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Falling coffee and cocoa prices likely to benefit Nestle India

Falling coffee and cocoa prices likely to benefit Nestle India
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First Published: Fri, Sep 30 2011. 01 15 AM IST

Updated: Fri, Sep 30 2011. 10 54 AM IST
The BSE FMCG index has outperformed the broader market in the past 12 months, gaining about 5% compared with a 16% drop in the benchmark Sensex. But Nestlé India Ltd outdid peers, gaining by about 27% in the same period.
The food company’s shares trade at a price-to-earnings multiple of about 41 times its estimated 2011 earnings per share (EPS) and about 34 times its 2012 EPS, based on consensus estimates polled by Reuters.
Sustaining these valuations would normally be tough. The company’s shares have done well, thanks to strong volume-led growth. It has not relied on price hikes to achieve revenue growth.
Nestlé has succeeded in absorbing some input cost hikes, raising product prices moderately, and growing both sales and profit, even though margins have been hit.
The company has been hiking prices of a few of its products such as dairy, coffee, and noodles to recover rising input costs.
But competition limits the ability to which Nestlé can pass on rising costs. Moreover, rising domestic inflation may affect consumer demand at some time, especially on discretionary spending, which could affect firms such as Nestlé.
But a fall in prices of two commodities may well provide some relief to Nestlé. The sharp rise in the price of coffee and cocoa has been reversed. Coffee bean prices have been falling sharply in September, and prices of Robusta grade coffee are down by about 14% so far in the month, almost back to their average levels in January.
Similarly, cocoa has fallen by about 13% in the month so far, and is trading below the monthly averages of 2010 and 2011. The drop in prices could be attributable to the likelihood of better supplies from leading crop-growing countries and also to the volatility that has gripped commodity markets.
Also See | Reversing Gains (PDF)
These two commodities join others whose price trends have turned benign, relative to the past few years. Sugar and wheat flour prices continue to remain in check, despite the start of the festival season. Wholesale sugar price is down by 6% from its January level and is up by 6% from its lowest point in the year so far.
Similarly, wheat price is down by 11% from its January level, and 2% above its lowest level. Palm oil prices are down by about 23% in the year so far.
A key exception should be prices of milk and related products in the domestic market, which continue to rise, but not as much as in 2010-11.
A softer trend in input prices should benefit Nestlé in the forthcoming quarters. Since it has not raised prices enough to cover price hikes, it may keep them constant and margins will improve.
But it may also choose to further drive up volume growth by giving additional volumes free, or by running other promotions. It could also choose to reinvest savings into advertising as well.
The risk of commodity prices resuming their upward march remains. Barring that eventuality, the input price situation appears to be favouring Nestlé.
Graphics by Ahmed Raza Khan/Mint
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First Published: Fri, Sep 30 2011. 01 15 AM IST