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The Taste Of India

Given the number of Nestle’s brands that are leaders, breaching its moat will be no cakewalk for rivals…

Nestle India is the country’s leading food products company. Its biggest economic moat is that it possesses a number of powerful brands, which are category leaders by a wide margin. Maggi Noodles is the biggest of them all. Lactogen, Cerelac, and Milkmaid are some of its other category leaders.
Nestle’s powerful brands have served the company well so far. However, times are now changing. New competitors have joined the fray who threaten to breach Nestlé’s moats. How successfully it fends off competition will determine whether Nestle will continue to be the success story it has been so far.

Sources of moat
N”oodles” of cash! Quick, answer these rapid fire questions: Which noodles did you grow up slurping? Which noodles do your kids love to have? Which noodles do you have in your office as a late-evening snack?
Did you answer Wai-Wai? Chings? Fun-Top? Nah, not likely! It would be Maggi Noodles for most of us while we were growing up and it still continues to be India’s most widely-recognised noodles brand.
Maggi’s stranglehold over the Indian market is evident from its 88 per cent market share in the instant-noodles category. It is Nestle’s cash cow that brings in an estimated 27 per cent of its revenues and 35 per cent of its EBITDA.
Baby foods. Maggi is not the only pony in Nestle’s stable. Its baby food products Cerelac, Lactogen, Nestum and Nan have acquired the status of generics in their category. Nestle’s products control 85 per cent market share. Baby products bring in half the revenue of Nestle’s Milk and Nutrition portfolio. This category in turn generates 40 per cent of the company’s sales.
Milkmaid. Launched four decades ago, Nestlé’s Milkmaid is still the market leader with a 55 per cent market share.
Other products. Nestle has a range of other products that have carved significant positions for themselves in the market.
Nestle Milk launched five decades ago has a 21 per cent market share — no small feat for a brand in a highly fragmented market and one that competes with the unbeatable local doodhwala.
Nestle Curd launched as late as 2001 has quickly captured 25 per cent of the market with a range of variants. Its dairy whitener “Everyday” has a 25 per cent market share as well.
Maggi Sauce remains sharply etched in the Indian psyche owing to the unforgettable Javed Jaffrey spots that would end with “Boss, it’s different!”. The product completes 25 years in India and commands 45 per cent market share.
Nestle’s instant coffee brand Nescafe is a widely recognized brand worldwide that has a 41 per cent market share in India.

What could cause moat to be breached
For a long time Nestle was not too concerned about competition — it didn’t have to because there was no serious competition. That is no longer the case. A host of players have now entered the fray in categories that previously had only a handful of players. So Nestle now finds itself battling against a host of Johnnies-come-lately.
Attack on Fort Maggi. One of the first attacks on Maggi Noodles came from unexpected quarters — from smaller players like Wai-Wai and Chings. Their secret weapon? They introduced a slew of flavours that customers could not get from Maggi. The customer now had choice: Veg, Spinach, Schezwan, Manchurian, Chicken Curry, Veg Curry, Chicken Pizza and Kimchi flavours among others now shared space with Maggi’s limited offering of Masala, chicken and prawn. The upstarts quickly captured 5 per cent market share at Maggi’s expense. Nestle took a beating but quickly corrected the situation. Now it has more than 10 flavours on the shelves.
The biggest challenge though came from the biggies — HUL (Knorr Soupy noodles), ITC (Sunfeast Pasta), and GSK (Foodles) —who entered the market nearly simultaneously. The difference between these competitors and any Nestle has seen earlier is that they are deep-pocketed. ITC, for instance, is known to have no qualms about losing money in the first few years in any new category that it enters as long as it captures market share (think biscuits at the expense of Britannia). GSK Consumer and HUL are competitors that will be in for the long haul. It is estimated that Maggi’s market share could fall to around 82 per cent by FY12. More competition will also mean lower margins as Nestle will have to make do with lower pricing power than it has enjoyed in the past.
Coffee wars. Nestle’s iconic brand Nescafe too is facing tough competition from HUL’s Bru. Both have an equal market share of around 40 per cent each of the Rs 2,000 crore branded coffee market in India. It is likely to be a battle between equals for the leadership of this segment. Beverages (this category includes Nescafe and Nestea) bring in 14.5 per cent of the company’s revenues.
However, Nestle still has a few products that do not face serious competition. These include baby foods products and its Milkmaid brand.

Growth drivers
Smarting under increased competitive heat, Nestle is setting out to correct things. It has planned aggressive marketing campaigns and chalked out an extensive capex programme of around $450 million (around `2,000 crore) in the next three years to take on the competition.
High capex. A new facility at Najangadh (Karnataka) for around Rs 900 crore will double the capacity for the production of noodles and other Maggi brands. A research and development (R&D) facility at Manesar (Haryana) that is being developed at an outlay of Rs 250 crore is expected to come online by July 2012. All in all around Rs 2,000 crore will be invested in capex over the next three years. Most of the capacity addition is expected in categories like prepared dishes, milk products and chocolates. Volume growth is expected to be in the 20 per cent range as a result of its recent initiatives. Increase in realisation though is expected to remain muted or under pressure.
Noodles. In the noodles category, Nestle has help from unexpected quarters. Higher spending by competitors is estimated to help the noodles category grow by 38 per cent compounded over the next two years. Nestle, it is estimated, will grow its noodles business by 32 per cent during the same period, piggy-backing on competitors’ ad spends.

Concern
Managing input price pressures. Nestle saw input prices rise by 11 per cent in CY10. Input price inflation is expected to remain high for some time before cooling off in the second half of the current calendar. Nestle is expected to take advantage of its supply chain relationships to help lower the input price impact. Margins for CY11 are expected to increase 50 bps on the back of better product mix and lower expected input price inflation.

Financials
Over the last five years, the company’s revenue has grown at a compounded annual growth rate (CAGR) of 20.29 per cent while its profit after tax has grown at 21.47 per cent. It is an entirely debt-free company. Over the last five years, the company has clocked a very high average return on equity of 109.06 per cent.

Valuation
Nestle’s dominance in the categories that it services is not lost on the market. The stock has been a darling of the stock market for quite some time. In the last one year the stock has gained 40 per cent (as compared to the Sensex’s 5 per cent). In the last five years, Nestle has gained 268 per cent, nearly double the Sensex’s gain of 142 per cent over the same period.
The stock though now appears to have overshot reasonable valuations. It trades at 43.23 times its 12-month trailing earnings, which is a 43 per cent premium to the average valuation of the sector. The stock has clocked a five-year EPS growth rate of 39.45 per cent. This gives it a PEG ratio of 1.10 (a PEG ratio of below one is considered attractive). Wait for the company’s fundamentals to catch up before entering the stock.