Analyst: Michelle Weerasinghe NESTLÉ LANKA PLC SRI LANKA Corporate Update HOLD NEST.N0000 Current Price: LKR 2,000.0 Fair Value: LKR 2,100.0 Mar 2016 KEY DATA Share Price (LKR) 2,000.00 52w High/Low (LKR) 2,322.00 / 1,984.20 Average Daily Volume (Shares) 1,699 Average Daily Turnover (LKR) 3,571,329 Issued Share Capital (Shares mn) 53.7 Market Capitalisation (LKR mn) 107,451 Price Performance (%) 1 mth 3 mths 12mths NEST 0% -9% -13% ASPI -5% -12% -15% Major Shareholders as at 31st Dec 2015 Nestle S A 90.82% HSBC International Nominees Ltd-SSBT 0.81% HSBC International Nominees Ltd-SSL 0.64% RBC Investor Services Bank 0.44% Ms Neesha Harnam 0.37% Estimated Free Float 9.18% Figure 1: NEST Price Volume Graph Affordability stirs up demand P/E 31 December 2013 2014 2015 2016E 2017E FY18E Revenue (LKR mn) 30,913 32,903 35,855 40,337 46,185 53,344 Net Profit (LKR mn) 3,317 3,787 4,124 5,274 6,161 7,680 EPS (LKR) 61.7 70.5 76.8 98.2 114.7 140.3 YoY % Growth 13% 14% 9% 28% 17% 22% Valuations PER (x) 32.4 28.4 26.7 20.9 17.9 14.6 PBV (x) 25.5 26.3 24.4 24.1 23.8 23.8 Div Yield (%) 3.0% 3.4% 3.1% 4.7% 5.5% 6.8% NAVPS 78.5 76.1 84.2 85.1 86.3 86.1 DPS (LKR) 60.0 68.5 64.5 97.2 113.5 138.9 Div Payout 97% 97% 84% 99% 99% 99% Nestlé Lanka PLC is expected to keep up its growth momentum to achieve an earnings CAGR of c.23% 2015-2018E. NEST s margins which expanded due to the decline in global commodity prices and energy prices is likely to be maintained amidst the increase in affordability levels of middle income earners driving NEST s volumes. Further, an attractive return is expected from exports revenue contribution due to the rupee depreciation. NEST s expensive multiples sustained by strong growth leads to a fair value of LKR 2,100.0. HOLD Revenue forecast at 14%: FC Research expects revenue to grow by c.49% in 2015-2018E growing at CAGR of c.14% throughout the period. Prices of Nestlé s products fall into the affordability level of Sri Lanka s growing middle income earning segment s rising income (2014 GNI per capita - USD 3,460) leading it to reach out to a wider group of consumers. Nestlé s rapidly growing export contribution (revenue contribution grew to 13% in 2014 from 11% in 2010) dominated by exports is expected to support revenue further, strengthened by the rupee depreciation. Disclosure on Shareholding: Source: CSE First Capital Equities (Pvt) Ltd and any of its affiliates do not hold shares in NEST and will not trade in this share for the seven trading days following the issue of this document. GP margin maintained at 42%: FC Research expects to maintain the GP margin target to reach c.42% by 2016E due to the advantage of lower cost of production. The slump in global oil prices (WTI -4.26% YTD) and the slowdown in Chinese economy have further led global commodity prices collapse making a considerable impact on Nestlé s raw materials such as wheat (-25% Jan-Nov 2015) and sugar (-2% YTD). Further, a growth in NEST s volumes due to economies of scale and price increase in products is further expected amid increased affordability of consumers. NEST overall return of 10% for 1 year period: NEST s strong earnings growth results in a CAGR of c.23% 2015-2018E. Our target price stands at LKR 2,100.0 providing a return of 10% including a dividend yield of 5%. [LKR 2,067.0 DCF based, LKR 2,160.0 PER based, 2,021.0 DDM based]
