Investors in food companies appear to be way ahead on the expectations curve. Nestlé India Ltd’s shares were down by 2.5% on Monday, after the company announced its June quarter results over the weekend. GlaxoSmithKline Consumer Healthcare Ltd (GSKCH) reported its results on Monday and its shares fell by 1.1%, too.
Both companies have been market outperformers as investors expected high sales growth, accompanied by a fall in food inflation, to result in higher profit growth.
GSKCH’s revenue rose by 22% year-on-year (y-o-y) to Rs674 crore, proving them right, but 15% growth in net profit is not what investors expected. Higher raw material cost was the main reason for lower profit growth. Material cost rose by 31% y-o-y.
Among the company’s key costs are those of milk and milk powder (40% share of raw material cost) and malt and malt extract (24% share).
Milk has been one of the few food items whose price rise is not showing signs of abating, unlike others such as wheat and sugar. But the rise in 2011 is slower than that in 2010.
Barley prices have surprisingly moved up and were higher by about 24% y-o-y in the June quarter. This may have affected GSKCH’s costs.
In July, the uptrend has snapped and prices are down by about 3% over its end-June levels. The company may have decided to absorb the cost as it may have seen it as being temporary.
Meanwhile, margins have taken a beating, down by 125 basis points y-o-y. One basis point is one-hundredth of a percentage point. Its advertising and promotion costs rose by 33% as the company attempts to drive up growth of existing and new categories such as instant noodles. That is working as seen from its healthy sales growth.
The question is whether raw material cost will ease enough for the high sales growth to translate into higher profit growth as well. And the second question is whether the current quarter is something of an aberration, with the spike in barley prices combining with milk’s tireless climb hitting margins hard.
On the first question, the situation is not as bad as it was, but milk prices are not likely to yield ground. If barley prices continue to ease, the situation will become more comfortable.
The second question will be answered only when the company announces its September quarter results.
If investors don’t see a spike in margins, their faith in the company’s strategy may go down a notch.
We welcome your comments at email@example.com