Nestle India - The Unassailable Monopoly
If you think the answer to the above lies in brands such as Nescafe, Maggi, Munch or Kit Kat, think again. Although there is no denying that these are solid power packed brands of Nestle too.
While we briefly touched upon the Investment Rationale for investing in Nestle in our Coffee Can Investment Rationale (Part 1) post, we delve into more detail in this post.
Quoting a famous dialogue delivered by Saif Ali Khan from the movie here,
“Bhao Bhagwan Che” This basically means, PRICE IS GOD in gujarati, a regional local language in india.
What Saif Ali Khan effortlessly does in this one sentence is
Lucidly explain Efficient Market Hypothesis (EMH) which basically suggests that anything and everything that you know about a stock is priced in
High PE Ratio should be seen with respect and not just with doubt or contention (covered in detail below)
Comparing Price with God is exactly the irrational exuberance investors should avoid at all costs without knowing about the business in detail
While most of the products mentioned at the start are visible to the consumer eye and have been consumed by most of us on multiple occasions, what people often tend to miss are their category leading – money making – monopoly brands.
Mind you: me, you, my parents and your parents and probably our children – all have had / will have exposure to this product.
So what are the top 3 brands of Nestle?
CERELAC, LACTOGEN & NAN
This video by Sonjoy Bhattacharya will give you a great perspective on how powerful the brands Lactogen, Cerelac and NAN are and why they will continue to be monopolies in the future, unless of course some new player comes and disrupts it (Similac from Abbott looks like the nearest competitor – but more on that later).
In case you do not wish to watch the video / haven’t watched it, the relevant synopsis is – No mother is going to experiment with her new born baby in trying a new brand for Infant Food or cereal – that is the kind of MOAT – Competitive Advantage that Nestle enjoys for multiple years and will continue to do so.
Let’s look at Nestle’s Investor Presentation
97% value share in the Infant Cereal Market – Let that sink in for a while.
A simple Google search will tell you the number of babies born in India in a day, let’s take a conservative estimate and say that 10% of that number buys Cerelac / Lactogen and NAN and extrapolate that number.
Compare that with the sales of Nestle over the last 10 years – you should have your answer.
Let’s also have a look at the Revenue mix of all the brands (category – wise) that Nestle has –
When Maggi got banned in the country, the stock had corrected from 7,000 to 5,700/5,400 levels – making it one of the most attractive times to enter. While this may be regarded as a Black Swan event that may / may not happen again, it may have given someone who bought at that level tremendous boasting rights to have had bought the stock then to say today that the stock is now trading at 15,000 levels.
While there was no change that happened to the remaining 70% of the revenue mix, it was a fraction of the 30% category of the Company that had got affected (as can be seen from the image above).
Talking about the present context w.r.t. the Covid – 19 pandemic, the stock had recently hit its all time high at almost 17,999 almost bucking the trend and going against the overall market sentiment. More on the price action later.
COST STRUCTURE – THE COMPLEXITY AROUND MILK AND IT’S VALUE CHAIN
Now, while we have talked about the Revenue side, let’s take a focus on the cost side. Most of the raw material cost that Nestle incurs is on Milk (~42%) as per their Investor Presentation.
The Indian milk market has been a really tough nut to crack. Various companies have tried and failed multiple models in this country. The fact that the global diary major Danone came to India and went back should speak volumes about how sourcing milk in India is not an easy game.
There’s a link to a 12+ minute video by CNBC talking about this here.
So much so that when we think of milk only two names pop in our head – Amul and Nestle. While we all know what Amul has done in this country and continues to do so, (GCMMF – Gujarat Co – Operative Milk Marketing Federation is the entity behind Amul), GCMMF is not listed and hence a lot of data is not available in the public domain. This brings us to the closest nation wide listed player – Nestle.
Until recently we have seen a flurry of startups trying to “disrupt” the milk market, along with a host of other established FMCG companies getting into dairy. Who will survive and who will flourish – only time will tell. As we write this article and have 200 other tabs open in our browser, it is disheartening to read that Doodhwala (a dairy based startup) has shut shop.