Figure 2: ASPI vs NEST 1.0 Introduction Local Multinational : Nestle Lanka PLC is engaged in manufacturing, marketing, selling and distribution of food and beverage products. It local portfolio of products carry some of the renowned brands in the country including Nestomalt, Milo, Milkmaid, Nespray and Maggi with 90% of its products being manufactured at its production facility in Kurunegala. Share Price Performance: NEST s price had been ranging between LKR 2,320-2,023 during the last 12 month period. Currently it trades at LKR 2,023, a - 12.8% decline in price since March 2015. With an estimated free float of 9.18% NEST has been recognized as an illiquid counter holding 4.17% of the total market capitalization. 2.0 Revenue to grow at 14% CAGR 2015-18E Source: FC Research 2.1 Growth in purchasing power & per capita GNI Figure 3: GNI per capita shows a steady growth compared to South Asian Region and Lower Middle Income Countries Source: The World Bank and FC Research Estimates GNI to grow at 13%: With the budgetary proposal on increasing the salary of government sector employees by LKR 10,000 in March 2015 together with implementation of several other proposals including reduction of energy prices as well as commodity prices leading to improved purchasing power, we expect Sri Lanka s per capita GNI (Gross National Income) to grow at an annual average of c.13% during 2015-2017E. GNI has grown at 12% CAGR in 2009-2014 and 13% CAGR in 2005-2009 displaying a healthy growth. Sri Lanka s GNI per capita in 2014 stands at USD 3,460, well above average South Asia s per capita GNI (USD 1,496) and that of lower middle income countries (USD 2,012). 2
LKR (mn) FC Research 2.2 Exports continue growth at 15% annually Figure 4: NEST Revenue Classification 13% Figure 5: Export Revenue (Maggi Coconut Milk Powder) 4,500 4,000 3,500 CAGR 15% 2010-14 87% Local Revenue Exports Source: Annual Report 3,000 2,500 2,000 Source: Annual Reports Exports to strengthen revenue: NEST, the world s largest exporter of coconut milk powder is expected to continue to grow its revenue by 15% annually being in line with its historical trend of 15% CAGR 2010-14. NEST s exports of coconut milk powder accounts for a notable 13% of its 2014 revenue, LKR 4.3bn, a shift from 11% in 2010 revenue. Maggi Coconut Milk Powder is solely developed in Sri Lanka and is now exported to nearly 60 countries across the world. Despite volatility in coconut prices, Sri Lanka s coconut milk powder exports have grown both in value and volumes. Figure 6: Marketing, Selling and Distribution Expenses over past 8 quarters Source: Quarterly Financial Reports 2.3 Negative publicity relating to Maggi noodles controversy Marketing expense growth to moderate: Marketing expenses grew by 19.3%YoY in 2015 compared to 16.7%YoY in 2014. Going forward it is expected that these expenses would moderate at c.19% through 2016E- 2017E and c.18% in 2018E. Increase in marketing expenses in the past: For the past 8 quarters marketing expenses had been increasing noticeably. For 4Q2015 and 3Q2015 marketing expenses had increased by 37%YoY for each quarter while marketing to revenue ratio had rocketed to 25% in 4Q2015 from 15% in 1Q2015 due to Maggi noodles controversy in India. In 2015 marketing expenses had increased by 26%YoY compared to 20% in 2014 and 19% in 2013. The increase in marketing expenses and promotional activities carried out to gain market consolidation are expected to boost NEST s revenue from 9% in 2015 to c.13% in 2016E. Sink in Maggi noodles sales: In June 2015 Nestle India destroyed more than USD50m worth of Maggi noodles, following a ban imposed by India's food safety regulator. The regulator stated that tests have found the instant noodles "unsafe and hazardous" and has accused Nestle of failing to comply 3
