Foods & Beverages | INDIA CONSUMER RELATED NOMURA FINANCIAL ADVISORY AND SECURITIES (INDIA) PRIVATE LIMITED Manish Jain +91 22 4037 4186 [email protected] NEW Anup Sudhendranath +91 22 4037 5406 [email protected] THEME ANCHOR REPORT Young and hungry Stocks for action While India’s middle-class consumption story remains a strong long-term theme, we Within the Indian consumer sector, we think the high-profile hygiene and personal care (HPC) subsector is already beyond prefer the food space vs personal care. the penetration phase, and further growth will have to be squeezed out from Our top BUYs are Jubilant Foodworks increasingly stiff competition. Traditional large HPC categories, such as soaps and and GSK Consumer, while we are detergents, have reached 90% or more penetration in both urban and rural markets. NEUTRAL on Nestle as we see shares On the other hand, the organised food space continues to be underpenetrated at less as fairly valued. Hindustan Unilever than 25%, even in urban areas, and this is where we see the next big investment story remains our top REDUCE idea. In this as rising incomes seek out consumption upgrades and create demand for packaged report, we also include an update on foods, health foods and non-traditional cuisine. As economic growth spreads into the QSR’s (Malaysia) India story. rural heartland, we think this trend will intensify. Our top picks on this theme are Jubilant Foodworks (exclusive franchisee for Dominos Pizza in India) and GSK Price Price Stock Rating (Rs) target Consumer (market leader in health drinks). We have two-year earnings CAGR Jubilant Foodworks (JUBI IN) BUY* 499 620 forecasts of 36% on average for food companies, putting them significantly ahead of GSK Consumer Healthcare BUY* 2,101 2,505 the HPC average of 14%. While current valuations for the food sector are at a 15% (SKB IN) Nestle (NEST IN) NEUTRAL 3,391 3,525 premium, we believe they should be higher given the longer-term opportunity. ITC (ITC IN) BUY 157 200 Hindustan Unilever (HUVR IN) REDUCE 276 222 We prefer food over hygiene and personal care Upgrading from Reduce to NEUTRAL.* Initiating coverage; Note: 16 February 2011 local prices Growth drivers in place Analysts Modern retail to play a critical role Manish Jain +91 22 4037 4186 Incumbents to have a strong advantage [email protected] Jubilant Foodworks and GSK Consumer our preferred picks Anup Sudhendranath +91 22 4037 5406 Nomura Anchor Reports examine the key themes and value drivers that underpin our [email protected] sector views and stock recommendations for the next 6 to 12 months. Any authors named on this report are research analysts unless otherwise indicated. See the important disclosures and analyst certifications on pages 157 to 160. Nomura 21 February 2011 Foods & Beverages | INDIA CONSUMER RELATED NOMURA FINANCIAL ADVISORY AND SECURITIES (INDIA) PRIVATE LIMITED Manish Jain +91 22 4037 4186 [email protected] NEW Anup Sudhendranath +91 22 4037 5406 [email protected] THEME Action Stocks for action We believe the food segment within the consumer sector will lead the next phase of Within the Indian consumer sector, we growth, while hygiene & personal care (HPC) growth will be more muted due to prefer the food space vs personal care. greater penetration levels in urban and rural markets. Changing lifestyles, Our top BUYs are Jubilant Foodworks increased urbanisation, growing incomes and increasing need for convenience and GSK Consumer, while we are imply that packaged food will be a key growth driver for FMCG. We initiate NEUTRAL on Nestle as we see shares as fairly valued. Hindustan Unilever coverage of SKB IN and JUBI IN with BUY calls and upgrade Nestlé to NEUTRAL. remains our top REDUCE idea. In this Catalysts report, we also include an update on Superior earnings growth and better profitability will likely lead the food sector to QSR’s (Malaysia) India story. grow faster than HPC and this will be reflected in P/Es, in our view. Price Stock Rating Price target Anchor themes Jubilant Foodworks (JUBI IN) BUY* 499 620 GSK Consumer Healthcare (SKB IN) BUY* 2,101 2,505 We believe over the medium term, the food sector will grow faster than HPC in Nestle (NEST IN) NEUTRAL 3,391 3,525 ITC (ITC IN) BUY 157 200 India from lower penetration and increased consumption. We are more upbeat on Hindustan Unilever (HUVR IN) REDUCE 276 222 the long-term growth story of the food sector than that of HPC. Upgrading from Reduce to NEUTRAL. * Initiating coverage Note: Pricing as of 16 February, 2011; local currency Young and hungry Analysts Manish Jain We prefer food over HPC +91 22 4037 4186 [email protected] Within India’s consumer sector, we believe food offers more long-term growth visibility than HPCs, and will likely lead sector growth