RESULT UPDATE

NESTLE INDIA Another tough quarter

India Equity Research| Consumer Goods

EDELWEISS 4D RATINGS Nestle’s Q1CY14 sales and PAT belied our expectations. Key negatives were: (i) multi year low of just 3.4% YoY domestic sales growth (7.7% YoY Absolute Rating HOLD in Q1CY13, 3.7% YoY in Q4CY13) and 4.4% YoY drop in export sales (~51% Rating Relative to Sector Underperformer YoY in Q1CY13, ~21% YoY in Q4CY13) due to high base and lower exports Risk Rating Relative to Sector Low to affiliates; (ii) 108bps YoY contraction in gross margin to 53.9% due to Sector Relative to Market Underweight high milk prices and 267bps YoY EBITDA margin dip due to higher ad and promotion (A&P) spends. Nestle’s volume growth continues to lag peers MARKET DATA (R: NEST.BO, B: NEST IN) and it needs to sharpen focus on new launches like pet care and water. CMP : INR 4,874 Although volume growth is likely to remain challenging, Nestle, with Target Price : INR 5,277 higher salience in sales to urban areas, could be one of the beneficiaries 52-week range (INR) : 5,865 / 4,566 of the much anticipated urban recovery. Maintain ‘HOLD’. Share in issue (mn) : 96.4 M cap (INR bn/USD mn) : 470 / 7,902 New launches, innovation need of the hour Avg. Daily Vol.BSE/NSE(‘000) : 44.6

Domestic sales growth (up 3.4% YoY) has been affected not only by discretionary SHARE HOLDING PATTERN (%) slowdown, but also by low pace of innovation/new launches. Nestle brought back Milo health drink on a small scale and is also selling its premium chocolate brands After Current Q3FY14 Q2FY14 Promoters * Eight and Fox’s through modern trade. In our view, the company needs to invest in 62.8 62.8 62.8 these brands so that they can gain visibility and scale. We are yet to see any positive MF's, FI's & BK’s 5.3 5.9 6.3 impact on financials after seven months of Mr. Etienne Benet (new MD) taking over. FII's 13.7 13.1 12.6 Others 18.3 18.2 18.3 * Promoters pledged shares : NIL Soaring milk prices sour gross margin; A&P spends stepped up (% of share in issue)

Surging milk prices took a 108bps YoY toll on gross margin (GSK Consumer’s margin too PRICE PERFORMANCE (%) dipped 82bps YoY). Recently, Amul and Mother Dairy increased milk prices by INR2 EW Consumer across all variants. Chances of milk prices rising further are high due to El Nino, which Stock Nifty Goods Index will result in higher fodder cost and lower milk production. Nestle stepped up A&P 1 month (5.9) 0.4 (2.6) spends in Q1CY14 resulting in 126bps YoY expansion in other expenditure. It launched 3 months (6.3) 10.5 4.2 ‘Share Your Goodness’ campaign which has received good response (as per company). 12 months (5.0) 13.5 3.7

Outlook and valuations: Fairly valued; maintain ‘HOLD’ Nestle will be one of the beneficiaries of potential urban recovery and has robust brands and strong portfolio of parent. Key concern is lack of innovation and aggression, which is hurting volume growth. At CMP, the stock is currently trading at P/E of 36.3x

CY14E and 30.9x CY15E. We maintain ‘HOLD/Sector Underperformer’. Abneesh Roy +91 22 6620 3141 Financials (INR mn) [email protected] Year to Dec Q1CY14 Q1CY13 % change Q4CY13 % change CY13 CY14E CY15E Pooja Lath Total op inc 23,215 22,554 2.9 22,630 2.6 91,011 103,091 116,875 +91 22 6620 3075 EBITDA 4,937 5,399 (8.6) 4,783 3.2 20,196 21,995 25,354 [email protected] PAT 2,592 2,791 (7.1) 2,715 (4.5) 11,033 12,757 14,966 Tanmay Sharma Dil. EPS (INR) 26.9 28.9 (7.1) 29.2 (8.0) 114.4 132.3 155.2 +91 22 4040 7586 Diluted P/E (x) 41.9 36.3 30.9 [email protected]

EV/EBITDA (x) 22.8 20.9 17.8 ROAE (%) 53.0 47.3 44.0 May 14, 2014 Edelweiss Research is also available on www.edelresearch.com, Bloomberg EDEL , Thomson First Call, Reuters and Factset. Edelweiss Securities Limited Consumer Goods

Peers getting aggressive in milk segment • In FY14, the production of milk is expected to be 139mt, of which one-fourth is cornered by organised players. • Earlier, multinational companies focused largely on valued added diary products and ultra high temperature (UHT) treated milk and sold them in special packs. • France’s Groupe Danone has launched its pouched milk packs in Pune under the brand name ‘Danone Dynamix’ in collaboration with Schreiber Dynamix (procuring and packing company for Danone Group). • Currently, Danone is selling toned milk, slim milk, milkshakes, chocolate smoothie, masala buttermilk and sweet lassi products in India. • Tirumala Milk Products was acquired by another French company, Le Groupe Lactalis, to enter into the Indian milk segment. “We will continue to take the right decisions in the short and Is Nestle going to aggressively re-enter the domestic health drink medium term to ensure that we consistently move towards our segment with Milo? ambition of being recognized as • Nestle India has on a small scale brought back its health drink Milo in India recently. the leader of Nutrition, Health • Currently, it is importing Milo and supplying it to a small set of consumers. and Wellness in India while • maintaining healthy overall Nestle is likely to consider ad spends and domestic production only after it garners performance.” scale. - Etienne Benet, MD, • The company seems to re-evaluating its take on Milo. Nestle India • Nestle Milo photo is shown in latest Annual report of Nestle India and its recent Analyst Meet ppt. • 400gm jar is priced at INR350 at a significant a premium (~2.5x) to Bournvita which is available at INR355 for 1kg jar, INR360 for 1 kg refill pack of Boost; Complan costs INR425 for a 1kg refill pack.