with food safety laws since it found higher-than-allowed levels of lead in some packets. The negative publicity relating to India s Maggi Noodles controversy deemed to have hampered the revenue growth during 2015 compelling NEST to boost their Marketing, Sales and Distribution expenses affecting the bottom line. 3.0 GP margin maintained at 42% Figure 7: GP margins GP Margins are expected to be maintained at c.42% 2016E- 2018E Margin to be maintained at 42%: NEST recorded a GP Margin of 42% in 4Q2015. We expect NEST s margins to be maintained at the same level (c.42%) by 2016E through 2018E from 40% in 2015 with growing economies of scales and possible increases in prices due to affordability level of consumers. 3.1 Exploiting the declining trend in commodity prices Declining Food Index unlikely to rise: Food and Agriculture Organization of the UN (FAO) Global Food Price Index fell 29% by end of January 2016 continuing the decline since April 2014. UN FAO the four year slump in world food prices is unlikely to recover in the near future provided continuity in high production and low energy costs in the industry. Figure 8: UN FAO s Global Food Index Source: Annual Reports and FC Research estimates Source: FAO 4
Figure 9: Global Wheat Prices Source: FAO Figure 9: Global Raw Sugar Prices Source: OECD Figure 10: Global Raw Sugar Prices Source: OECD Figure 11: Local Retail Fresh Milk Prices Source: Dept. of Animal Production and Health 5
LKR per Litre FC Research 3.2 Favourable energy costs Energy Cost Favourable on NEST: NEST will benefit from the favourable energy cost prevailing in the country. The fuel costs and LP gas prices were slashed as a result of implementation of budget proposals (Diesel -21%YoY, LP Gas -16%YoY). This will help NEST to reduce the cost pressure placed on production as well as selling and distribution. Further, the Sky Lighting system, installed in 2013 which reduces dependency on electrical power and uses day light in a controlled manner inside manufacturing facilities and warehouses is expected to deliver significant savings in electricity in the future. Figure 12: Lanka Auto Diesel Prices 125 120 115 110 105 100 95 90 85 Source: CEYPETCO Figure 13: LP Gas Prices of 12.5kg Cylinder Source: litrogas 6
5.0 Expensive multiples but high growth P/E 31 December 2013 2014 2015 2016E 2017E FY18E Revenue (LKR mn) 30,913 32,903 35,855 40,337 46,185 53,344 Net Profit (LKR mn) 3,317 3,787 4,124 5,274 6,161 7,680 EPS (LKR) 61.7 70.5 76.8 98.2 114.7 140.3 YoY % Growth 13% 14% 9% 28% 17% 22% Valuations PER (x) 32.4 28.4 26.7 20.9 17.9 14.6 PBV (x) 25.5 26.3 24.4 24.1 23.8 23.8 Div Yield (%) 3.0% 3.4% 3.1% 4.7% 5.5% 6.8% NAVPS 78.5 76.1 84.2 85.1 86.3 86.1 DPS (LKR) 60.0 68.5 64.5 97.2 113.5 138.9 Div Payout 97% 97% 84% 99% 99% 99% Expensive multiples sustained by high growth: NEST s revenue is expected to grow 2015E-18E CAGR of c.14% given the expected increase in demand for NEST s products while cost savings are to be achieved by favourable energy costs and commodity prices. Hence FC Research target price for NEST stands at LKR 2,100.0 The target price of LKR 2,100.0 is based on the average price of LKR 2,067.0 via DCF valuations, LKR 2,160.0 via PER based valuations and LKR 2,021.0 via DDM based valuations. 5.1 Fair Value of LKR 2,100.0 Expected NEST price for FY16E DCF Valuation based target price 2,066.9 PER based target price 2,159.8 DDM based target price 2,021.0 Average Target Price 2,082.6 We have obtained the target price of LKR 2,100.0 by rounding off the value calculated by applying the DCF, DDM and PER techniques. Return Target Price 2,100.0 Current Price 2,000.0 Capital Gain (LKR) 100.0 Dividend FY16E (LKR) 97.2 Capital Gain % 5% Dividend Yield % 5% Total Return % 10% 7