over the next decade. Rising Anup Sudhendranath commodity costs, intensifying competition, high price elasticity of demand and +91 22 4037 5406 deep penetration imply that growth in HPC over the long term may continue to lag [email protected] that in the food sector. Growth drivers in place We believe that the Indian food sector is likely to register steady sales growth in the high teens over the next decade on rising penetration, increasing urbanisation and lifestyle changes. Over the medium term, the food sector will likely also benefit from a shift towards branded and organised packaged foods. Modern retail to play a critical role We believe that over the next decade, the evolution of modern retail will play a critical role in the growth rate of the food sector. A wider availability of products, focus on increasing consumption and supply chain efficiencies suggest faster growth prospects. Private labels will play a critical part in expansion of emerging categories, in our view. Incumbent to have a strong advantage Given brand loyalty and rigid consumer preferences, we believe the incumbent advantage is strong in the food sector. Companies with strong mother brands have greater pricing power, which will likely help in combating commodity price inflation and maintaining profitability. Jubilant and GSK consumer our preferred picks in food We believe that given strong incumbent advantage, GSK Consumer and Jubilant Foodworks will be the key beneficiaries and initiate on both stocks with BUYs. We upgrade Nestle to NEUTRAL (from Reduce) as valuations remain high. Nomura 1 21 February 2011 Foods & Beverages | India Manish Jain Contents Industry snapshot 4 Executive summary 8 India consumer: growth momentum picking up … 10 … primarily aided by the food segment 10 HPC has been the big laggard 10 Consistency of growth food vs. HPC 11 Where we stand today 13 Industry dynamics: food and HPC 14 Learning from the HPC industry 15 Competition in food and HPC 16 Expect food to lead sector growth 17 Long-term growth drivers in place 19 Organised food market still in infancy 19 Huge rural opportunity still to be tapped 19 Even urban markets are still fairly underpenetrated 22 Newer and emerging categories to grow fastest 26 A tale of two giants: HUL vs Nestlé India 27 Growth and profitability: Nestlé wins hands down 27 Competition: a consistent issue with HUL 28 Challenges in the food space 30 Food inflation a cause for concern 30 Food availability may also be an issue 32 Low success rate in new food product launches 33 Heterogeneity of the market is a big challenge 35 Indian consumer still evolving 36 Future trends 38 Dining in vs eating out 38 Competition continues to rise 39 Innovation is key to success 39 Regulatory environment to get tougher 40 Role of modern retail 42 Evolution of modern retail key to driving FMCG sales 42 F&B segment to lead the way 42 Consumer wallet still dominated by Food & Beverage 43 Private labels – a modern retail phenomenon 43 Modern retail to help convert non-users to users 46 Modern Retail’s role in developing the supply chain 47 Nomura 2 21 February 2011 Foods & Beverages | India Manish Jain Global food industry 48 Global food opportunity is evolving 48 However consumer preferences across regions different 48 Food inflation to be a global concern 48 India to follow global trends 49 The China example 49 Valuations reflects higher growth 50 Feedback from company visits 51 Marico on the foods business 51 Pantaloon on the food business 52 KFC on the India opportunity 56 ITC on the food category 58 Future value retail on food business 59 Bharti Wal-Mart on cash and carry business 59 Jubilant Foodworks on what’s made it successful 61 Latest company views Jubilant Foodworks 65 GSK Consumer Healthcare 95 Nestle India 122 ITC 130 QSR Brands Berhad 138 Hindustan Unilever 146 Nomura 3 21 February 2011 Foods & Beverages | India Manish Jain Drilling down Industry snapshot Fast moving consumer good (FMCG) sector growth to be led by food… Exhibit 1. FMCG industry: food sector leads growth Exhibit 2. Increased share of food in FMCG Size CY06 Size CY10E CAGR Share CY06 Share CY10E Segment (Rs bn) (Rs bn) (%) Segment (%) (%) Food 299.1 596.4 18.8 Food 40.9 45.9 HPC 292.3 488.9 13.7 HPC 40.0 37.7 Others 139.3 213.2 11.2 Others 19.1 16.4 Total FMCG 730.7 1,298.5 15.5 Total FMCG 100.0 100.0 Source: AC Nielsen Data, Nomura Research Source: AC Nielsen Data, Nomura Research … however, large categories in food still under-penetrated Exhibit 3. Low penetration even in urban markets Category Size (Rs bn) Urban penetration (%) Ice-cream 20 25 Milk powder 8 7 Chocolates 27 28 Ketchup 5 15 Coffee 9 23 Source: Godrej Consumer, Nomura Research FMCG sector growth will be led by the emerging food sector Exhibit 4.