In our view, Nestle should re-enter this segment as Milo still has brand pull. The health drink segment continues to see good growth and Nestle India has lot of spare capacity. However, in our view, re-capturing market share is going to be difficult for Nestle Milo as GSK Consumer has a stronghold in the category (clocking strong volume growth with market share gains). Nestle can potentially gain from Heinz’s Complan since it seems to have lost focus (Parent company has been sold off) and its India operations have been going through a tough phase. Also, Nestle will have to be aggressive on both ad spends and innovations on Milo (on both these parameters we have found Nestle India lagging in the past three years).

Chocolate and confectionary: What new can Nestle do? • FY14 witnessed the launch of premium chocolate Alpino.

• From the analyst meet presentation, one can see the images of its international chocolate brands like FOX’S, After Eight and Kitkat Dark.

• If response picks up, we believe it may go for advertising and start domestic production. On the online retail website (e bay) After Eight is available at INR360 for 200gm pack, FOX’S Crystal Clear candy is available at INR15 0 for 180gm box.

2 Edelweiss Securities Limited Nestle India

Our recent Meeting with New Nestle India MD (Mr. Etienne Benet) & Team in Analyst Meet| Key Takeaways • Mr. Etienne Benet has worked for 25 years in Nestle in Finance and General Management, most of which are in emerging markets (in Egypt, Greece, Indonesia; has handled water portfolio in some countries).

• Nestle has recently come out with its first ever corporate ad in India. • Water and pet foods can potentially be launched in India, but right now management will focus on fixing a few things (in our view, ramp up feet on street, increase aggression on current products). • Lot of rationalisation is behind, though some will still happen especially due to phasing out issue.

• Nestle currently has 7,159 employees and has added 151 employees in the past one year, most of who are to increase feet on street.

• NHW (Nutrition, Health and Wellness) is a key area of focus. Surprisingly, Nestle considers chocolates also to be part of NHW. • In milk products & nutrition, two thirds of products have done well, ghee has been defocused on surge in raw material prices. In milk products & nutrition, in CY13, volumes declined 3% YoY while sales rose 2.4% YoY. • In noodles, Nestle has 80% share. In prepared dishes & cooking aids, in CY13, volumes increased 3.8% YoY while sales were up 11.8% YoY. Maggi has become a large business, so even achieving 12-15% growth can be a good acheivement. Maggi sales increased 2.5x in 5 years (in spite of entry of new players). It is likely to see very soon a new innovation.

• Chocolates & confectionary portfolio suffered as Nestle trimmed the INR0.50 éclairs which had low margin. In chocolates & confectionary, in CY13, volumes declined 2.2% YoY while sales jumped 9.3% YoY.

• Beverages has been impacted by rationalisation of single serve and low price points. CY13 beverages volumes increased 3% YoY while sales rose 12.9% YoY.

• The new R&D center has been set up at Manesar, India. The cost of this plant has been borne by its parent Nestle SA. Royalty will remain the same. • New launch is based on market attractiveness and availability of funds for marketing. So new launches will take some time.

• Nestle will continue to focus on strengthening portfolio and allocating resources.

• Nestle has 5 brands in top 100 (as per Brand Equity - Most Trusted Brands 2013 – Economic Times).

• MAGGI is the No. 1 food brand.

• MUNCH, KIT-KAT and NESTLÉ MILK CHOCOLATE amongst top 5 chocolate brands.

• NESCAFÉ is amongst the Top 5 brands in hot beverages.

• Bad monsoon can lead to milk scarcity, which could be good for large companies as shortage of milk could mean higher demand for milk powder.

3 Edelweiss Securities Limited Consumer Goods

• Nestle does not take decisions based on a quarter, but evaluates growth more from yearly basis.

• Cooking aid, Masala magic is seeing high growth (on low base), and can become large over the longer term.

• Nestle operates in a tight margin band.

• The key countries of exports for Nestle India are Turkey, Bangladesh and Russia.

Nestle CY13 annual report | Key highlights • Believes that the slowdown in growth in India is temporary and the same will bounce back. • Nestle is spending ~CHF1.5bn globally every year on nutrition research.

• Dairy industry has the potential to become important backbone of the economy. Nestle has done a lot of work in developing Moga as the hub for high quality milk.

• The average productivity in Moga is 4-5x that of average productivity of the country.

• Nestle’s effort is to improve economics of the dairy business and enhance productivity for farmers. • The company is investing in coffee farming in South India, as well as chicory farming in North and West India.

• Nestle is in touch with 2,00,000 farmers. • Nestlé's extensive investment in continuous Research & Development, food technology, and nutritional expertise is a strong competitive advantage.

• The company’s products are constantly bench-marked on the 60/40+ concept. This has two objectives—to gain approval of at least 60% consumers in a taste test against equivalent competitor products and to bring nutritional advantage or an additional nutritional ‘plus’ to the product’s role in die t based on a nutritional profiling system. • Finding ways to reduce saturated fats, sugar and salt content.

• During 2013, over 1,700 farmers were provided training on NESCAFÉ Better Farming Practices, as well as soil testing/recommendations. • Nestle has been rolling out the Healthy Kids Programme in association with leading universities to help students in village schools understand the basics of nutrition, good health and balanced diets from locally available foods.

• The company is focusing on reinforcing fundamentals of growth drivers, further improving operational efficiencies and rationalising stock keeping units (SKUs).

• During CY13, Nestlé Continuous Excellence has been rolled out across all locations in India for cost saving initiatives.

Packaged foods • Maggi maintained its lead and is ranked the No.1 food brand as per Brand Equity.

• In CY13, it launched Maggi Hungroo and Maggi Magical Masala Noodles keeping in mind consumer preferences.

