherbrandsintheMFDandMilkAdditivesspaceCompany Brand Grammage Price(Rs) Price/Gm

Abbott

Ensure 400 398 0.995

Ensure 1000 792 0.792

Ensure Gold 400 415 1.038

Abbott

Pedia Sure Vanilla 400 459 1.148

Pedia Sure Premium Chocolate 400 469 1.173

Pedia Sure Vanilla 900 884 0.982

Pedia Sure Premium Chocolate 900 889 0.988

AbbottMama's Best (Vanilla, Chocolate) 400 299 0.748

Glucernaa for Diabetes 400 550 1.375

Wockhardt

Protinex 200 179 0.895

Protinex 400 333 0.833

Protinex Mama 200 189 0.945

Protinex Diabetes Cure 200 178 0.890

Protinex Junior 400 349 0.873

ZydusWellness Acti Life 300 145 0.483

Source:Industry,PLResearch

South & East captured, North and West the final frontiers: We dont expec

meaningful change in regional balance. GSK derives nearly 90% of its revenues from

South and East region. Preference for white beverages, given the milk deficiency inthose regions, is a key factor behind this. Essentially, MFD is divided into two

segments, with White comprising nearly 75% and Brown accounts for the rest. GSK is

present in Brown segment through its Boostand Maltova brands. White MFD is used

as a milk substitute in those markets. North and West have a good milk supply chain

precluding the need for substitutes. Bulk of the 20k outlet addition during 1QCY12

has happened in North and West.



13/48

May 07, 2012 13


Exhibit13: South&Eastdominatestheregionalmix

South

45%

East

38%

West

4%

North

6%

Exports

6%


Exhibit14: Regionwisemarketshare

78% 75%

34%

23%

0%

20%

40%

60%

80%

100%

East South North West


Even its market share in North and West are much lower at 34% and 23% visavis

75% and 78% in South and East, respectively. Penetration levels are quite low at 10%

in North and West v/ s 45% in South.

While we dont expect regional balance to change meaningfully in the near term

GSK, nonetheless, has a strong opportunity to increase its presence in these markets

Increased distribution reach and emphasis on price point skus can aid GSK in

expanding the shares in those markets.

Distributionexpansion

GSKs current direct reach of 0.7m outlets has a lot of scope for expansion. Its totadistribution reach of 1.5m outlets compares unfavourably with the likes of Nestle

and Britannia (4-5m). It has recently restructured its distribution structure with

reduction in direct distributors from 2000 to 500, while Sub-stockists were doubled

to 4000. It plans to increase the reach by adding 50-60k outlets per year. Expanding

reach in rural markets, which currently contributes 27% of sales, will also help drive

penetration for GSK.

Most of GKSs peers have gained significantly by expanding rural presence in recent

years (HUVR, MRCO, NEST, GCPL etc). Importantly, penetration in rural markets

remains at 10% for MFD category, hence, offering enough headroom for GSK to

expand its presence.

NonMFDsegment

Mixedbagasyet;longwaytogobeforeitattainscriticalmass

In order to reduce dependence on Horlicks and MFD segment, GSK has entered

various nutritional and processed food categories like Biscuits, Instant Noodles

Sports Drink, Cereal Bars, Glucose and Oats.



14/48

May 07, 2012 14


Using the equity of Horlicks as the umbrella brand, GSK launched products in

aforementioned new categories over the last 4-5 years (Horlicks Foodles, Horlicks

Nutribar,HorlicksChillDood,HorlicksBiscuits,HorlicksOats,HorlicksGlaxoseD etc)

Exhibit15: NonMFDsegmentstillhas alongwaytogo

95.3

%

96.0

%

96.0

%

95.0

%

94.0

%

93.0

%

4.1% 3.5% 3.5% 4.4% 5.6% 6.8%

0%

20%

40%

60%

80%

100%

CY06 CY07 CY08 CY09 CY10 CY11

Malted Foods Biscuits and snacks Others


Performance of the diversification basket has not been impressive as yet and has

failed to attain critical mass in any of the non-MFD categories. While we

acknowledge its early days for some of the categories (Oats, Glucose, Sports drink)

but even for categories like Biscuits and Noodles, it has not gained meaningfu

market share. Out of the five categories, we reckon Biscuit is relatively better placed

for GSK. However, it remains confined to niche positioning and controls less than 1%

of market. That said, it has delivered 30% growth in CY11 and continued the

momentum in 1QCY12 with a 31% growth with volumes growing at ~20%

Leveraging the brand equity of Horlicks in allied nutritional categories seems to be a

step in right direction. However, stretching the equity too far runs the risk of dilut ing

the core proposition.

Given the extremely low salience of these categories (~6%) in GSKs scheme of

things, we dont see any meaningful impact of success or otherwise of non-MFD

categories in the near term. However, consistent failure to build scale/market share

in such categories will be viewed negatively by investors, in our view and hence

have implications for GSKs medium term valuation multiples.



15/48

May 07, 2012 15


We discuss below our thoughts on non-MFD categories of GSK:

Biscuits: It is one of the largest FMCG category, with ~Rs13k crore market size. Itis widely penetrated (90% plus) but consumption patterns still offers

opportunity (1.8kg per capita consumption v/s 5.5kg in South East Asian

economies.) GSKs Biscuits revenues have grown at a CAGR of ~30% in CY07-11

In CY11, it has registered 30% growth in Biscuits and carrying the momentum

forward in CY12 with 1QCY12 Biscuit sales growing 31%. GSKs presence is

limited to the Milk segment though it has tried innovation through Corn Flake

variants too. We forecast ~20% CAGR sales growth for Biscuits. GSKs strategy of

building niches will help it maintain margins/profitability but will restrict the

possibility of gaining meaningful market shares.

Noodles: GSK entered Instant Noodles category (~Rs20bn) in Q4CY09 andquickly garnered ~3% market share within 12 months of launch. Differentiated

product positioning (higher nutritional value, vitamin-packet health maker

sachet) helped in gaining consumer trails. However, market share has stagnatedafter that. Management attributes it to capacity issues from third-party

manufacturer like IndoNissan. However, in our view, ITCs entry in the segment

through Yippee and consequent aggressive trade promotion prevented Foodles

from gaining further shares. Yippee now commands ~10% market share. We

note that GSK is in the process of re-configuring the existing supply chain.

Ready-to-eat convenience food is poised for strong growth due to favourable

macro factors and GSKs success in this category can help act as major catalys

for revenue performance.

Nutribar, Chill Dood: Nutribar was positioned as a healthy snack betweenmeals. These products were withdrawn pertaining to various issues e.g. low

consumer traction, manufacturing-related issues. We reckon these products

were ahead of time and may see a re-entry in revamped format and strategy

later.

Oats: GSK has recently entered the breakfast market with Horlicks Oats. Oats isRs2bn category, growing at 25% pa. While its early days, our channel checks

suggest initial response has been good. GSK has introduced Horlicks Oats in fou

Southern States and is now the third largest player in those markets behind

Quaker and Saffola, with 12% market share.

Lucozade and Boost: Lucozade is aimed at capturing share in a fast growingenergy drinks market, valued at Rs1.5bn. GSK also entered ~Rs6bn Glucosesegment with BoostGlucose in South, North and West markets and GlaxoseD in

East.

Overall, in the non-MFD space, GSKs performance is a mixed bag, with Biscuits

putting relatively better show driven by niche positioning. Rest of the categories are

small in terms of revenue and salience and will need to be nurtured before they gain

critical mass and start contributing to the overall revenue growth. Noodles, Oats and

Glucose offer decent upside, given the changing food habits.



