In the last few quarters, Nestle has recorded robust growth in processed foods, mainly driven by price hikes.
We expect the slowdown in modern trade and the company’s focus on smaller packs to slow its growth momentum. We forecast 18.2% revenue CAGR over CY08-10, largely driven by volume growth.
Raw material costs make up ~50% of turnover. Key raw materials are milk, coffee, wheat and vegetable oils.
The outlook for prices is not benign, with the risk on the upside. Nestle had a peak 22.8% EBITDA margin in Q1CY08. We estimate rising raw material costs will pull down PAT margins – from the 14.3% Q1CY08 peak to 12.4% in CY09.
The processed foods sector is attracting newer entrants, with lower-priced products. Keener competition places Nestle’s growth momentum at risk.
We initiate coverage with a HOLD rating and a target price of Rs1,495. At our target price, the stock should trade at 23x CY09e earnings, a 10% premium to Hindustan Unilever’s target PE of 21x.