4 Edelweiss Securities Limited Nestle India

• Maggi soups, that was renovated and launched towards the end of CY12, continued to receive positive feedback from consumers.

Chocolate and confectionery • Chocolate and confectionery business continues to grow steadily and maintained its leadership in the chocolatey wafer segment for lighter eating with Nestlé Kitkat, NESTLÉ MUNCH and whites with Nestlé MILKYBAR. • As per Brand Equity NESTLÉ MUNCH, KITKAT & NESTLÉ Milk Chocolate are in the top 5 chocolate brands in India.

• In the strategy towards premiumisation ALPINO was launched in CY13.

Milk products and nutrition • This business sustained its performance and focused on renovating products in line with consumer insights and emerging science based knowledge.

• The business continued its efforts to educate consumers on the importance of nurturing healthier and happier generations and organised several initiatives. • Nestle launched the “Superbaby” campaign to promote breastfeeding during World Breastfeeding Week.

• With support from Nestlé R&D, Nestle launched NAN PRO1, an Infant Formula with probiotics.

• The performance of NESTLÉ EVERYDAY Dairy Whitener was adversely affected due to overall slowdown in the dairy whitener category, driven by increase in availability of liquid milk in key markets of North and East.

Coffee and beverages • This business clocked good growth in CY13 with both the coffee brands NESCAFÉ and NESCAFÉ SUNRISE delivering good growth.

• Relaunch of NESCAFÉ in new, premium jars and focus shift to cups led the brand’s growth.

• NESCAFÉ SUNRISE launched a new, customized blend – SUNRISE Strong for the Andhra Pradesh market, which led to a strong performance in the state. • NESTLÉ PROFESSIONAL, the out-of-home segment, continued to further strengthen its leadership in the coffee vending solutions business.

• The launch of new NESCAFÉ solutions in office will commence in CY14.

Reach • Focus in CY13 was to improve availability in a sustained manner even in secondary and tertiary towns.

• Nestle added another 2,45,000 outlets in CY13.

• The company has invested in improving sales automation systems to enhance productivity of sales force.

• Nestle is strengthening partnerships with customers in organised trade.

5 Edelweiss Securities Limited Consumer Goods

Financials • Net domestic sales grew 7.1% YoY contributed by net realisations and volume growth in the main product categories. Export sales surged 47.1% YoY primarily due to export to affiliates.

• Export sales was helped by good sales of coffee and infant-nutrition products to affiliate companies. Also, exports of culinary products picked up in some new markets. • Depreciation and amortization increased due to expansion in production capacities made over CY12 together with amortisation of capitalised borrowing costs and exchange differences. • Provision for contingencies increased further by INR620.5mn resulting mainly from issues, which are under litigation/dispute and other uncertainties requiring management judgement. • Nestle has recommended a final dividend of INR12.5 per share for CY13 in addition to the two interim dividends aggregating to INR36 during CY13 (total dividend of INR48.5).

CY14 • CY14 has commenced with caution coupled with the impending general elections which may further increase uncertainties and ambiguity. • Nestle is hopeful of sustaining its performance through calibrated steps.

Chart 1: Domestic sales and exports disappoint 80.0

55.0

30.0 (%) 5.0

(20.0)

(45.0) Q1CY10 Q2CY10 Q3CY10 Q4CY10 Q1CY11 Q2CY11 Q3CY11 Q4CY11 Q1CY12 Q2CY12 Q3CY12 Q4CY12 Q1CY13 Q2CY13 Q3CY13 Q4CY13 Q1CY14

Exports growth Net domestic sales growth Net sales growth

Source: Company, Edelweiss research

6 Edelweiss Securities Limited Nestle India

Chart 2: EBITDA margin declines YoY 30.0

24.0

18.0 (%) 12.0

6.0

0.0

Q1CY10 Q2CY10 Q3CY10 Q4CY10 Q1CY11 Q2CY11 Q3CY11 Q4CY11 Q1CY12 Q2CY12 Q3CY12 Q4CY12 Q1CY13 Q2CY13 Q3CY13 Q4CY13 Q1CY14

Chart 3: COGS as % of sales increase YoY 52.0

50.0

48.0 (%) 46.0

44.0

42.0 Q1CY10 Q2CY10 Q3CY10 Q4CY10 Q1CY11 Q2CY11 Q3CY11 Q4CY11 Q1CY12 Q2CY12 Q3CY12 Q4CY12 Q1CY13 Q2CY13 Q3CY13 Q4CY13 Q1CY14

Chart 4: Other expenses as a % of sales increase YoY 26.0

24.8

23.6 (%) 22.4

21.2

20.0

Q1CY10 Q2CY10 Q3CY10 Q4CY10 Q1CY11 Q2CY11 Q3CY11 Q4CY11 Q1CY12 Q2CY12 Q3CY12 Q4CY12 Q1CY13 Q2CY13 Q3CY13 Q4CY13 Q1CY14 Source: Company, Edelweiss research

7 Edelweiss Securities Limited Consumer Goods

Chart 5: Tax rate 40.0

32.0

24.0 (%) 16.0

8.0

0.0

Q1CY10 Q2CY10 Q3CY10 Q4CY10 Q1CY11 Q2CY11 Q3CY11 Q4CY11 Q1CY12 Q2CY12 Q3CY12 Q4CY12 Q1CY13 Q2CY13 Q3CY13 Q4CY13 Q1CY14 Source: Company, Edelweiss research

Table 1: Overall volume growth Period Volume growth (% YoY) CY03 10.2 CY04 5.1 CY05 4.9 CY06 8.3 CY07 13.8 CY08 16.9 CY09 14.9 CY10 17.0 CY11 6.8 CY12 0.8 CY13 1.9 Source: Company, Edelweiss research

