Nestle’s growth draws investors

Nestle’s growth draws investors
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First Published: Wed, Mar 05 2008. 10 55 PM IST

Updated: Wed, Mar 05 2008. 10 55 PM IST
Shares of Nestle India Ltd have risen 9% in the past two trading sessions, riding piggyback on impressive results and the market’s sudden interest for defensive stocks from the FMCG (fast-moving consumer goods) and pharmaceuticals space. Nestle has bounced back well after a lacklustre performance in 2006, when profit before interest and tax had risen just 3%. Last year, profit jumped by over 30%, partly because of the low base in 2006, but largely owing to impressive volume growth and price increases.
Domestic sales grew by 22% in the December quarter, the fourth consecutive quarter where growth has been higher than 20%. For the year, domestic sales grew 25%, which is much higher than the growth in the overall FMCG industry. Analysts point to increasingly aggresive sales and marketing efforts by the company that , coupled with the rise of the organized retail format, has helped sales growth pick up. The company’s leading products are prepared dishes, cooking aids, chocolates and confectionery, all of which are thriving because of increased urbanization.
According to an analyst with a domestic brokerage, roughly half of the increase in domestic sales would be because of volume growth. While the benefits of scale have helped improve margins, so have the company’s price increases. Profit margin improved by 86 basis points, even though raw material costs continued to climb (up 120 basis points for the year). The growth in profit before interest and tax may have been even higher, but for a change in account policy on employee benefits. In the December quarter, profit growth stood at 32.6% and margin expansion was as high as 126 basis points, much higher than the 70 basis points improvement in the first three quarters.
While Nestle’s results are indeed impressive, a large part of its recent revaluation is owing to a shift in investor preference towards defensive stocks. As uncertainty abounds, companies such as Nestle which are growing steadily have suddenly found more takers. And this is despite the fact that the stock price is at 35 times trailing earnings. But quality FMCG stocks have always commanded a premium. Besides, Nestle has a unique accounting policy of providing aggressively for contingencies.
These provisions have been gradually coming down, and in 2007 there was a large write-back of earlier provisions, leading to a credit of about Rs60 crore. With large provisions having been made in the past, there could be some positive surprises in the future as well.
A tsunami of liquidity
We’ve heard a lot about how the credit crunch in the Western financial markets is affecting liquidity. Huge losses have punched a hole in the balance sheets of US and European banks and till such time they are able to repair their net worth, their ability to lend will remain impaired. That has hurt liquidity. But there’s a flip side to the story.
High oil prices have led to windfall gains by oil exporters. That money has to go somewhere. So far, what seems to be happening is that countries in the Persian Gulf region that have their currencies pegged to the dollar, are seeing a big rise in inflation as their central banks mop up dollars and release the local currency into their money markets. Foreign exchange reserves held by these countries are rising.
Moreover, the magnitude of the rise in dollar gains is truly staggering. According to a research note from Morgan Stanley, A Petrodollar Tsunami Warning by Stephen Jen and Charles St-Arnaud, the market value of annual cross-border oil flows is around $2 trillion (Rs80 trillion), evenly split among Gulf Co-Operation Council (GCC), non-GCC and non-Opec oil ­exporters.
While part of the oil receipts—Morgan Stanley’s estimate is 10%—will be invested by these countries within their borders, in infrastructure and the like, the bulk of the windfall will find its way into global financial markets. The note says that about half of it is likely to be invested by sovereign wealth funds, with the rest being direct investments in financial assets. The note ends with the dramatic flourish: “A tsunami is coming.”
At the moment, much of the money is going either into US bonds or, through sovereign wealth funds, into US financial institutions. But with the slowdown in the US and a falling dollar, it makes sense to diversify holdings. Indian markets should benefit, just as Indian engineering firms are already profiting from the boom in West Asia.
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First Published: Wed, Mar 05 2008. 10 55 PM IST
More Topics: Nestle | Shares | FMCG | Sales | Profit |