Maggi ban hits Nestle hard; task for new CEO Narayanan cut out

Nestle India has reported its first quarterly loss in nearly 15 years as its battle with India's food regulator FSSAI continues over the ban on its iconic Maggi noodles. 

The company had to withdraw Maggi noodles from the domestic market. Reports emerged that it burnt packets worth Rs 320 crore as they were found to have excessive quantities of MSG and lead. The company has been firefighting since, and brought in a new CEO. Currently, Nestle India and FSSAI are slugging it out in the Bombay High Court. 

On the back of this controversy regarding the safety of its flagship food product, Nestle India reported dismal June quarter results. The company reported a net loss of Rs 64.4 crore as against a net profit of Rs 287.86 crore in the same quarter of last year. 

Nestle India reported an exceptional item of Rs 451.66 crore, which "relates to estimates of loss on account of stocks withdrawn including incidental costs thereto and other related costs incurred."

The total income of Nestle India declined sharply by 20% at Rs 1,957 crore. The company said that the ban on Maggi was the result of this sales drop. 

The new CEO Suresh Narayanan said that the quarter was very challenging for the company and it is trying its best to bring Maggi back on the shelves as soon as possible. 

Unfortunately for Nestle, its other segments are also facing headwinds, and the company needs a new robust strategy to regain its position in the market. "We note that Chocolates (segment) are facing competition from Mondelez and Mars, Coffee from Hindustan Unilever’s Bru Gold and Nutrition from Abbott and Med Johnson. We would watch out for Nestle's initiatives in the challenging environment," Amnish Aggarwal and Gaurav Jogani of Prabhudas Lilladher, on July 29 wrote. 

Rajasa Kukulvarapu and Poornaa Venkatesan of Jefferies, in a July 19 report said ,"Nestle has gone through its weakest growth phase in the past three years (c.9% p.a. vs historical average of c.14% p.a.) While excessive focus on margins may have been a factor, one also needs to consider the broad- based slowdown in consumption, especially in urban discretionary categories. Nestle's product and channel rationalization exercise during this period also contributed to the volume weakness, even as it resulted in a stronger margin profile." 

Analysts tracking the company and the sector aren't much enthused about the prospects of the stock price. 

Latika Chopra of JP Morgan, in a report dated June 2 wrote, "We expect the stock to remain weak given the concerns have now spread across various states and Central government has also ordered for an investigation. For Nestle, Maggi brand (of which noodles form a lion's share) accounts for ~30% of its revenue, and is the only segment which is registering positive volume growth in recent quarters. In the past, controversies relating to food safety have taken a toll on the industry as seen in case of lower sales of soft drinks (pesticide issue in mid-2000s) and chocolates (contamination issues in 2003)."

Following the results, Nirmal Bang, in a report dated July 30, said, "Even after adjusting for Maggi noodle reversal of Rs 2.88 billion, net sales of Nestle India declined YoY in 2Q CY15. Losses on account of Maggi noodle problem were higher than anticipated. Moreover, compared to our earlier expectation of the problem getting resolved by July 2015, there are no signs of a re-launch as of now."

The brokerage cut its stock target price and said, "Thus, even as we introduce CY17E EPS and value the company on the average of CY16E EPS and CY17E EPS and keep the valuation multiple unchanged (34x, in line with 10-year average), there is only a marginal increase in our target price to Rs 5,273 (from Rs 5,114 earlier), down 14.3% from the current market price." 

Aggarwal and Jogani of Prabhudas Lilladher, wrote, "We believe that doing estimates without any clarity on the future of Maggi Noodles and various expense heads would be just a theoretical exercise. We believe that the situation remains highly volatile and is subject to fast changes, depending on court verdict and success of NEST in engaging with the regulators to resolve the issue."

They said, "We believe that the coming couple of quarters will continue to have exceptional expenses on account of litigation, testing, stock destruction, permanent employees, facility maintenance and overheads etc, which will distort the reported numbers. However, we believe Q3 numbers would give better clarity on this."

Jefferies Equity Research has initiated a 'buy' call on the stock in its report on July 19, before the company announced its results for the first quarter of current fiscal.  It said, "The business has faced a series of crises in recent years with weak volumes, rising competition and now the Maggi ban. We believe these are largely transitory in nature. We expect Nestle India to ride through this phase, backed by its core strengths – sharp brand positioning, strong urban distribution network and an exceptional supply chain, aided by a recovery in urban discretionary consumption."

Kukulvarapu and Venkatesan of Jefferies, said, "Maggi is at the centre of regulatory action by the Indian food regulator. While a resolution and its timing is hard to predict, the next 2-3 quarters would be weak. the segment accounts for c.28% on Nestle's revenues and c.20-23% of EBITDA. A clean chit by regulators in other countries and history of food-related issues in India suggest that the impact on consumer perception may be limited. We forecast c.45% decline in revenues in CY15E, but factor in c.18% p.a. growth over CY16-17E."

The duo said, "Near-term outlook looks weak; however, we believe concerns are in the price and see limited downside from here. Risks: prolonged and adverse resolution on the Maggi ban; quality lapses and regulatory issues; and prolonged demand weakness."