Nestle India Ltd’s operating profit margin fell in the March quarter compared with the year-ago period due to a sharp increase in other expenditure and not because of input costs.
Material cost to sales fell in the March quarter, repeating a trend seen in the December quarter. As a result, its margins improved over the December quarter.
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The consumer foods firm appears to have got the upper hand over rising input costs through a mixture of selective price hikes, improved product mix and economies of scale. A lower proportion of free volumes, used as a promotional tool, was also partly responsible for the fall in the material cost to sales.
Nestle India’s sales rose by 22%; domestic sales increased by 23%, while exports grew by just 10%. Operating profit margin fell by 30 basis points year-on-year (y-o-y), chiefly due to a 24% increase in other expenditure. One basis point is one-hundredth of a percentage point.
Advertising and promotion expenses are likely to be the main reason behind the sharp jump in other expenditure. Since the company has cut down promotional volumes, which become expensive when input costs are soaring, it may have stepped up on advertisements to keep up sales momentum.
Nestle India’s profitability was lower y-o-y, but has risen by nearly 140 basis points over the December quarter. Thus, growing competition in the instant noodles segment does not appear to have affected it yet. Apart from a better product mix, Nestle India is expanding its capacity to meet growth targets. That also gives it the benefit of economies of scale.
The key concerns for the company were competition and rising input costs. Though competition is still there, its impact appears to be negligible. Input costs appear to have become a lesser threat, and a good crop output in fiscal 2011 should see prices remain stable, even if they do not decline.
Prices of milk, wheat flour and sugar are stable compared with the calendar year 2010. These three contribute nearly half to Nestle’s input costs. Skimmed milk and green coffee prices have risen sharply compared with the March quarter. Similarly, palm oil prices had also risen sharply in the March quarter.
If coffee prices stay high, exports will be hit, and domestic demand, too, could get affected due to hikes in product prices. Global sourcing and forward buying may buy Nestle India some time from the input cost inflation.
Packaging cost is another concern, as rising crude oil prices will feed into higher plastic cost. While there may be some pain still in store for Nestle India, unlike 2010, it does not appear to be a key concern. What could be a key concern is if competition steps up the heat in 2011, goaded by stable input costs, and if it spreads to other categories as well.
The company’s net profit grew by 27% y-o-y in the March quarter, partly due to lower tax. A tax holiday for its Pantnagar factory in Uttarakhand will change to a 30% exemption from 100% so far from 1 April.
Its tax incidence will increase as a result. Once its new projects come on stream, the debt it plans to raise will also result in higher interest costs, and depreciation will increase.
Some near-term effect of these events will be visible on profits, but investors should keep their eyes on sales growth and profitability. If it can maintain current levels of growth and keep profitability intact, then the other factors will not matter much in the longer run.
Graphic by Sandeep Bhatnagar/Mint
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