16/48

May 07, 2012 16


We expect the proportion of Non-MFD segments to move from 6.8% in CY11 to 7.5%

in CY14e.

UpsideinBusinessAuxiliaryincomefromdistributingparentsOTCvariants

GSK distributes/markets OTC brands of its parent e.g. Iodex, Crocin, Eno, Breathe

Right and Sensodyne for a commission which is booked as business auxiliary income

This contributes ~15% of GSKs EBITDA. Managements intends to introduce new

brands under this arrangement from its parents portfolio. We expect this segment

income to grow at 15% cagr in CY11-14e (34% growth in 1QCY12).

Exhibit16: Businessauxiliaryincomebenefittingfromparentswideningportfolio

1.7%

1.9%

2.1%

2.3%

2.5%

2.7%

0

200

400

600

800

1000

1200

CY06 CY07 CY08 CY09 CY10 CY11 CY12E CY13E

Business Auxiliary income As a % of sales (RHS)


Q1CY12Resulthighlights

Revenue growth stood at 14.5% driven by 7% volume growth. Adjusted for CSDwhich stopped orders post Feb, volume growth is 9.5%.

CSD contributes 8% of GSKs revenues and has de-grown 30% in volumes for1QCY12.

Horlicks and Boost volumes posted 9.4% and 2.1% growth respectively. Reported gross margins were down 250bps YoY and QoQ. It is primarily owing to

inventory draw dawn pertaining to finished goods (Rs780mn) related to planned

plant maintenance activities. Adjusted for it, gross margin would havecontracted 30bps, per management. However, it has no impact on EBITDA

number.

Other income up 41% driven by better yields and 34% growth in businessauxiliary income from parent.

PAT grew 19% to Rs1.32bn as tax rate for the quarter was down 120bps.



17/48

May 07, 2012 17


Financials

Expectsteady17%salesgrowthinCY1114E

We expect GSK to register steady 17% sales CAGR in CY11-14e, driven by healthy

9.5%-10.5% volume growth in the core MFD segment. Low penetration and

distribution expansion should drive the volume growth, in our view. Given its pricing

power and market share leadership in the segment, we expect GSK to deliver a

realisation growth of 6-7%.

Exhibit17: SteadygrowthintheheadlineP&Litems

19.8

%

16.8

%

17.4

%

18.2

%

16.6

%20.0

%

15.2

%18.3

%

18.4

%

18.4

%

28.8

%

18.5

%20.3

%

18.0

%

18.6

%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

CY10 CY11 CY12E CY13E CY14E

Sales growth EBITDA growth PAT growth


GSKs pricing power is visible in its ability to maintain operating margins in a tight

18.5-19.5% band for the last three years, notwithstanding the input cost inflation in

the past two years. GSKs key raw materials Milk, SMP, Barley and Packaging

ingredients were on an uptrend. We model for ~8-10% inflation in RM index and

expect GSK to neutralise the same by price hikes.

We model for a gross margin expansion of a sedate 40bps over the next three years.



18/48

May 07, 2012 18


Exhibit18: Weexpect40bpsexpansioninopmarginsoverCY1114e

60.5%

61.0%

61.5%

62.0%

62.5%63.0%

63.5%

18.4%

18.5%

18.6%

18.7%

18.8%

18.9%

19.0%

19.1%

19.2%

CY09 CY10 CY11 CY12E CY13E CY14E

EBITDA Margins Gross margins (RHS)


We dont expect GSK to enter many new categories; it will rather consolidate the

existing non-MFD presence, in our view, given the lower than expected success of

Nutribar and Foodles. Hence, we dont see a spike in ad-spends. Ad-spends to sales

ratio has risen from 12-13% band to 15-16% in the last three years. This is primarily

to support new launches in Biscuits, Noodles etc.

We model flat ad-spends for the next two years and expect a healthy 19% earnings

CAGR for next three years.

Cashrichbalancesheet;robustFCFgeneration

GSK has a net cash balance sheet with cash on the books of Rs10.8bn, translating to

Rs256 per share. We expect GSK to generate FCF of Rs 16bn over CY11-CY14e. GSKs

cash conversion ability is unparalleled with the FCF to PAT conversion ratio averaging

1.23x since CY07.

Exhibit19: Robustcashrichbalancesheet

(2,000)

(1,500)

(1,000)

(500)

0

0

2,000

4,000

6,000

8,000

10,00012,000

14,000

16,000

18,000


Cash and investments Net working capital (RHS)




19/48

May 07, 2012 19


Exhibit20: PayoutratioisaweaklinkforGSK

38.0%

81.8%

48.2%52.7% 52.7% 52.7%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%



Exhibit21: Wedontexpectmuchchangeinreturnratios

25.0

%

27.2

%

26.8

% 27.9%

32.2%

33.8%

34.3

%

34.4

%

34.7

%

40.0%

60.0%

80.0%

100.0%

120.0%

15%

20%

25%

30%

35%

40%

CY06

CY07

CY08

CY09

CY10

CY11

CY12E

CY13E

CY14E

RoE Cash as % of capital employed(RHS)


We model for a net capex of Rs2.5bn and Rs1.5bn for CY12e and CY13e, in line with

management guidance. Majority of the capex is directed at capacity expansion at

Sonepat. First line will commence operations in 3QCY12e and remaining by June13.

Despite the strong cash generation, GSKs payout has been conservative, with an

average payout ratio of ~32%, excluding special dividend in CY10, when it distributed

70% of PAT to shareholders.



20/48

May 07, 2012 20


Valuationandoutlook

GSKs valuations have undergone significant re-rating post CY08. This was driven by

steady volume growth in core MFD segment, aggressive launches in new categories

and preference for safe haven buying in volatile broader market environment. GSKsaverage 12 month forward P/E for last one, two and three years is 25.2x, 24.6x and

22x, respectively.

While we expect GSK to deliver steady earnings CAGR of 18.3 % in CY11-14e, we see

very little chances of further re-rating owing to lack of meaningful success in new

categories. Dominant positioning in its core business, robust cash generation and

expected 18.3% earnings growth underscore our target P/E mult iple of 25x. We

arrive at a one-year forward target price of Rs3,200, an upside of 18%. Hence, we

init iate with a BUY rating.

Further re-rating will be predicated on GSK achieving meaningful marketshare/ critical mass in its non-MFD business.