Table 2: Segmental performance CY04 CY05 CY06 CY07 CY08 CY09 CY10 CY11 CY12 CY13 Milk Products & Nutrition Volume growth (% YoY) 7.4 2.7 2.9 5.4 10.1 13.1 7.6 2.5 (5.1) (1.1) Price growth (% YoY) 1.6 6.1 6.3 16.3 11.7 5.4 11.6 17.8 21.4 6.7 Beverages Volume growth (% YoY) (4.0) (1.6) (9.2) 7.9 0.0 (3.1) 13.2 0.9 (5.0) 9.3 Price growth (% YoY) 0.8 12.1 14.4 10.6 10.9 3.6 (1.2) 17.8 10.6 7.9 Prepared dishes and cooking aids Volume growth (% YoY) 3.8 8.5 20.0 24.8 30.1 21.7 24.4 13.2 8.0 3.8 Price growth (% YoY) (1.0) 9.9 (0.7) 4.6 3.5 4.3 3.9 10.3 4.4 7.0 Chocolate & confectionary Volume growth (% YoY) 9.9 11.3 15.8 17.6 12.4 9.7 21.2 (1.5) (9.4) (2.2) Price growth (% YoY) (6.3) (0.3) 2.3 6.1 6.3 3.5 4.3 14.4 17.3 12.4 Source: Company, Edelweiss research

8 Edelweiss Securities Limited Nestle India

Outlook and valuations: Fairly valued; maintain ‘HOLD’ Nestle continues to grow slower than peers like GSK Consumer, Britannia, Dabur (foods) and HUL (foods). This is due to lack of aggression on innovations and new product launches which we believe need to pick up to drive volume growth. Although domestic sales remain subdued, the company has ample capacity to meet demand due to the commissioning of new factories. We hope that the new Managing Director, Mr Etienne Benet will bring in higher aggression and renewed focus by revitalising the product portfolio through new product launches and innovations. We are yet to see any positive impact on financials after seven months of Mr. Etienne Benet (new MD) taking over. We maintain our target of 34x CY15E to arrive at a target price of INR5,277. We maintain ‘HOLD’ recommendation and ‘Sector Underperformer’ rating.

9 Edelweiss Securities Limited Consumer Goods

Financial snapshot (INR mn) Year to December Q1CY14 Q1CY13 % change Q4CY13 % change CY13 CY14E CY15E Net revenues 23,135 22,481 2.9 22,523 2.7 90,619 102,155 115,970 Other operating income 81 73 10.7 107 (24.6) 392 936 905 Total operating income 23,215 22,554 2.9 22,630 2.6 91,011 103,091 116,875 Cost of goods sold 10,707 10,158 5.4 10,494 2.0 41,224 47,385 54,062 Employee expenses 1,840 1,710 7.6 1,858 (1.0) 7,415 8,275 9,162 Other expenses 5,732 5,287 8.4 5,496 4.3 22,176 25,437 28,297 Total expenditure 18,279 17,155 6.6 17,847 2.4 70,815 81,096 91,521 EBITDA 4,937 5,399 (8.6) 4,783 3.2 20,196 21,995 25,354 Depreciation 839 821 2.2 757 10.9 3,399 3,566 3,849 EBIT 4,097 4,578 (10.5) 3,927 4.3 16,797 18,429 21,505 Other income (incl. associates) 309 127 143.0 319 (3.0) 831 1,404 1,681 Provision for contingencies 339 323 4.8 83 309.6 621 400 450 EBIT including other income 4,068 4,382 (7.2) 4,163 (2.3) 17,007 19,433 22,736 Interest 103 79 29.4 101 1.5 365 393 399 Exceptionals - - 102 (100.0) 138 - - Profit before tax 3,965 4,302 (7.8) 4,062 (2.4) 16,642 19,040 22,337 Tax 1,374 1,512 (9.1) 1,347 2.0 5,609 6,283 7,371 Core profit 2,592 2,791 (7.1) 2,715 (4.5) 11,033 12,757 14,966 Equity capital (FV INR 10) 964 964 964 964 964 964 No. of shares (mn) 96 96 96 96 96 96 Diluted EPS (INR) 26.9 28.9 (7.1) 29.2 (8.0) 114.4 132.3 155.2

As % of net revenues COGS 46.1 45.0 46.4 45.3 46.0 46.3 Employee cost 7.9 7.6 8.2 8.1 8.0 7.8 Other expenses 24.8 23.5 24.4 24.4 24.7 24.2 EBITDA 21.3 23.9 21.1 22.2 21.3 21.7 EBIT 17.6 20.3 17.4 18.5 17.9 18.4 PBT 17.1 19.1 18.0 18.3 18.5 19.1 Reported net profit 11.2 12.4 12.0 12.1 12.4 12.8 Tax rate 34.6 35.1 33.2 33.7 33.0 33.0

Change in Estimates CY14E CY15E New Old % change New Old % change Comments Net revenue 102,155 104,655 (2.4) 115,970 120,639 (3.9) Subdued domestic and export sales growth EBITDA 21,995 23,469 (6.3) 25,354 27,218 (6.8) Soaring milk prices and increase in A&P spends EBITDA margin 21.3 22.2 21.7 22.4 Core profit 12,757 13,687 (6.8) 14,966 16,132 (7.2) PAT margin 12.4 13.0 12.8 13.3 Source: Edelweiss research

10 Edelweiss Securities Limited Nestle India

Company Description Nestle, a 62.8% subsidiary of its parent Nestlé S.A. of Switzerland, is India’s third largest FMCG company after HUL and ITC. The company set up its first factory at Moga, Punjab, to develop milk production. Over the years, Nestlé has set up seven factories across the country, and is now involved in manufacturing and marketing a range of quality products. It has well-established brands, including Maggi, Nescafe, Lactogen, KitKat, and Milkmaid. Nestlé enjoys leadership position in its core categories like baby foods, instant noodles, and instant coffee. It enjoys a distinct advantage over competitors in the F&B space on account of its strong focus on developing products around the nutrition, health, and wellness platform, and a culture of renovation and innovation in its offerings, backed by strong parent support.

