Rising prices are a worry for companies selling food products. If they do not hike prices, margins will be hit and if they do, volume growth may decline. This dilemma is evident in Nestle India Ltd’s results. It has a strong portfolio of products driving growth, with domestic sales in the December quarter rising by 25.3% to Rs1,261 crore, compared with the year-ago period. Part of this growth was attributable to a low base effect and also to favourable weather, which led to higher sales across its categories. In 2009, its domestic sales grew by 20%.
While Nestle’s sales growth was above expectations, its net profit was lower due to inflation in material costs and certain one-off items. Actuarial costs for retirement benefits have been a volatile factor in company results, as changes in interest rates lead to changes in provisions.
Nestle’s employee costs rose by 65% to Rs138 crore during the quarter, over the year-ago period, chiefly due to provisions for retirement benefits. While Nestle has not disclosed the actuarial component in employee costs, employee cost in the previous quarter was only Rs97 crore.
But the bigger worry is material costs, which make up nearly half of Nestle’s sales. In the December quarter, material costs went up by nearly 1 percentage point to 48%. Milk, sugar, coffee seeds, flour and vegetable oils are some of the key material inputs. Milk and sugar costs have been rising sharply. If material costs rose at a faster rate than sales, it indicates that Nestle is keeping price hikes moderate. New product/variant launches, too, may have played a role in higher material costs. Consumer non-durable companies have been spending heavily on advertising, Nestle being no exception with its other expenditure (including advertising costs) rising by 30% to Rs364 crore.
The combination of these events led to Nestle’s operating profit margin falling to 14.7% in the December quarter from 19.2% a year ago. Even after adjusting for the one-off increase in employee costs, its margin would have declined. The outcome was Nestle’s net profit falling by 6.8% to Rs113 crore in the December quarter, a rare event in the history of Nestle.
Nestle is playing for the long term, focusing on market share and volume growth, even if it means lower profitability in the near term. That is a sound strategy for a consumer goods company. Costs will fall eventually and margins will return to normal levels, but sustaining volume growth and regaining share are tougher tasks.
Based on its fiscal 2009 earnings, Nestle trades at a price-earnings multiple of 38 times. That seems justified based on its high sales growth and strong product portfolio but not in an environment where there is uncertainty on the margin front.
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