Exhibit22: GlobalPeerValuationComparisonCompany

Name

Price

(Local

Currency)

MktCap

(US$Bn)

EPS EPSCAGR EV/EBITDA PE P/BVSales

CAGRRoE

FY13 FY14 FY15 FY1315 FY13 FY14 FY13 FY14 FY13 FY14 FY1315 FY13

Danone 55 35.1 3.2 3.5 3.9 10.5% 11.2 10.4 17.1 15.5 2.5 2.4 7.3% 15.0

Nestle S.A 55 182.7 3.3 3.6 3.9 8.3% 11.5 10.7 16.7 15.4 2.9 2.8 7.1% 17.8

Kraft 39 69.7 2.5 2.8 3.1 10.4% 10.2 9.5 15.6 14.1 1.9 1.8 3.7% 12.4

Pepsico 67 104.6 4.1 4.4 4.8 8.7% 10.2 9.7 16.3 15.1 4.5 4.4 2.9% 29.5

Coca Cola 77 174.6 4.1 4.5 4.9 9.7% 13.7 12.7 19.0 17.3 5.2 4.8 4.8% 28.0Kellogg 50 18.0 3.3 3.6 3.9 8.6% 10.0 9.2 15.1 14.0 6.3 5.3 7.0% 60.5

Heinz 54 17.3 3.3 3.6 3.8 7.1% 10.7 10.3 16.2 15.1 4.9 4.3 6.3% 33.0

Source:Bloomberg,PLResearch

Exhibit23: Oneyear forwardPEBand

0

500

1,000

1,500

2,000

2,500

3,000

3,500

Jan-03

Jul-03

Jan-04

Jul-04

Jan-05

Jul-05

Jan-06

Jul-06

Jan-07

Jul-07

Jan-08

Jul-08

Jan-09

Jul-09

Jan-10

Jul-10

Jan-11

Jul-11

Jan-12

29x26x

23x20x17x

14x11x

8x

Source:CompanyData,Bloomberg,PLResearch



21/48

May 07, 2012 21


Exhibit24: P/EforGlaxoSmithKlineConsumerProductsvsSensex

0.0

5.0

10.0

15.0

20.025.0

30.0

Jan-03

Sep-03

May-04

Jan-05

Sep-05

May-06

Jan-07

Sep-07

May-08

Jan-09

Sep-09

May-10

Jan-11

Sep-11

May-12

GlaxoSmithKline Consumer Products Sensex


Exhibit25: Premiumvs.Sensexhasexpandedto120%

-100.0%

-50.0%

0.0%

50.0%

100.0%

150.0%

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12




22/48

May 07, 2012 22


Riskfactors

Risingcommoditycosts: GSK is critically dependent on Milk and Barley. Sharp spike

up in these RM items can lead to deterioration in margins, in turn, resulting in lower-than-expected earnings.

Competitive threat in core MFD segment: Entry of new competitor with deep

pockets can pose an incremental threat to GSKs dominance in the category.

Failure innew product launch: Failure to attain critical mass in new launches can

lead to de-rating.

Macroslowdown: Slowdown in government spending in rural areas can restrict the

penetration of MFD segment in those markets, impacting GSK.



23/48

May 07, 2012 23


IncomeStatement(Rsm)

Y/eDecember 2010 2011 2012E 2013E

NetRevenue 23,800 27,798 32,633 38,565

Raw Material Expenses 8,712 10,250 12,012 14,413

Gross Profit 15,088 17,548 20,621 24,152

Employee Cost 2,297 2,584 3,165 3,664

Other Expenses 8,285 9,772 11,314 13,215EBITDA 4,506 5,193 6,141 7,274

Depr. & Amortizat ion 397 460 556 698

Net Interest 26 35 40 45

Other Income 435 704 842 1,010

ProfitbeforeTax 4,518 5,403 6,387 7,540

Total Tax 1,520 1,851 2,113 2,494

ProfitafterTax 2,998 3,552 4,275 5,046

Ex-Od items / Min. Int.

Adj.PAT 2,998 3,552 4,275 5,046

Avg.SharesO/S(m) 42.1 42.1 42.1 42.1

EPS(Rs.) 71.3 84.5 101.6 120.0

CashFlowAbstract(Rsm)

Y/eDecember

2010

2011

2012E 2013E

C/F from Operations 5,192 3,818 4,675 5,947

C/F from Investing (2,868) (1,969) (2,446) (3,710)

C/F from Financing (2,519) (1,778) (1,948) (2,297)

Inc. / Dec. in Cash (195) 71 281 (60)

Opening Cash 366 171 242 521

Closing Cash 171 242 521 458

FCFF 4,945 3,572 2,476 4,803

FCFE 4,945 3,572 2,476 4,803

KeyFinancialMetrics

Y/eDecember

2010

2011

2012E 2013E

Growth

Revenue (%) 19.8 16.8 17.4 18.2

EBITDA (%) 20.0 15.2 18.3 18.4

PAT (%) 28.8 18.5 20.3 18.0

EPS(%) 28.8 18.5 20.3 18.0

Profitability

EBITDA Margin (%) 18.9 18.7 18.8 18.9

PAT Margin (%) 12.6 12.8 13.1 13.1

RoCE (%) 32.3 34.0 34.5 34.6

RoE (%) 32.2 33.8 34.3 34.4

BalanceSheet

Net Debt : Equity

Net Wrkng Cap. (days) (25) (52) (17) (18)Valuation

PER (x) 37.9 32.0 26.6 22.5

P / B (x) 11.8 9.9 8.4 7.2

EV / EBITDA (x) 25.2 21.8 18.4 15.6

EV / Sales (x) 4.8 4.1 3.5 2.9

EarningsQuality

Eff. Tax Rate 33.6 34.3 33.1 33.1

Other Inc / PBT 9.6 13.0 13.2 13.4

Eff. Depr. Rate (%) 6.6 7.2 6.3 6.7

FCFE / PAT 164.9 100.6 57.9 95.2

Source:CompanyData,PLResearch.

BalanceSheetAbstract(Rsm)

Y/eDecember 2010 2011 2012E 2013E

Shareholder's Funds 9,600 11,442 13,466 15,855

Total Debt

Other Liabilities

TotalLiabilities 9,600 11,442 13,466 15,855

Net Fixed Assets 3,106 3,718 5,661 6,463Goodwill

Investments 9,590 10,555 10,501 12,711

Net Current Assets (3,363) (3,230) (3,096) (3,718

Cash&Equivalents 171 242 521 458

OtherCurrentAssets 4,470 5,904 6,126 7,235

CurrentLiabilities 8,004 9,376 9,743 11,411

Other Assets 267 399 399 399

TotalAssets 9,600 11,442 13,466 15,855

QuarterlyFinancials(Rsm)

Y/eDecember

Q2CY11

Q3CY11

Q4CY11 Q1CY12

NetRevenue 6,534 7,201 6,021 8,130

EBITDA 985 1,180 616 1,617

%ofrevenue 15.1 16.4 10.2 19.9

Depr. & Amortization 113 117 121 119


Other Income 360 476 487 479

ProfitbeforeTax 1,223 1,530 973 1,964

Total Tax 398 499 382 645

ProfitafterTax 825 1,030 591 1,320

Adj.PAT 825 1,030 591 1,320

KeyOperatingMetrics

Y/e

December

2010

2011

2012E 2013ESales growth 19.8 16.8 17.4 18.2

Gross margins 62.2 61.8 62.0 61.5

EBITDA margins 18.9 18.7 18.8 18.9

MFD volume growth 13.3 9.0 10.5 10.5




24/48

NestleIndia

Qualitydoesntcomecheap

May07,2012

Prabhudas Lilladher Pvt. Ltd. and/or its associates (the 'Firm') does and/or seeks to do business with companies covered in its research report s. As a result investors should be aware ththe Firm may have a conflict of interest that could affect the objectivity of the report. Investors should consider this report as only a single factor in making their investment decision.