Investment Theme Nestle India (Nestle) is the best play on Indian processed food industry, which is on a high growth trajectory with multiple growth drivers in place, including low penetration levels, rising income levels, urbanisation, and changing lifestyle. Nestlé with established brands across food categories is expected to be a major beneficiary of this growth. Nestle is increasingly focusing to expand into tier II and tier III cities by introducing stock-keeping units (SKUs) below INR 10. Also, company has effectively leveraged its recent innovations/renovation positioned on health and wellness platform to gain incremental sales. Nestle’s high pricing power on account of strong brand equity shall aid in fighting margin pressure despite inflationary concern. Low volume growth in the past couple of quarters is a cause of concern.

Key Risks Sharp increase in input costs Sharp rise in the prices of its key inputs such as milk, wheat flour, edible oils, and sugar could impact margins adversely.

Competition from new entrants GSK Consumer, ITC and HUL entered the noodles category in select markets and this could increase the ad spend for Nestlé. Nestlé also faces competition from dairy cooperatives like Amul and Mother Dairy, which have low focus on maintaining profit margins. Increase in competition could also limit Nestlé’s ability to pass on input price hikes to consumers.

Failure of new product launches Nestlé has launched premium variants in various categories such as chocolates, noodles, ketchup, and dairy products, which could hit margins, in case they do not click in the market.

11 Edelweiss Securities Limited Consumer Goods

Financial Statements Key Assumptions Income statement (INR mn) Year to December CY12 CY13 CY14E CY15E Year to December CY12 CY13 CY14E CY15E Macro Net revenue 83,023 90,619 102,155 115,970 GDP(Y-o-Y %) 6.2 5.0 4.8 5.4 Other Operating Income 323 392 936 905 Inflation (Avg) 8.9 7.4 6.2 5.5 Operating Revenue 83,345 91,011 103,091 116,875 Repo rate (exit rate) 8.5 7.5 8.0 7.8 Materials costs 37,764 41,224 47,385 54,062 USD/INR (Avg) 48.0 54.5 62.0 60.0 Gross profit 45,582 49,787 55,706 62,812 Company Employee costs 6,634 7,415 8,275 9,162 Revenue growth (Y-o-Y %) Other Expenses 16,809 18,222 20,738 23,194 Volume growth (domestic) 4.7 (2.0) 1.6 3.9 Advertisement & sales costs 3,559 3,955 4,699 5,103 Pricing change (domestic) 15.2 14.6 7.7 8.6 EBITDA 18,580 20,196 21,995 25,354 Milk Products & Nutrition vols increase 2.5 (5.1) (1.1) 2.0 Depreciation & Amortization 2,840 3,399 3,566 3,849 Milk Products & Nutrition price increase 17.8 21.4 6.7 9.0 EBIT 15,740 16,797 18,429 21,505 Beverages vols increase 0.9 (5.0) 9.3 8.0 Other income 310 831 1,404 1,681 Beverages price increase 17.8 10.6 7.9 9.0 Provision for contingencies 258 621 400 450 Prepared dishes and cooking aids vols increase 13.2 8.0 3.8 5.0 Interest expenses 266 365 393 399 Prepared dishes and cooking aids price increase 10.3 4.4 7.0 7.0 Profit before tax 15,526 16,642 19,040 22,337 Chocolate & confectionary vols increase (1.5) (9.4) (2.2) 3.0 Provision for tax 4,847 5,609 6,283 7,371 Chocolate & confectionary price increase 14.4 17.3 12.4 10.0 Net profit 10,679 11,033 12,757 14,966 Excise as % of Gross Sales 2.4 3.3 3.4 3.4 Prior period adjustments (net) - 138 - - EBITDA margin assumptions Profit after minority interest 10,679 11,171 12,757 14,966 COGS as % of sales 47.8 45.3 45.3 46.0 Shares outstanding (mn) 96 96 96 96 Fresh milk as % of sales 25.2 24.4 20.1 19.2 Diluted EPS (INR) 110.8 114.4 132.3 155.2 Milk derivatives as % of sales 11.8 12.4 11.8 11.5 Dividend per share (INR) 48.5 48.5 55.6 65.2 Grain flour as % of sales 8.6 9.8 10.4 10.5 Dividend payout (%) 43.8 41.9 42.0 42.0 Edible oils as % of sales 9.0 8.6 8.2 7.5 Green coffee and chicory as % of sales 8.6 8.6 9.0 9.2 Common size metrics Sugar as % of sales 5.2 5.5 4.8 4.7 Year to December CY12 CY13 CY14E CY15E Packing materials as % of sales 16.4 16.7 17.1 17.4 Materials costs 45.3 45.3 46.0 46.3 Financial assumptions Employee expenses 8.0 8.1 8.0 7.8 Tax rate (%) 30.7 31.2 33.7 33.0 Advertising & sales costs 4.3 4.3 4.6 4.4 Capex (INR mn) 19,532 18,754 4,756 5,853 Depreciation 3.4 3.7 3.5 3.3 Debtor days 4 4 3 4 EBITDA margins 22.3 22.2 21.3 21.7 Inventory days 66 72 66 72 Net profit margins 12.8 12.1 12.4 12.8 Payable days 63 49 52 49 Cash conversion cycle (days) 8 27 17 27 Growth ratios (%) Interest rate on o/standing debt (%) 0.5 2.5 3.1 3.3 Year to December CY12 CY13 CY14E CY15E Dividend as % of net profit 48.3 43.8 41.9 42.0 Revenues 10.8 9.1 12.7 13.5 Yield on cash 22.4 26.7 16.3 17.0 EBITDA 17.9 8.7 8.9 15.3 Net profit 11.1 3.3 15.6 17.3 EPS 11.1 3.3 15.6 17.3

