Relentless pressure on margins at Nestle India a cause for concern

Relentless pressure on margins at Nestle India a cause for concern

Nestle India Ltd’s revenue rose by 20% year-on-year (y-o-y) in the June quarter, with domestic sales growing by 21%. Sales to other countries were affected because of a ban on milk powder export.

Nestle’s sales growth vindicates its strategy to focus on volume growth to increase its market share, and hiking product prices selectively so as to not affect demand.

Healthier volume growth is always good for a consumer company as it is more sustainable; and when input costs go down, margins improve and profits rise at a faster rate.

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The price rise in a few commodities such as wheat and sugar has abated. But milk has been stubbornly trudging up, while raw coffee and edible oils—egged on by palm oil—became the relatively new additions to the list of expensive raw materials.

That pulled down Nestle’s operating profit margin in the June quarter by 50 basis points (bps) y-o-y. One basis point is one-hundredth of a percentage point.

That isn’t so bad, and is partly explained by the selective price hikes mentioned earlier and a fall or lower increase in the prices of inputs such as wheat and sugar.

But margins are down by around 1.3 percentage points on a sequential basis. This is a concern. If this continues for a few more quarters, it can take the sheen off its healthy top line growth, or force the company to hike prices by more than it would like, which may, in turn, hit demand.

Wage inflation continues to be high, which appears to be an industry-wide phenomenon, and growth in other expenditure seems to indicate that advertising and promotion spends remain high too. Freight charges have also increased because of fuel price hikes. The scope for cutting down on expenses appears limited.

Nestle’s profit before tax rose by 16%, while net profit growth was only 9.8% as one of its factories exited from a 100% tax holiday to a 30% exemption. The company has proved its ability to keep sales growth relatively high, without using price hikes as the main weapon. The burden of improving profitability, therefore, falls on input costs.

Wheat and sugar prices are currently benign, but milk prices are likely to rise. Both palm oil and coffee prices have fallen significantly in recent weeks. If that becomes a trend, Nestle’s margins may become healthier. But that is more a hope than certainty at this point; after all, who’s to say which commodity takes its place next in the inflation league tables?

The Nestle stock has been a market outperformer, but may strain to hold that position in future, unless margins improve.

Graphic by Ahmed Raza Khan/Mint

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