Gautam [email protected]

+91-22-66322233

Rating Accumulate

Price Rs4,576

Target Price Rs5,015

Implied Upside 9.6%

Sensex 16,913

Nifty 5,114

(PricesasonMay07,2012)Tradingdata

Market Cap. (Rs bn) 441.2

Shares o/s (m) 96.4

3M Avg. Daily value (Rs m) 205

Majorshareholders

Promoters 62.76%

Foreign 11.03%

Domestic Inst. 7.81%

Public & Other 18.40%

StockPerformance

(%)

1M

6M

12M

Absolute (2.4) 4.8 14.1

Relative 0.9 8.5 22.8

HowwedifferfromConsensus

EPS(Rs) PL Cons. %Diff.2012 120.1 119.9 0.2

2013 146.7 146.2 0.3

PricePerformance(RIC:NEST.BO,BB:NESTIN)

Source:Bloomberg

0

1,000

2,000

3,000

4,0005,000

6,000

May-11

Jul-11

Sep-11

Nov-11

Jan-12

Mar-12

May-12

(Rs)

Processedfoodscategoryonstrong longtermfooting: Changing lifestyles andgrowing urbanisation theme along with rising incomes should drive long term

growth in Processed foods which currently forms a mere ~5% share of overal

foods industry. Nestle is well placed to capitalise on this long term opportunity

given its market leading position in key categories which imparts strong pricingpower and its proven ability to consistently outmanoeuvre competition.

Creating capacities to meet future demand: In order to fulfil the growingdemand for its products, Nestle is currently in an aggressive capacity expansion

phase, with an investment of ~Rs22bn over CY11-13e.We expect increased

capacities to drive the volumes albeit with a higher near term capital costs.

Recentvolumegrowthperformancebelowpar;weexpectrevival in2HCY12Nestles recent volume growth, was below par and has raised concerns about its

pricing driven growth strategy and justification for expensive valuations which it

commands. We expect recovery in volumes in 2HCY12 on the back of increased

promotions, expanded capacities and comparable base.

Distributionexpansionakeyenabler: Nestle has expanded its coverage at 15%cagr over CY07-11 and now reaches ~4.4mn outlets (40% of universe). We see

further scope for expansion, especially in rural markets and expect Nestle to

leverage its PPP port folio to drive rural reach.

Initiate with Accumulate: We expect an earnings CAGR of 17% in CY11-13edriven by revenue CAGR of 20% and flat op margins. We arrive at a 12 month

forward target price of Rs5000, based on rolling forward P/E of 32x, in line with

3 year average. Nestles premium valuations are well supported by its strong

pricing power, leadership position in its core categories and robust capita

efficiency ratios. Spike in commodity costs, volume growth deceleration and

dilution in pricing power are the key risks to our rating

Keyfinancials(Y/eDecember) 2010 2011 2012E 201Revenues (Rs m) 62,736 75,146 89,591 107,92

Growth(%) 21.8 19.8 19.2 20

EBITDA (Rs m) 12,685 15,765 18,788 23,03

PAT (Rs m) 8,370 10,188 11,579 14,14

EPS(Rs) 86.8 105.7 120.1 146

Growth(%) 20.0 21.7 13.7 22

Net DPS(Rs) 48.5 48.5 50.0 77

Profitability&Valuation 2010 2011 2012E 201

EBITDAmargin

(%)

20.2 21.0

21.0 21

RoE(%) 116.5 95.7 75.2 69

RoCE(%) 116.6 65.9 47.8 50

EV / sales (x) 7.0 6.0 5.0 4

EV / EBITDA (x) 34.6 28.5 23.8 19

PE (x) 52.7 43.3 38.1 31

P / BV (x) 51.6 34.6 24.4 19

Netdividendyield(%) 1.1 1.1 1.1 1

Source:CompanyData;PLResearch



25/48

May 07, 2012 25

Nestle India

InvestmentArguments

ProcessedFoodsextremelyfavourablelongtermdynamics

Processed Foods category is set to reap long-term benefits driven by favourable

demographics, rising incomes and changing consumer preferences. Lifestyle changes

is expected to drive the consumption of packaged and convenience foods. Rising

urbanisation, increasing population of working women and growing influence o

modern retail are they key positive catalysts for Processed Foods sector, which at

~US$25bn, is ~5-6% of overall Foods industry. It is expected to grow at 20% plus

CAGR in the medium term.

Exhibit1: ProcessedandPackagedFoodsisfractionofoverallFoodsindustryPackaged Foods

5%


Nestle, Indias largest processed foods player, is the key beneficiary of this

favourable underlying shift. Nestles product portfolio comprises Milk Products and

Nutrition (44% of sales), Prepared Dishes and Cooking aids (27%), Chocolates &

Confectionaries (15%) and Beverages (14%). It enjoys leadership position in all the

categories, barring Chocolates, where its No. 2. Over the past 5-6 years, Nestle has

benefited from the above mentioned factors and posted revenue CAGR of 20.4% for

CY05-11, driven by volume CAGR of 13.8%. This strong performance was essentially

driven by new product/category introductions, innovation/renovation and increasing

geographical reach.



26/48

May 07, 2012 26

Nestle India

Exhibit2: PresenceacrossnicheurbanfocussedcategorieswithdominantmarketpresenceCategory Subcategory Brand Marketposition

Milk&InfantNutrition Milk Nestle a+, Slim Milk, Creamy

YoghurtSlim Dahi,Acti Plus Probiot ic Dahi, Real Fruit

Yoghurt,Jeera Raita

Dairy Whitener & Ghee Everyday Leader

Desserts Milkmaid Creations Recent launch

Nutrition milk for Kids Neslac

InfantFood Infant food Cerelac, Lactogen, NAN Dominant Leader

PreparedDishesandCookingAids Instant Noodles2 Minute, Dumdaar,Cuppa

Mania,Noodletz,Mult igrain, Vegetable Att aDominant Leader

Pasta Maggi Pazzta

SoupsHealthy Soups,Souper-roni(combo of Soup and

Macaroni)

Sauces Tomato Ketchup, Tomato Sauce, Pichkoo Sauce Leader

CookingAids Bhuna MasalaGravy dishes, Vegetables, Dal, Ginger Garlic Cooking

base

Coconut Milk powder Maggi Coconut Milk Powder

Magic Cubes Maggi Magic cubes (Veg Masala,Chicken)

Taste Enhancer Masala-e-magic

Pizza Sauce Maggi Pizza mazza

ChocolatesandConfectionery Milk Nestle Milk Chocolate Leader

Dark Dark Chocolate, Dark Chocolate Dry Fruits

White Nestle Milkybar,Milkybar Choo Recent launch

Fine Nestle Select ions Fine Chocolates Recent launch

Wafer Kitkat,Munch,Milkybar Crispy Wafer Leader

Confectionery Polo, Polo Hole New Fashion

Beverages

Instant Coffee

Nescafe Classic LeaderMy First Cup

Cappuccino

Sunrise

Sunrise Premium

Iced Tea Nestea


Nestle has a very well-balanced portfolio, spanning Foods and Beverages categories

which even after strong growth in the recent past , remains under-penetrated and

offers an attractive medium-to-long term opportunity for Nestle.

Exhibit3: BarringChocolates,itenjoysleadershippositioninginrestofthesegmentsCategory %contributiontosales Marketposition Keycategories Keybrands

Milk products and Nutrit ion 44.7% No 1 Baby Foods, Infant Formula,Dairy Whitener Cerelac, Nan, Lactogen

Prepared Dishes & Cooking aids 28.5% No 1 Instant Noodles, Sauce, Pasta, Soup Maggi

Chocolates & Confectionery 13.9% No 2 Wafter, Eclairs,Whites Kitkat, Munch, Bar One

Beverages 12.9% No 1 Instant Coffee Nescafe




27/48

May 07, 2012 27

Nestle India

We discuss below some of the strategies deployed by Nestle which has worked and

in our view, should continue to work in the future:

Abilitytooutmanoeuvrethecompetition

Over the years, Nestle has consistently demonstrated its ability to

manage/outmanoeuvre the competit ion. Given the attractive growth profile o

Nestles categories, competitors have tried to wrest market shares frequently

However, strong brand equity of Nestles brands and Nestles strategy of frequent

innovation/renovation as well as introduction of new product variants has helped

maintain the leadership status of Nestle. Recent example being Instant Noodles

where despite entry of deep pocket MNCs and domestic players, Maggis volume

growth hasnt suffered.