12 Edelweiss Securities Limited Nestle India

Balance sheet (INR mn) Cash flow metrics As on 31st December CY12 CY13 CY14E CY15E Year to December CY12 CY13 CY14E CY15E Equity capital 964 964 964 964 Operating cash flow 16,934 17,964 14,435 18,636 Reserves & surplus 17,020 22,723 29,238 36,881 Investing cash flow (9,408) (4,409) (5,853) (4,200) Shareholders funds 17,984 23,688 30,202 37,846 Financing cash flow (5,132) (5,801) (7,135) (8,222) Borrowings 10,502 11,895 11,395 10,895 Net cash flow 2,394 7,753 1,448 6,215 Deferred tax liability 1,621 2,155 2,155 2,155 Capex (18,754) (4,756) (5,853) (4,200) Sources of funds 30,107 37,737 43,752 50,895 Dividends paid (5,435) (5,471) (6,242) (7,323) Tangible assets 32,043 33,693 34,627 35,278 CWIP (incl. intangible) 3,441 2,947 4,300 4,000 Profitability & efficiency ratios Total net fixed assets 35,484 36,640 38,927 39,278 Year to December CY12 CY13 CY14E CY15E Non current investments - 2,241 2,241 2,241 ROAE (%) 69.5 53.0 47.3 44.0 Current Investments 3,649 6,270 6,270 6,270 ROACE (%) 65.5 58.0 53.5 52.4 Cash and equivalents 2,370 7,494 8,942 15,156 Inventory day 72 66 72 72 Inventories 7,456 7,359 9,282 10,590 Debtors days 4 3 4 4 Sundry debtors 876 843 1,231 1,397 Payable days 49 52 49 49 Loans and advances 1,796 2,253 2,253 2,253 Cash conversion cycle (days) 27 17 27 27 Other current assets 10 43 43 43 Current ratio 0.8 1.0 1.1 1.4 Total current assets (ex cash) 10,138 10,498 12,809 14,283 Trade payable 5,394 6,330 6,361 7,258 Operating ratios Others current liabilities 16,138 19,075 19,075 19,075 Year to December CY12 CY13 CY14E CY15E Total current liabilities & 21,532 25,406 25,436 26,333 Total asset turnover 4.3 2.7 2.5 2.5 Net current assets (ex cash) (11,395) (14,908) (12,627) (12,050) Fixed asset turnover 3.5 2.8 3.0 3.3 Uses of funds 30,107 37,737 43,752 50,895 Equity turnover 6.3 4.4 3.8 3.4 Book value per share (INR) 186.5 245.7 313.2 392.5 Valuation parameters

Free cash flow (INR mn) Year to December CY12 CY13 CY14E CY15E Year to December CY12 CY13 CY14E CY15E Diluted EPS (INR) 110.8 114.4 132.3 155.2 Net profit 10,679 11,171 12,757 14,966 Y-o-Y growth (%) 11.1 3.3 15.6 17.3 Add : Non cash charge 3,364 4,246 4,359 4,698 CEPS (INR) 140.2 149.7 169.3 195.1 Depreciation 2,840 3,399 3,566 3,849 Diluted PE (x) 43.3 41.9 36.3 30.9 Others 524 848 793 849 Price/BV (x) 25.7 19.5 15.3 12.2 Gross cash flow 14,044 15,418 17,116 19,664 EV/Sales (x) 5.6 5.1 4.5 3.9 Less: Changes in WC 2,938 1,872 2,680 1,027 EV/EBITDA (x) 25.1 22.8 20.9 17.8 Operating cash flow 11,106 13,546 14,435 18,636 Dividend yield (%) 1.0 1.0 1.2 1.4 Less: Capex 18,754 4,756 5,853 4,200 Free cash flow (7,647) 8,790 8,582 14,436

Peer comparison valuation Market cap Diluted PE (X) EV/EBITDA (X) ROAE (%) Name (USD mn) CY14E CY15E CY14E CY15E CY14E CY15E Nestle Ltd 7,902 36.3 30.9 20.9 17.8 47.3 44.0 Colgate 3,217 32.8 28.8 23.6 20.6 97.5 98.0 Dabur 5,538 31.2 26.3 23.9 19.8 35.4 34.1 Emami 1,679 22.9 19.8 19.7 16.5 40.0 36.9 GlaxoSmithKline Consumer Healthcare 2,931 28.5 24.3 18.6 15.5 30.9 30.8 Godrej Consumer 4,543 29.6 24.1 20.6 17.0 22.3 23.5 Hindustan Unilever 21,007 31.4 28.4 22.6 20.2 85.6 74.4 ITC 48,262 28.1 24.4 18.4 15.9 37.1 38.2 Marico 2,530 25.7 21.2 16.3 13.3 22.0 21.9 Median - 29.6 24.4 20.6 17.0 37.1 36.9 AVERAGE - 29.7 25.4 20.5 17.4 46.5 44.6 Source: Edelweiss research

13 Edelweiss Securities Limited Consumer Goods

Additional Data Directors Data Mr. Antonio Helio Waszyk Chairman & Managing Director, Executive Director Mr. Shobinder Duggal Director - Finance & Control, Executive Director Mr. Christian Schmid Director - Technical, Executive Director Dr. Rakesh Mohan Non-Executive & Independent Mr. Ashok Kumar Mahindra Non-Executive & Independent Mr. Ravinder Narain Non-Executive & Independent Mr. Michael W. O. Garrett Non-Executive & Independent Dr. Swati A. Piramal Non-Executive & Independent Mr. Richard Sykes Non-Executive

Auditors - A. F. Ferguson & Co.