5.2 Discounted Cash flow Valuation COE (K e) R f 10% R m 17% 0.51 K e =R f + (R m -R f ) 14% Valuations 2016E NPV 109,454 (+) Cash 1,591 (-) Debt - Total Value of Equity 111,046 No. of shares 54 Value of Equity per share 2,067 WACC Ke 14% Kd 7% D/E Assumption 40 / 60 Terminal Growth (%) 3% WACC 11% Terminal Growth (%) WACC 2067 9% 10% 11% 12% 13% 1% 2157 1925 1726 1587 1461 2% 2415 2122 1878 1712 1563 3% 2759 2375 2067 1863 1685 4% 3240 2712 2310 2053 1834 5% 3961 3184 2632 2297 2020 PER based Valuation FY16E Earnings (LKR 'Mn) 5,274 No. of Shares ('Mn) 54 FY16E EPS 98.17 Expected Average PER 22.0x Price at 22.0x FY16E Earnings 2,159.8 5.3 Average PER of 22.0 times Figure 14: PE Band Graph Source: CSE and FC Research NEST price has been trading between 22.0x 30.0x bands during the last 3 years. We expect NEST to trade at a PER of 22.0x on 2016E earnings by end of 2016E. NEST s 2016E EPS is expected to reach LKR 98.17. At 22.0x earnings, the price for NEST stands at LKR 2,159.8. 5.4 Dividend Discount Model Valuation Valuations 2016E NPV - Dividends 108,582 No. of shares 54 Value of Equity per share 2,021 8
Appendix 1 Income Statement Income Statement (LKR mn) 2013 2014 2015 2016E 2017E 2018E Y/E 31st December Revenue 30,913 32,903 35,855 40,337 46,185 53,344 Cost of Sales -20,252-20,767-21,381-23,395-26,788-30,940 Gross Profit 10,662 12,135 14,474 16,941 19,398 22,405 Other Operating Income / (Expense) -35 92-13 -13-13 -13 Marketing, Selling and Distribution Expenses -4,577-5,502-6,918-7,664-8,775-9,602 Administrative Expenses -1,914-1,966-2,125-2,332-2,510-2,692 Results from Operating Activities 4,135 4,759 5,418 6,932 8,099 10,097 Finance Income 28 33 38 38 38 38 Finance Expenses -80-27 -31-31 -31-31 Net Finance Expense -52 7 8 8 8 8 Profit Before Taxation 4,083 4,766 5,426 6,940 8,107 10,105 Income Tax Expense -766-979 -1,301-1,666-1,946-2,425 Profit for the Year 3,317 3,787 4,124 5,274 6,161 7,680 EPS 61.7 70.5 76.8 98.2 114.7 140.3 Source: Annual Reports and FC Research Estimates 9
Appendix 2 Balance Sheet Balance Sheet (LKR mn) 2013 2014 2015 2016E 2017E 2018E As at 31st December ASSETS Non-Currrent Assets Property, Plant and Equipment 4,572 5,209 5,477 5,570 5,551 5,435 Capital Work-in-Progress 238 206 144 144 144 144 Current Assets 4,810 5,415 5,621 5,713 5,695 5,579 Inventories 2,604 2,953 3,322 2,420 2,771 3,201 Trade and Other Receivables 2,101 1,816 2,107 2,420 2,771 3,201 Amounts Due from Related Parties 228 305 204 204 204 204 Cash and Cash Equivalents 788 283 868 1,591 1,197 1,448 5,720 5,356 6,501 6,636 6,943 8,053 Total Assets 10,530 10,771 12,122 12,349 12,638 13,632 EQUITY AND LIABILITIES Equity Stated Capital 537 537 537 537 537 537 Retained Earnings 3,678 3,551 3,984 4,037 4,099 4,176 4,216 4,088 4,522 4,574 4,636 4,713 Non-Current Liabilities Retirement Benefit Obligations 469 515 522 522 522 522 Deferred Tax Liabilities 460 641 699 699 699 699 929 1,156 1,222 1,222 1,222 1,222 Current Liabilities Trade and Other Payables 2,975 3,765 4,137 4,211 4,286 4,950 Amounts Due to Related Parties 800 749 714 714 714 714 Income Tax Payable 619 706 942 1,043 1,195 1,448 Dividends Payable 88 103 137 137 137 137 Bank Overdrafts 904 205 448 448 448 448 Total Current Liabilities 5,385 5,527 6,379 6,553 6,781 7,698 Total Liabilities 6,314 6,683 7,600 7,775 8,002 8,919 Total Equity and Liabilities 10,530 10,771 12,122 12,350 12,638 13,632 NAVPS 78.5 76.1 84.2 85.1 86.3 86.1 Source: Annual Reports and FC Research Estimates 10
Appendix 3 Cash flow Statement Cash flow Statement (LKR mn) 2013 2014 2015 2016E 2017E 2018E Y/E 31st December Cash Flow from Operating Activities Profit Before Taxation 4,083 4,766 5,426 6,940 8,107 10,105 Adjustments for; Depreciation 540 548 603 657 668 666 Amortisation 11 0 0 0 0 0 Impairment of Fixed Assets 5 11 0 0 0 0 (Gain) / Loss on Sale of Property, Plant and Equipment 2-47 -31 0 0 0 Amortisation of Staff Loan Interest 17 17 18 0 0 0 Interest Expense 80 25 31 31 31 31 Interest Income -28-33 -29-38 -38-38 Provision for Obsolete Inventories 40-8 0 0 0 0 Inventory Written Off 173 160 120 0 0 0 Provision for Impairment of Trade Receivables 