Creatingcategoriesoffuture;drivinginnovation

Nestle has been ahead of the curve in creating categories of tomorrow (Noodles

Value added Dairy) and tapping the latent consumer demand for such products

Given the rapid change in consumption patterns underpinned by various macro

factors its essential to have a portfolio which meets the needs of consumers and

preferably stays ahead of such needs.

This basically requires strong innovation focus which we believe is one of the key

strengths of Nestle. It has consistently tapped the rich heritage and portfolio of its

parents to introduce new innovative products/categories in India across Infant

Nutrit ion, Instant Noodles and Chocolates categories.



28/48

May 07, 2012 28

Nestle India

Exhibit4: RecentinnovationsofNestle..


Nestle is in the process of setting up a local R&D centre at Manesar at a capex of

Rs2.3bn, which basically reasserts the innovation focus for developing locally

relevant offerings. The centre will focus on developing Popularly PositionedProducts, which can meet specific needs of consumers belonging to lower income

groups, and provide high-quality and nutritional foods at affordable prices. These

products are also expected to be sold in other countries.



29/48

May 07, 2012 29

Nestle India

AddressingruralmarketsviaLUPportfolio

Nestle has come a long way from being a pure premium products player to a

company which has offerings for urban as well as rural consumers alike. This has

been made possible through expansion of portfolio at popular price points (Res1, 2

5, 10). It has helped in driving the volume growth for Nestle and also in recruitingconsumer (low price points sometimes act as trials for recruiting new consumers for

a category).

However, recent actions (defocusing 0.5 Re price point in Chocolates (Eclairs)

indicate the disadvantage of PPP i.e. impact on margins. In an environment of rising

commodity costs, like now, persisting with lower price points adversely impacts

gross margins and can test the patience of management. Nestles preference for

profitability will mean abandoning LUP strategy in such times, though on a case-to

case basis.

Exhibit5: LUPportfolioPrice

point

Brand/SKU

Rs 1 Nescafe Classic, Milkybar

Rs 2 KitKat, Polo, Munch, Nescafe Sunrise

Rs 5 Maggi Noodles, KitKat, Munch, Polo, Barone, Everyday Whitener, Nescafe Sunrise

Rs 10 Maggi Noodles, KitKat, Barone, Milkybar, Whitener, Nescafe


Distributionexpansionat15%CAGRv/s5%CAGRforindustry

Nestle has consistently increased its distribution reach by adding 0.4-0.5m outlets

per annum. Over the last four years, its reach has expanded from 2.3m outlets in

CY07 to 3.6m out lets as of October 2011, a CAGR of 15% v/s 5% CAGR of sector.

This has been a factor behind 20% plus sales CAGR over CY06-11. We expect the

investment behind distribution expansion to continue and see more scope fo

enhancing rural reach, given lower rural contribution for Nestles sales (~20-25%) vis

avis other consumer peers (30%-50%).

Exhibit6: Consistentreachexpansiontodrivemediumtermgrowth

2.3

2.57

2.87

3.18

3.58

0

0.1

0.2

0.3

0.4

0.5

2.0

2.5

3.0

3.5

4.0

CY07 CY08 CY09 CY10 CY11

No of outlets (Mn) Outlet addition during the year (m) (RHS)




30/48

May 07, 2012 30

Nestle India

Rich global heritage of parent; can be tapped for future

innovations/newproductintroductions

Nestles parent, Nestle SA, has a wide bouquet of products, covering eight categories

which contribute ~US$100bn of revenues annually. It can leverage the expertise ofits parent in Foods space and continue to premiumize its local portfolio by launching

new products from the global portfolio with suitable alteration to meet local tastes

and preferences. Development of R&D facility at Manesar will help in addressing this

strategy.

Exhibit7: Parentsportfolio


Currently, Indias contribution to global sales at ~1.5% is miniscule in Nestles

scheme of things. However, given the expected 20% plus sales CAGR in the mediumterm, we see Indian entity becoming ever important as its parent looks to expand

emerging markets presence.



31/48

May 07, 2012 31

Nestle India

Exhibit8: EnoughscopefortappingintoparentsportfolioCategories Sales(BNCHF) %contributionPowdered & Liquid Beverages 18.2 21.8%

Water 6.5 7.8%

Milk Products & Ice Cream 16.4 19.6%

Nutrition & Health Care 9.7 11.6%

Prepared Dishes & Cooking Aids 13.9 16.6%

Confectionery 9.1 10.9%

PetCare 9.8 11.7%

TotalNestleGlobalSales 83.6 100.0%

CY 11 Nestle India Sales (CHF bn) 1.32

%ofglobalsales 1.58%


Buildingcapacitiesforfuture;willpropelvolumegrowth

Nestles confidence in long-term opportunity can be gauged from the magnitude of

its capex plans as it corrects the supply-side equation.

In order to fulfil the rising demand for its products, Nestle has undertaken an

aggressive capex programme. With an investment of ~Rs22bn, Nestle is beefing up

its capacit ies through Brownfield as well as Greenfield expansion across its six plants

For CY11, it had spent Rs17bn and plans to spend another Rs12-13bn over the next

24 months.

Major capex is directed towards Chocolates and Prepared Dishes categories where it

estimates strong growth, going forward, given the lower penetration. Curren

growth in Nestle is constrained by capacity and hence, creating supply to meet

future demand is absolutely crit ical from medium term growth viewpoint.

This capex is going to more than double its gross block over CY10-12e period and

result in doubling of capacity across manufacturing units.



32/48

May 07, 2012 32

Nestle India

Exhibit9: Aggressivecapexunderscoresthehugesizeofprize

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

0.0

5.0

10.0

15.0

20.0

CY08 CY09 CY10 CY11 CY12E CY13E

Capex (Rs bn) Capex as % of sales (RHS)


Detailsof

capex

spent

on

various

plants

Manufacturingplant

locationPlannedCapex(Rsbnapprox) Category

Samalkha 6.5 Infant formula

Nanjangud 4 Instant noodles

Ponda 5 Chocolates

Gujarat 5 Noodles & Confectionery

Bicholim 1.5 Cooking aids and prepared dishes


Nestle is funding the capex investments through an ECB of US$450m from its parent

Out of this, Nestle has borrowed US$157mn till March 2012. It has capitalized part o

the interest costs and kept the outstanding ECB liability un-hedged.

Once the new capacities come on-stream, we expect Nestles volume growth to

accelerate, especially in Chocolates, Infant Nutrition and Noodles. It will also hasten

the pace of new launches, we believe. Thaliwal unit has already commenced

production of Munch and some culinary products.

The capex commitment clearly indicates Nestles expectation of future growth in its

categories. However, this accelerated investment in capacity building will result in

higher capital costs (interest and depreciation) in the near term. Additionally, it wil

also dilute the return ratios.



33/48

May 07, 2012 33

Nestle India

Recent volume growth moderation a concern; expect revival in

2HCY12

Nestles volume growth in 2HCY11 and 1QCY12 was below par, invoking concerns

around its pricing driven growth strategy with disproportionate focus on marginsKey investor concern being deceleration in volume growth does not justify its

expensive valuations.