Top 10 holdings Perc. Holding Perc. Holding Life Insurance Corp of India 2.49 Arisaig Partners Asia Pte Ltd 1.90 Aberdeen Asset Management Plc 1.75 Harris Trust & Savings Bank 1.01 Vontobel Asset Management Ag 0.85 Vanguard Group Inc 0.42 UTI Asset Management Co Ltd 0.37 Tata AIA Life Insurance 0.34 Blackstone Asia Advisors Llc 0.33 First State Investments 0.33 *as per last available data

Bulk Deals Data Acquired / Seller B/S Qty Traded Price

No Data Available

*in last one year

Insider Trades Reporting Data Acquired / Seller B/S Qty Traded

No Data Available

*in last one year

14 Edelweiss Securities Limited RATING & INTERPRETATION

Company Absolute Relative Relative Company Absolute Relative Relative reco reco risk reco reco Risk Asian Paints BUY SP M Bajaj Corp HOLD SU H Colgate HOLD SP M Dabur BUY SO M Emami BUY SP H GlaxoSmithKline Consumer HOLD SP M Healthcare Godrej Consumer BUY SP H Hindustan Unilever REDUCE SU L ITC BUY SO L Marico BUY SO M Nestle Ltd HOLD SU L Pidilite Industries BUY SP M United Spirits BUY SP H

ABSOLUTE RATING

Ratings Expected absolute returns over 12 months

Buy More than 15%

Hold Between 15% and - 5%

Reduce Less than -5%

RELATIVE RETURNS RATING

Ratings Criteria Sector Outperformer (SO) Stock return > 1.25 x Sector return

Sector Performer (SP) Stock return > 0.75 x Sector return

Stock return < 1.25 x Sector return

Sector Underperformer (SU) Stock return < 0.75 x Sector return

Sector return is market cap weighted average return for the coverage universe within the sector

RELATIVE RISK RATING

Ratings Criteria

Low (L) Bottom 1/3rd percentile in the sector

Medium (M) Middle 1/3rd percentile in the sector

High (H) Top 1/3rd percentile in the sector

Risk ratings are based on Edelweiss risk model

SECTOR RATING

Ratings Criteria Overweight (OW) Sector return > 1.25 x Nifty return

Equalweight (EW) Sector return > 0.75 x Nifty return

Sector return < 1.25 x Nifty return

Underweight (UW) Sector return < 0.75 x Nifty return

15 Edelweiss Securities Limited Consumer Goods

Edelweiss Securities Limited, Edelweiss House, off C.S.T. Road, Kalina, Mumbai – 400 098. Board: (91-22) 4009 4400, Email: [email protected] Vikas Khemani Head Institutional Equities [email protected] +91 22 2286 4206 Nischal Maheshwari Co-Head Institutional Equities & Head Research [email protected] +91 22 4063 5476

Nirav Sheth Head Sales [email protected] +91 22 4040 7499

Coverage group(s) of stocks by primary analyst(s): Consumer Goods Asian Paints, Bajaj Corp, Colgate, Dabur, Godrej Consumer , Emami, Hindustan Unilever, ITC, Marico, Nestle Ltd, Pidilite Industries, GlaxoSmithKline Consumer Healthcare, United Spirits

Recent Research Date Company Title Price (INR) Recos

13-May-14 GSK Volumes decent; milk prices 4,145 Hold Consumer dent margins; Result Update 09-May-14 United W&M sale deleverages, 2,777 Buy Spirits increases focus; EdelFlash

06-May-14 Emami Volumes dip; Needs to focus 467 Buy on sales rather than margins; Result Update

Distribution of Ratings / Market Cap Edelweiss Research Coverage Universe Rating Interpretation

Buy Hold Reduce Total Rating Expected to

Rating Distribution* 133 40 16 190 Buy appreciate more than 15% over a 12-month period * 1 stocks under review Hold appreciate up to 15% over a 12-month period > 50bn Between 10bn and 50 bn < 10bn

Reduce depreciate more than 5% over a 12-month period Market Cap (INR) 126 55 9

16 Edelweiss Securities Limited Nestle India

DISCLAIMER

General Disclaimer: This report has been prepared by Edelweiss Securities Limited (Edelweiss). Edelweiss, its holding company and associate companies are a full service, integrated investment banking, portfolio management and brokerage group. Our research analysts and sales persons provide important input into our investment banking activities. This report does not constitute an offer or solicitation for the purchase or sale of any financial instrument or as an official confirmation of any transaction. The information contained herein is from publicly available data or other sources believed to be reliable, but we do not represent that it is accurate or complete and it should not be relied on as such. Edelweiss or any of its affiliates/ group companies shall not be in any way responsible for any loss or damage that may arise to any person from any inadvertent error in the information contained in this report. This report is provided for assistance only and is not intended to be and must not alone be taken as the basis for an investment decision. The user assumes the entire risk of any use made of this information. Each recipient of this report should make such investigation as it deems necessary to arrive at an independent evaluation of an investment in the securities of companies referred to in this report (including the merits and risks involved), and should consult his own advisors to determine the merits and risks of such investment. The investment discussed or views expressed may not be suitable for all investors. We and our affiliates, group companies, officers, directors, and employees may: (a) from time to time, have long or short positions in, and buy or sell the securities thereof, of company (ies) mentioned herein or (b) be engaged in any other transaction involving such securities and earn brokerage or other compensation or act as advisor or lender/borrower to such company (ies) or have other potential conflict of interest with respect to any recommendation and related information and opinions. This information is strictly confidential and is being furnished to you solely for your information. This information should not be reproduced or redistributed or passed on directly or indirectly in any form to any other person or published, copied, in whole or in part, for any purpose. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject Edelweiss and affiliates/ group companies to any registration or licensing requirements within such jurisdiction. The distribution of this report in certain jurisdictions may be restricted by law, and persons in whose possession this report comes, should inform themselves about and observe, any such restrictions. The information given in this report is as of the date of this report and there can be no assurance that future results or events will be consistent with this information. This information is subject to change without any prior notice. Edelweiss reserves the right to make modifications and alterations to this statement as may be required from time to time. However, Edelweiss is under no obligation to update or keep the information current. Nevertheless, Edelweiss is committed to providing independent and transparent recommendation to its client and would be happy to provide any information in response to specific client queries. Neither Edelweiss nor any of its affiliates, group companies, directors, employees, agents or representatives shall be liable for any damages whether direct, indirect, special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information. Past performance is not necessarily a guide to future performance. The disclosures of interest statements incorporated in this report are provided solely to enhance the transparency and should not be treated as endorsement of the views expressed in the report. Edelweiss Securities Limited generally prohibits its analysts, persons reporting to analysts and their dependents from maintaining a financial interest in the securities or derivatives of any companies that the analysts cover. The information provided in these reports remains, unless otherwise stated, the copyright of Edelweiss. All layout, design, original artwork, concepts and other Intellectual Properties, remains the property and copyright Edelweiss and may not be used in any form or for any purpose whatsoever by any party without the express written permission of the copyright holders.