6 11 8 0 0 0 Provision for Retirement Benefit Obligations 100 162 99 0 0 0 Net Fair Value Loss on Derivatives 0 1 0 0 0 0 Operating Profit Before Working Capital Changes 5,030 5,612 6,243 7,590 8,767 10,763 Working Capital Changes (Increase) / Decrease in Inventories -944-500 -462 902-351 -430 (Increase) in Trade and Other Receivables -321 196-197 -313-351 -430 Increase / (Decrease) in Trade and Other Payables 801 738 310 74 75 664 Cash Generated From Operations 4,565 6,046 5,894 8,252 8,140 10,568 0 0 0 0 0 0 Interest Paid -80-25 -31-31 -31-31 Income Tax Paid -474-692 -1,000-1,565-1,793-2,172 Retirement Benefit Obligations Paid -108-181 -115 0 0 0 Net Cash Flows Generated from Operating Activities 3,903 5,147 4,110 6,657 6,317 8,365 Cash Flow from Investing Activities Purchase of Property, Plant and Equipment -530-1,166-813 -750-650 -550 Proceeds from Sale of Property, Plant and Equipment 66 49 35 0 0 0 Interest Received 10 16 11 38 38 38 Net Cash Flows Used in Investing Activities -455-1,101-767 -712-612 -512 Cash Flow from Financing Activities Dividends Paid -2,890-3,853-3,001-5,222-6,100-7,603 Net Cash Flows Used in Financing Activities -2,890-3,853-3,001-5,222-6,100-7,603 Net Decrease in Cash and Cash Equivalents 559 193 342 724-395 251 Cash and Cash Equivalents at the Beginning of the Year -675-116 77 419 1,143 748 Cash and Cash Equivalents at the End of the Year -116 77 419 1,143 748 999 Bank Overdrafts -904-205 -448-448 -448-448 Cash in Hand and Balances with Bank 788 283 868 1,591 1,197 1,448 Source: Annual Reports and FC Research Estimates 11
HEAD OFFICE 347 1/1, Dr. Colvin R. De Silva Mawatha, Colombo 2 Sales Desk: +94 11 2145 000 Fax: +94 11 2145 050 BRANCHES 347 1/1, Matara Negombo Dr. Colvin R. De Silva Mawatha, No. 24, 1/3, 2nd Floor, No.72A, 2/1, Colombo 2 Lakshman Cooray Building, Old Chilaw Road, Sales Desk: +94 11 2145 000 Matara First Capital Equities (Pvt) Ltd Anagarika Dharmapala Mw, Negombo Fax: +94 11 2145 050 Tel: +94 41 2237 636 Tel: +94 31 2233 299 SALES BRANCHES CEO Jaliya Wijeratne +94 71 5329 602 Negombo Priyanka Anuruddha +94 76 6910 035 Colombo Priyantha Wijesiri +94 76 6910 036 Damian Le Grand +94 77 7383 237 Nishantha Mudalige +94 76 6910 041 Matara Isuru Jayawardana +94 76 7084 953 Sumeda Jayawardana +94 76 6910 038 Anushka Buddhika +94 77 9553 613 Kapila Weerasinghe +94 71 5329 615 Gamini Hettiarachchi +94 76 6910 039 Thushara Abeyratne +94 76 6910 037 RESEARCH Dimantha Mathew +94 11 2145 016 Amanda Lokugamage +94 11 2145 015 Atchuthan Srirangan +94 11 2145 017 Michelle Weerasinghe +94 11 2145 018 FIRST CAPITAL GROUP HEAD OFFICE BRANCHES No. 2, Deal Place, Matara Kurunegala Kandy Colombo 3 No. 24, 1/3, 2nd Floor, No. 6, 1st Floor, No.213-215, Tel: +94 11 2576 878 Lakshman Cooray Building, Union Assurance Building, Peradeniya Road, Anagarika Dharmapala Mawatha, Rajapihilla Mawatha, Kandy Matara Kurunegala Tel: +94 41 2222 988 Tel: +94 37 2222 930 Tel: +94 81 2236 010 Disclaimer: This Review is prepared and issued by First Capital Equities (Pvt) Ltd. and is based on information available in the public domain, internally developed and other sources believed to be correct. Although all reasonable care has been taken to ensure that the contents of this document are accurate, First Capital Equities (Pvt) Ltd and its Directors and employees, are not responsible for its accuracy, usefulness and reliability and disclaim liability for any loss suffered by the use of information contained herein. First Capital Equities (Pvt) Ltd may act as a Broker in the investments which are the subject of this document or any related investments and may have acted on or have used the information contained in this document, or the research or analysis on which it is based, before its publication.