Volume growth moderation was a consequence of channel and portfolio

rationalisation. Specifically it exited low margin Eclairs SKU, stopped milk product

supply to CSD, grammage reduction in Chocolates and Instant Noodles and ban on

export of milk products. We expect a recover in volumes post 2HCY12e on the back

of aggressive consumer and trade promotions, heavy ad-spending and comparable

base. As such, we see recent volume headwinds as a one off

Exhibit10: VolumegrowthdeceleratedinCY11

17.6%

11.4%

7.1%8.1%

1.5%

0.0%

5.0%

10.0%

15.0%

20.0%

CY10 1QCY11 2QCY11 3QCY11 4QCY11

Volume growth


Newpackagingnorms;lowimpactforNestle

Ministry of Consumer Affairs, Government of India, has issued a notification (The

Legal Metrology (Packaged Commodities) Rules, 2011) which essentially restricts the

packaging flexibility for 20 product categories (details on next page) which are

specified in the second schedule of the above rule. It will come into effect from July

1, 2012. While the affected parties are appealing / lobbying against the move, iimplemented, this will be a negative for Consumer companies, especially for those

driving the popular price point strategies (Rs5, Rs10).

Consumer companies prefer to keep popular price points untouched while tinkering

with grammage content; a successful strategy in driving penetration in rural markets

The government action apparently makes it easier for consumers to compare prices

for different brands and make better informed decisions.



34/48

May 07, 2012 34

Nestle India

20 categories to come under the new rule: The aforementioned notificationcovers 20 consumer categories e.g. Baby Foods, Biscuits, Bread, Tea, Coffee

Milk Powder, Rice, Salt, Soap, Paints etc. Some of the HPC categories, where this

notification doesnt apply, include key Hair Care categories - Shampoo, Hair Oil

Oral Care - Tooth Paste, Tooth Powder and Skin Care - Fairness Cream etc. Forsome categories, restriction doesnt apply below certain threshold grammage

content e.g. Detergents and Milk Powder below 50gm.

Impact on PPP strategy: Over the last 2-3 years, most of the consumecompanies have focussed on expanding rural reach (HUVR, SKB, MRCO, GCPL

DABUR etc.) in order to drive penetration-led growth. Popular price point (Rs2

Rs5, Rs10) strategy has been a key catalyst in ensuring this growth, as Indian

consumer typically gives more importance to price v/s volume/grammage. In an

inflationary scenario, companies typically adjust grammage content instead of

hiking prices, especially at lower price points, as price elasticity is higher at such

price points. With this new notification, PPP strategy will be rendered void as

grammage content cant be altered to non-standard sizes (e.g. 430gm, 720gm

etc). This will result in price changes in-turn rendering the popular price points

incrementally vacant. Even the often used extra grammage promotional offers

will cease to exist, as doing so will lead to non-compliance. This grammage

promotion is typically used a) during new launches to drive trials and b) when

raw material prices correct, instead of passing the price correction, companies

rather offer more grammage content for limited period to drive off-take.

Negative, if implemented; will require price adjustments: Overall we believethis notification will adversely impact the price point strategies in an inflationary

environment; especially, when expanding the rural distribution reach is the key

focus area for most of the sector universe.

SpecificImpactonNestle: We dont expect significant impact for Nestle as BabyFood and Milk Powder doesnt have any significant contribution from price point

packs. Coffee is the only category where some minimal impact can be seen.

Segmentwisestrategy

MilkProductsandNutrition(44%ofsales)

Nestle enjoys significant first-mover advantage in Infant Food segment where

advertising is banned. Its brands Cerelac, Nestogen, Nestum, Naan, Lactogen define the category. Growth in Infant formula will be driven by combination of

population growth, favourable demographic trends and distribution extension

Rising influence of modern retail is also an enabler. Nestle is also a leader in Dairy

Whitener(Everyday) and SweetenedCondensedMilk(Milkmaid).



35/48

May 07, 2012 35

Nestle India

Exhibit11: VolumesimpactedinCY11duetochannelcorrectionandbanonexportofSMP

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

CY05 CY06 CY07 CY08 CY09 CY10 CY11 CY12E CY13E

Volume Value Realization


Nestle also has a presence in regular dairy segment viz. Milk, Curd. However, given

the fragmented nature of these product categories, pricing power is a casualty

Secondly, procurement of Milk is a challenge as supply chain is highly complex

Nestle currently procures Milk through Milk District Model which basically collects

milk from thousands of farmers on a daily basis. However, co-operatives like Amu

are better placed in milk procurement. With the expected entry of ITC in dairy

segment, competition for procurement will see a further increase.

We expect revenue growth of 19.2% CAGR over CY11-13e in this segment driven by

volume growth of 12%. Nestle has recently started phasing out low margin channels

(Canteen Stores department where debtor days is an issue) and Exports which

impacted volume growth during CY11.

Restriction of competitive activity in this segment is a key advantage for an

incumbent like Nestle.



36/48

May 07, 2012 36

Nestle India

PreparedDishesandCookingAids(28%ofsales)

Nestle created the Instant Noodles category in mid-80s which today has grown to

Rs20bn size. Strong growth in this category has attracted many competitors viz. ITC

GSK and HUL over the last 2-3 years. Before the entry of these players, Nestle was

virtually the category and hence, loss in market share was a foregone conclusion

However, Nestle has maintained the strong volume growth trajectory of its iconic

Maggi brand through introduction of variants catering to various consumer

preferences. Of the new players who entered recently, only ITC has managed a

double-digit market share (Sunfeast Yippee), driven by its unparalleled distribution

strength, in our view. GSKs Horlicks Foodles is back on the drawing board afte

gaining init ial 3% market share.

Exhibit12: Grammagecorrectionresultedinrelativelysedate15%volumegrowthinCY11

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%40.0%



Source:Company

Data,

PL

Research

Entry of new players has accelerated the category growth, in turn, helping the

category leader. Nestle also benefited in Noodles due to its popular price point

strategy (Rs5 and Rs10), especially in rural markets. With the capacity expansion

(Nestle has already commissioned the additional Noodle capacity at Nanjangud), we

expect the category to deliver ~20% volume growth CAGR for Nestle.

It is also present in Soup, Sauces and Pasta. Apart from Soup, where it enjoys No 2

position (Knorr is No 1), Nestle is leader in Sauce and Pasta segment. It is growing in

these segments via innovation and new variant introductions.

We expect Prepared Dishes to post 27% revenue CAGR over CY11-13e, driven by

volume growth of 18% CAGR.



37/48

May 07, 2012 37

Nestle India

ChocolatesandConfectionary(14%ofsales)

Nestles presence in Chocolates is through niche sub-categories like Wafers and

Whites. Overall in Chocolates, it plays second fiddle to Cadbury.

Its growth in this category has been driven by focus on distribution expansion in

rural markets, popular price point strategy, strong growth in modern trade and

introduction of new variants in Kitkat and Munch.

Exhibit13: CappedLUPportfoliotomaintainmargins

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%




Capacity expansion (doubling capacity at Ponda) should drive volume growth in the

near term. It has recently launched Selection and Dark chocolates. We expect furthe

new product introductions in this category.

Lower volume growth in CY11 is owing to conscious decision of exiting low margin

Eclairs segment (Rs0.5 price point). We see limited benefits of this strategy as it wil

put medium term volume growth at risk to manage the near-term margin pressures.