Analyst Certification: The analyst for this report certifies that all of the views expressed in this report accurately reflect his or her personal views about the subject company or companies and its or their securities, and no part of his or her compensation was, is or will be, directly or indirectly related to specific recommendations or views expressed in this report.

Analyst holding in the stock: No.

Edelweiss shall not be liable for any delay or any other interruption which may occur in presenting the data due to any reason including network (Internet) reasons or snags in the system, break down of the system or any other equipment, server breakdown, maintenance shutdown, breakdown of communication services or inability of the Edelweiss to present the data. In no event shall the Edelweiss be liable for any damages, including without limitation direct or indirect, special, incidental, or consequential damages, losses or expenses arising in connection with the data presented by the Edelweiss through this presentation.

17 Edelweiss Securities Limited Consumer Goods

Disclaimer for U.S. Persons This research report is a product of Edelweiss Securities Limited, which is the employer of the research analyst(s) who has prepared the research report. The research analyst(s) preparing the research report is/are resident outside the United States (U.S.) and are not associated persons of any U.S. regulated broker-dealer and therefore the analyst(s) is/are not subject to supervision by a U.S. broker-dealer, and is/are not required to satisfy the regulatory licensing requirements of FINRA or required to otherwise comply with U.S. rules or regulations regarding, among other things, communications with a subject company, public appearances and trading securities held by a research analyst account. This report is intended for distribution by Edelweiss Securities Limited only to "Major Institutional Investors" as defined by Rule 15a-6(b)(4) of the U.S. Securities and Exchange Act, 1934 (the Exchange Act) and interpretations thereof by U.S. Securities and Exchange Commission (SEC) in reliance on Rule 15a 6(a)(2). If the recipient of this report is not a Major Institutional Investor as specified above, then it should not act upon this report and return the same to the sender. Further, this report may not be copied, duplicated and/or transmitted onward to any U.S. person, which is not the Major Institutional Investor. In reliance on the exemption from registration provided by Rule 15a-6 of the Exchange Act and interpretations thereof by the SEC in order to conduct certain business with Major Institutional Investors, Edelweiss Securities Limited has entered into an agreement with a U.S. registered broker-dealer, Enclave Capital, LLC ("Enclave"). Transactions in securities discussed in this research report should be effected through Enclave Capital, LLC. Disclaimer for U.K. Persons The contents of this research report have not been approved by an authorised person within the meaning of the Financial Services and Markets Act 2000 ("FSMA"). In the United Kingdom, this research report is being distributed only to and is directed only at (a) persons who have professional experience in matters relating to investments falling within Article 19(5) of the FSMA (Financial Promotion) Order 2005 (the “Order”); (b) persons falling within Article 49(2)(a) to (d) of the Order (including high net worth companies and unincorporated associations); and (c) any other persons to whom it may otherwise lawfully be communicated (all such persons together being referred to as “relevant persons”). This research report must not be acted on or relied on by persons who are not relevant persons. Any investment or investment activity to which this research report relates is available only to relevant persons and will be engaged in only with relevant persons. Any person who is not a relevant person should not act or rely on this research report or any of its contents. This research report must not be distributed, published, reproduced or disclosed (in whole or in part) by recipients to any other person. Disclaimer for Canadian Persons This research report is a product of Edelweiss Securities Limited ("ESL"), which is the employer of the research analysts who have prepared the research report. The research analysts preparing the research report are resident outside the Canada and are not associated persons of any Canadian registered adviser and/or dealer and, therefore, the analysts are not subject to supervision by a Canadian registered adviser and/or dealer, and are not required to satisfy the regulatory licensing requirements of the Ontario Securities Commission, other Canadian provincial securities regulators, the Investment Industry Regulatory Organization of Canada and are not required to otherwise comply with Canadian rules or regulations regarding, among other things, the research analysts' business or relationship with a subject company or trading of securities by a research analyst. This report is intended for distribution by ESL only to "Permitted Clients" (as defined in National Instrument 31-103 ("NI 31-103")) who are resident in the Province of Ontario, Canada (an "Ontario Permitted Client"). If the recipient of this report is not an Ontario Permitted Client, as specified above, then the recipient should not act upon this report and should return the report to the sender. Further, this report may not be copied, duplicated and/or transmitted onward to any Canadian person. ESL is relying on an exemption from the adviser and/or dealer registration requirements under NI 31-103 available to certain international advisers and/or dealers. Please be advised that (i) ESL is not registered in the Province of Ontario to trade in securities nor is it registered in the Province of Ontario to provide advice with respect to securities; (ii) ESL's head office or principal place of business is located in India; (iii) all or substantially all of ESL's assets may be situated outside of Canada; (iv) there may be difficulty enforcing legal rights against ESL because of the above; and (v) the name and address of the ESL's agent for service of process in the Province of Ontario is: Bamac Services Inc., 181 Bay Street, Suite 2100, Toronto, Ontario M5J 2T3 Canada.

Copyright 2009 Edelweiss Research (Edelweiss Securities Ltd). All rights reserved

Access the entire repository of Edelweiss Research on www.edelresearch.com

18 Edelweiss Securities Limited