Coming back to Nestle.
Power packed Brands – Check
Market Leaders in categories that it operates in – Check
Sourcing Strength – Check
Tremendous Barriers to Entry in the Infant Food market – Check
Once again, it was really interesting to hear Saurabh Mukherjea talk about Nestle’s longevity of their Moat around Infant Food here.
To summarize the longevity of Moat around infant food, here are the key points:
Infant Food in India is a prescription drug which means it cannot be advertised in the country The WHO prescribes mother’s breast milk to be the best source of nutrition, thus the Government would be skeptical to grant fresh licenses for manufacturing Infant Food in India Infant food is a high margin, fast moving product. It is rarely discounted and always in demand bought by parents around the year.
Nestle’s numbers have been phenomenal and ticks all the boxes of what Saurabh Mukherjea calls to be a “Classic Compounder” making it a great company. It’s Return on Capital Employed has been consistently higher than 50% going to even 130–140% in some years for decades. The company has planned multiple launches for the future and is presently focusing on giving more extensions to its existing brands.
Anytime it makes over and above what it does – which it does most of the times, it gives it as special dividend – over and above their regular dividend. They have announced a total dividend payout of 255 till December ’19.
Just to give you some perspective, we use the Maggi masala sachet on almost everything from chips to egg whites. It was launched at a price of 3 then 4 and now it’s at 5 within almost a year (pricing power).
We have seen various street food vendors use the masala on almost anything and everything that they sell.
Nescafe Chilled Latte was a product that was long overdue and we can see how that is being consumed all round the year now.
How can we forget our beloved Maggi?
It still has around 20–30 launches planned for the future.
(Every time we do a fresh search about Nestle India, we find new products. For example, this time we found a higher value-added pack for Nescafe and Resource protein. See it for yourself here.)
Should you buy the Nestle stock? – In a nutshell, identify great companies and invest in them – don’t have a trader’s mentality of shortchanging yourself saying – oh look, we bought at 100, exited at 150 only to realize the stock is now at 4,000 8 years later. Think of yourself as a part owner of the Company. Would you want to setup a factory, invest in brands, hire a sales team and fire them after 4 months?
THE HIGH P/E DILEMMA
There is a very popular notion centered around investing which often misinterprets the PE ratio to be directly proportional to being the degree of pricing. At the end of the day, the PE ratio is just a measure of what is the willingness of Investors to pay for a particular stock based on past projections for the future. That assumption by it’s very nature is flawed.
A high PE ratio should always be seen with respect, what it basically tells us that investors or the market today is willing to pay a very high premium to the earnings potential of the stocks based on past performance or future assumptions. This gives a very little margin of safety to the investor who tries to buy this stock. Now this leaves us with two conclusions –
Either the stock of the company is a really great asset to own
The collective wisdom of investors is foolish and the asset has become thoroughly overpriced
Howard Marks has time and again told us a very simple philosophy to investing where you buy an asset cheap and sell it when it becomes expensive to make money. On the other hand you could buy a great company’s stock at a high valuation – think Kodak, Polaroid, AIG, IBM which either went bankrupt or was close to bankruptcy when held over a long period of time.
The examples cited above are again not related to India and India as a market gives us a very unique structure to work with. Coming back to Nestle, their tryst with high PE has stayed in India dating back to almost ’90. You can read more about this here.
KEY FINANCIAL SNAPSHOT
The company follows the calendar year as its financial year. The dip in sales between 2014 and 2015 was on account of the Maggi ban also translating into a drop in share price during that period. Despite the ban, the ROCE of the company was way greater than 15% at 29%. The company has maintained a healthy dividend payout ratio throughout the last 10 years. Both Debtor and Inventory days have been consistent in the range of 3-5 days and 10-12 days respectively.
Disclaimer: This post was written by Saket Mehrotra on his website and has been reproduced here (with certain minor edits) with his kind permission.