We model for 24.2% revenue growth in CY11-13e driven by a volume CAGR of 15%.



38/48

May 07, 2012 38

Nestle India

Beverages(14%ofsales)

Within the beverages segment, it sells Instant Coffee and Nestea. Its the laggard

within the overall Nestle portfolio as exports have been de-focussed. Also, certain

channels were de-emphasized due to working capital issues. Nonetheless, domestic

volumes posted a healthy 10% volume growth. It has re-launched Nescafe in CY11

and has commenced aggressive brand investment spends via celebrity endorsement

It is positioning Coffee as a youth drink, given the changing lifestyle patterns and

increased out-of-home coffee consumption.

Exhibit14: ExportsimpactedCY11performance

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%




We estimate 16.4% revenue growth for Beverages in CY11-13e led by ~12% volume

CAGR.



39/48

May 07, 2012 39

Nestle India

Financials

StrongrevenueandEPSgrowth,dilutioninreturnratios

We expect Nestle to register strong 17.5% EPS CAGR over CY11-13e driven by a)

revenue CAGR of 20%, which in turn, is led by Prepared Dishes and Milk products

segment and b) flattish operating margins as mix deterioration is neutralized by price

hikes.

Exhibit15: Wemodelfor19%revenueCAGRoverCY1113e

20.1

%

20.7

%

16.6

%

17.6

%29

.2%

24.9%

24.8%

26.3

%

26.4

%

12.7

%2

1.7

%

23.6%

11.8

% 18.8

%

14.4

%

13.3

%

0.0%

10.0%

20.0%

30.0%

40.0%

CY10 CY11 CY12E CY13E

Milk products and Nutrition Prepared Dishes & Cooking aids

Chocolates & Confectionery Beverages


Exhibit16: Prepareddishestofurtherenhanceitssalience

44.5

%

43.7

%

43.2

%

43.4

%

44.3

%

43.5

%

43.7

%

42.7

%

41.7

%

22.0% 20.5% 19.8% 17.9% 15.4% 14.1% 13.9% 13.3% 12.6%

19.0

%

20.3

%

21.4

%

23.5

%

25.6

%

27.1

%

28.1

%

29.4

%

30.8

%

0%

20%

40%

60%

80%

100%


Milk products and Nutrition Prepared Dishes & Cooking aids

Chocolates & Confectionery Beverages




40/48

May 07, 2012 40

Nestle India

Exhibit17: Categorywiserevenuesplit(Rsm)Categoryrevenues CY09 CY10 CY11 CY12E CY13E

Milk products and Nutrition 23,113 27,763 33,510 39,783 47,620

Prepared Dishes & Cooking aids 13,350 17,250 21,545 27,560 34,800

Chocolates & Confectionery 7,719 9,759 10,997 13,724 16,963

Beverages 8,042 8,994 10,684 12,556 14,484


Exhibit18: Sales growth driven by pricing in CY11; new capacity to help volumes CY12eonwards

13

.7%

24.4

%

23.4

%

18.6

% 21.9

%

19.8

%

19.3

%

20.5

%

8.3

%13

.8% 1

6.9

%

1

4.9

%17.0

%

6.8

%

15.5

%17.6

%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%


Sales growth Volume growth


Exhibit19: Pricehikesandchannelmiximprovementhelpedmargins

18.0%

19.0%

20.0%

21.0%

22.0%

48.0%

50.0%

52.0%

54.0%

56.0%


Gross margins EBITDA margins (RHS)




41/48

May 07, 2012 41

Nestle India

Exhibit20: Expect~20%earningscagroverCY1113e

17.1%

0.3%

30.7% 31.0%

23.5%

20.0% 21.7%

13.7%

22.1%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%



Inputcost

volatility

Milk and Milk-based raw materials constitute ~45% of Nestles RM basket. Green

Coffee, Palm Oil, Sugar and Wheat are the other key raw materials. Milk prices have

been inflationary in the recent years. Nestles raw material index has moved up from

100 in CY07 to 136 in CY11 (at the end of September 2011). Post September 2011

Sugar and Coffee prices have moved up 15-20% and Wheat as well as SMP are down

~ 8% and 4%, respectively. In order to maintain its operating margins, Nestle recently

exited some of the low margin segments and channels (CSD). In Chocolates, it exited

Eclairs segment, while in Beverages and Milk Products, it has rationalized its exports

portfolio.

Exhibit21: 5yearinflationinkeyRM(CAGR)13.2% 13.2% 13.1%

9.0%

4.7%

7.4%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

Milk Green

Coffee

SMP Sugar Wheat Vegetable

Oil




42/48

May 07, 2012 42

Nestle India

Exhibit22: Milk

10.0

12.0

14.0

16.0

18.0

20.0

22.0

24.0

26.0

28.0


(Rs/Kg

)


Exhibit23: GreenCoffee

50.0

70.0

90.0

110.0

CY06 CY07 CY08 CY09 CY10 CY11 CY12ECY13E

(Rs/Kg

)


Exhibit24: SMP

90.0

110.0

130.0

150.0

170.0

190.0


(Rs/Kg)


Exhibit25: Sugar

10.0

15.0

20.0

25.0

30.0

35.0

40.0


(Rs/Kg)


Exhibit26: Wheat

10.0

12.0

14.0

16.0

18.0


(Rs/Kg)


Exhibit27: VegetableOil

45.0

50.0

55.0

60.0

65.0

70.0

75.0

80.0

85.0

90.0


(Rs/Kg)


Given Nestles continued aggressive capex spending plans for CY12e, we expect

deterioration in its capital efficiency ratios. However, as the capacity utilisation starts

improving CY12e onwards, improvement in RoE/RoCE should follow. Dividend

payout should also see decline in CY12e and CY13e. We expect it to hover around

60% mark.



43/48

May 07, 2012 43

Nestle India

Valuations

Nestle has outperformed the FMCG index as well as broader markets over the last 5

6 years. It outperformed BSE FMCG by 11.5% CAGR and Sensex by 20.5% CAGR

respectively over CY05-11. This outperformance is driven by consistent earningsgrowth of ~20% (earnings CAGR of 19% for CY05-11) and continued dominance in its

core business categories.

Outperformance over CY08/9-11 is more pronounced (outperformance of 36% CAGR

vs. Sensex and 13.6% vs. BSE FMCG), given the volatile broader market conditions

leading to flight for safety trade. Nestles robust balance sheet with best in class

return ratios, healthy free cash flows and consistent dividend payout, coupled with

high quality management also helped in an environment where defensives were

widely sought after.

At current price, it trades at CY12e and CY13 P/E of 38.2x and 31.3x, respectivelyCurrent P/E is at a premium of ~ 15% to its 3-year average. Thanks to

outperformance in a risk-averse market, Nestles premium to sensex has expanded

to 162% vs 3 year average of 110%.

We value the stock at 32x one-year forward EPS and arrive at a target price of

Rs5,015, an upside of 9.8%. Our target P/E is based on 3 year average. .

Attractive category dynamics of Nestle benign competition in mainstay Infant

Nutrition business, strong market positioning in growing categories and healthy

pricing power offers good earnings visibility. Despite the favourable long term

category characteristics, competition, as yet had limited success in categories likeInstant Noodles. We forecast earnings CAGR of 17.5% for CY11-13e, which we

believe, can help sustain the premium valuations. Nestles efforts to build supply for

future via aggressive capex investments is a medium term positive and will help

drive volume growth.

Exhibit28: OneyearforwardPEBand

0

1,000

2,000

3,000

4,000

5,000

6,000

Jan-03

Jul-03

Jan-04

Jul-04

Jan-05

Jul-05

Jan-06

Jul-06

Jan-07

Jul-07

Jan-08

Jul-08

Jan-09

Jul-09

Jan-10

Jul-10

Jan-11

Jul-11

Jan-12

40x36x

32x28x

24x20x16x

12x




44/48

May 07, 2012 44

Nestle India

Exhibit29: P/EforNestlevsSensex

0.0

10.0

20.0

30.0

40.0

50.0

Jan-03

Sep-03

May-04

Jan-05

Sep-05

May-06

Jan-07

Sep-07

May-08

Jan-09

Sep-09

May-10

Jan-11

Sep-11

May-12

Nestle India Sensex


Exhibit30: Premiumvs.Sensexhasexpandedto160%

-50.0%

0.0%

50.0%

100.0%150.0%

200.0%

250.0%

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12


Risks

Spike in input costs, dilution in pricing power and improvement in broader markets

which reduces the preference for defensive stocks constitute the key risk factors to

our rating.



45/48

May 07, 2012 45

Nestle India

IncomeStatement(Rsm)

Y/eDecember 2010 2011 2012E 2013E

NetRevenue 62,736 75,146 89,591 107,926

Raw Material Expenses 30,556 35,894 42,746 51,373

Gross Profit 32,181 39,252 46,845 56,553

Employee Cost 4,585 5,680 6,501 7,775

Other Expenses 14,911 17,807 21,557 25,748EBITDA 12,685 15,765 18,788 23,030

Depr. & Amortization 1,278 1,533 2,144 2,841


Other Income 54 (301) (335) (322)


Total Tax 3,264 4,264 4,963 6,061

ProfitafterTax 8,187 9,615 10,972 13,475

Ex-Od items / Min. Int. (184) (573) (607) (667)

Adj.PAT 8,370 10,188 11,579 14,143

Avg.SharesO/S(m) 96.4 96.4 96.4 96.4

EPS(Rs.) 86.8 105.7 120.1 146.7

CashFlowAbstract(Rsm)

Y/eDecember

2010

2011

2012E 2013E

C/F from Operations 10,748 13,054 14,339 18,268

C/F from Investing (4,306) (17,509) (7,373) (6,938)

C/F from Financing (5,445) 4,175 (6,349) (10,071)

Inc. / Dec. in Cash 997 (281) 616 1,259

Opening Cash 1,556 2,553 2,272 2,888

Closing Cash 2,553 2,272 2,888 4,033

FCFF 9,084 6,634 (123) 12,147

FCFE 9,084 16,342 (832) 10,647

KeyFinancialMetrics

Y/eDecember

2010

2011

2012E 2013E

Growth

Revenue (%) 21.8 19.8 19.2 20.5

EBITDA (%) 20.2 24.3 19.2 22.6

PAT (%) 20.0 21.7 13.7 22.1

EPS(%) 20.0 21.7 13.7 22.1

Profitability

EBITDA Margin (%) 20.2 21.0 21.0 21.3

PAT Margin (%) 13.3 13.6 12.9 13.1

RoCE (%) 116.6 65.9 47.8 50.0

RoE (%) 116.5 95.7 75.2 69.1

BalanceSheet

Net Debt : Equity (0.3) 0.6 0.3 0.2

Net Wrkng Cap. (days) (17) (21) (28) (20)Valuation

PER (x) 52.7 43.3 38.1 31.2

P / B (x) 51.6 34.6 24.4 19.3

EV / EBITDA (x) 34.6 28.5 23.8 19.3

EV / Sales (x) 7.0 6.0 5.0 4.1

EarningsQuality

Eff. Tax Rate 28.5 30.7 31.1 31.0

Other Inc / PBT 2.0 1.9 1.6 1.7

Eff. Depr. Rate (%) 6.9 6.0 5.3 6.0

FCFE / PAT 108.5 160.4 (7.2) 75.3Source:CompanyData,PLResearch.

BalanceSheetAbstract(Rsm)

Y/eDecember 2010 2011 2012E 2013E

Shareholder's Funds 8,554 12,740 18,072 22,861

Total Debt 9,709 9,000 7,500

Other Liabi li ties 333 435 584 826

TotalLiabilities 8,887 22,883 27,656 31,187

Net Fixed Assets 13,616 29,944 34,917 38,814Goodwill

Investments 1,507 1,344 1,600 1,800

Net Current Assets (6,236) (8,404) (8,862) (9,427

Cash&Equivalents 2,553 2,272 2,888 4,033

OtherCurrentAssets 7,907 10,458 12,729 15,505

CurrentLiabilities 16,696 21,135 24,479 28,965

Other Assets

TotalAssets 8,887 22,883 27,655 31,187

QuarterlyFinancials(Rsm)

Y/eDecember

Q2CY11

Q3CY11

Q4CY11 Q1CY12

NetRevenue 17,631 19,631 19 ,547 20,475

EBITDA 3,445 4,103 4,127 4,572

%ofrevenue 19.5 20.9 21.1 22.3

Depr. & Amortizat ion 367 394 446 528


Ot her Income 80 121 181 136


Total Tax 956 1,134 1,148 1,272

ProfitafterTax 2,138 2,612 2,412 2,757

Adj.PAT 2,138 2,612 2,412 2,757

KeyOperatingMetrics

Y/e

December

2010

2011

2012E 2013EVolume growth 17.0 6.8 15.5 17.6

EBITDA margins 20.0 20.7 20.8 21.2

Sales growth 19.8 19.3 20.5 21.3




46/48

May 07, 2012 46

Nestle India

THIS PAGE IS INTENTIONALLY LEFT BLANK



47/48

May 07, 2012 47

Nestle India

THIS PAGE IS INTENTIONALLY LEFT BLANK



48/48

Nestle India

Prabhudas Lilladher Pvt. Ltd.

3rd Floor, Sadhana House, 570, P. B. Marg, Worli, Mumbai-400 018, India

Tel: (91 22) 6632 2222 Fax: (91 22) 6632 2209

RatingDistributionofResearchCoverage

21.3%

54.0%

23.3%

1.3%

0%

10%

20%

30%

40%

50%

60%

BUY Accumulate Reduce Sel l

%ofT

otalCoverage

PLsRecommendation

Nomenclature

BUY : Over 15% Outperformance to Sensex over 12-months Accumulate : Outperformance to Sensex over 12-months

Reduce : Underperformance to Sensex over 12-months Sell : Over 15% underperformance to Sensex over 12-months

TradingBuy : Over 10% absolute upside in 1-month TradingSell : Over 10% absolute decline in 1-month

NotRated(NR) : No specific call on the stock UnderReview(UR) : Rating likely to change shortly

This document has been prepared by the Research Division of Prabhudas Lilladher Pvt. Ltd. Mumbai, India (PL) and is meant for use by the recipient only as

information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of PL. It should not be

considered or t aken as an offer to sell or a solicitation to buy or sell any security.

The information contained in this report has been obtained from sources that are considered to be reliable. However, PL has not independently verif ied the accuracy

or completeness of the same. Neither PL nor any of its affiliates, its directors or its employees accept any responsibility of whatsoever nature for the information

statements and opinion given, made available or expressed herein or for any omission therein.

Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The

suitability or otherwise of any investments will depend upon the recipient's particular circumstances and, in case of doubt, advice should be sought from an

independent expert/ advisor.

food initiation[1]

Documents