Financial Statement Analysis - Nestle

ABS TRA CT Nest lé India , oper atin g in the FMC G sect or, is a subs idiar

Project Course name: Financial Management II

Nestle – Financial Statement Analysis

FAS Group No: E2 Ashish Rakheja Pankaj Deshpande Sarthak Chandra Shruti Shukla Sreeda P

15F113 15F134 15F144 15F148 15F153

TERM 3 – 2016 T A PAI MANAGEMENT INSTITUTE, MANIPAL

Table of Contents 1. Introduction to FMCG Industry....................................................................3 2. Nestle – An Overview.................................................................................... 3 3. Common Size and Trend Analysis...............................................................4 3.1 Common Size Analysis of Income Statement......................................................4 3.2 Trend Analysis – Income statement.....................................................................5 3.3 Common Size of Balance Sheet..........................................................................5 3.4 Trend Analysis of Balance Sheet.........................................................................6 4. Financial Forecasting.................................................................................... 7 4.1 Pre-forecasting Ratios......................................................................................... 8 4.2 Post Forecasting Ratios..................................................................................... 10 5. Dividend Policy............................................................................................. 11 6. Working Capital Financing Policy..............................................................12 References........................................................................................................ 13

1. Introduction to FMCG Industry In 2015, globally FMCG industry faced with two main challenges.  

Continued negative growth in people’s disposable incomes Changing consumer attitudes toward products and brands

To respond to this challenge companies must take alternate routes to reach to customers. It is anticipated that global FMCG ecommerce will have an increase of $17 billion in sales by the end of 2016. It is also expected that Asia will be the next major growth market.[1] As per the report by AC Nielsen, the market size of FMCG sector in India is estimated to grow by 12% in 2016 with food products accounting for 43% of the overall market. [2] Nestle being one of the prominent player in the food and beverage segment in India it is necessary to analyse their financial performance over the years and correlate it with their strategies.

2. Nestle – An Overview Nestlé India has a presence in milk & nutrition, beverages, ready-to-cook food & cooking aids and chocolate & confectionery segments of the Indian FMCG market. About 20% of Nestle India’s revenue comes from the sales of Maggi – their flagship product in the ready-to-cook food segment. With the FSSAI issuing a ban on Maggi on June 5 th, 2015 Nestle reported a net loss of INR 64.40 crores in the second quarter ended June 30, 2015. [3] This further led to a decrease in net sales by 17.2% by the year end of 2015 compared to 2014.

Figure 1: Quarterly record of Nestle for past 5 years

The financial position of Nestle prior to Maggi ban, and the impact of Maggi ban will be studied in detail through common size and trend analysis of Nestlé’s financial statements.

3. Common Size and Trend Analysis In this section common size analysis of Nestle Income Statement and Balance Sheet is performed for the past 6 years (From 2010 to 2015). Also, in this section trend analysis of Nestle Income Statement and Balance Sheet is performed for the past 6 years (From 2010 to 2015) taking 2013 as the base year.

3.1 Common Size Analysis of Income Statement 

Operating Profit



Interest Expense

From 2010 to 2011, Nestle’s COGS as percentage of sales decreased as a result of improved product/channel mix and Neslte’s continuous initiative to improve its operations. This resulted in sudden increase in operating profits from 18.16% in 2010 to 20.37% in 2010. Late in 2014 although sales increased by 8.2%yoy, Nestle saw a decrease in operating profits as percentage of sales, this is mainly due to higher cost of milk and its derivatives in India that was higher than their costs in international market which lead Although the COGS decreased by 23% in 2015 compared to 2014, the sudden drop in net sales by 17.2% as a result of Maggi ban issue caused their operating profits to further drop to 16.09%. Nestle’s interest expense increased drastically from 0.02% of sales in 2010 to 0.4% in 2013. From analysing the balance sheets for this period we see that their Longterm borrowings increased up to Rs.118948 lakhs. This is mainly due to the restatement of External Commercial Borrowings at the closing exchange rate in 2013. Also US $192mn remained outstanding since 2012 and the annualised cost over the loan period, Further in 2014 the sales increased by 8.2% from 2013 and the repayment of ECB loans lead to a sudden decrease in Nestle’s interest expense. 

Pre-Tax Income Pre-tax income as %sales remained almost constant around 18% from 2010 to 2014. However, in 2015 the value decreased drastically to 10.02%. The decline in sales in 2015 as a result of Maggi ban lead nestle to move to operating losses of Rs.48975 lakhs from an operating profit of Rs.753lakhs in 2014.



Net Income Available to Common Shareholders Similar to pre-tax income, net income was almost stable at 12-13% from the period 2010 to 2014. In 2015, it reduced to 6.93% as a result of the Maggi ban issue. Net sales worth Rs. 30340 lakhs had to be reversed during the full year ended December 2015 as the Maggi noodle packets had to be withdrawn from traders and market due to the ban. This further increased Neslte’s operating expenses which further added to the decline net income.

3.2 Trend Analysis – Income statement

From the above graph, it is evident that net profit, net sales was the highest in 2014 compared to last 6years, whereas Operating profits was the highest in 2013 and pretax income was the highest in 2014. 2015 had the lowest value for all these parameters as a result of Maggi ban issue and loss of faith in the brand from customers. Although Nestle suffered loss due to this incident only in Q2 of FY2015, they were not able to pull up their sales drastically in the remaining 6 months since the ban and as a result faced 11.24% decrease in sales compared to 2013. This sudden decrease in sales attributed to the decline in their net income during the period, although their operating income increase by 87% compared to 2013. To further understand the operating and financing measures taken by Nestle during the period 2010 to 2015 we carry out common size and trend analysis of their balance sheets during this period.

3.3 Common Size of Balance Sheet 

Total Assets

The total current assets of Nestle as a percentage of total assets reduced from 46.78% in 2010 to 29.31% in 2011. At the same time the total long-term assets increased from 53.22% in 2010 to 70.69% in 2011. There was 101.5% increase in Nestle’s cash in 2011 compared to 2010, while their short term investments reduced by 65%. They also invested heavily in fixed assets in 2011. In 2013, Nestle acquired non-controlling stake in “Sahyadri Agro and Dairy Ltd.” and also invested in long term tax free bonds. However, the investment in fixed assets was comparatively less. In 2013, their cash balance and current investments also increased by 227% and 72% respectively due to better cash flows from operations. In 2014, the extra cash balance was used to repay the ECB loans as a results their cash reduced by 41% compared to 2013. In 2015, the inventories increased as a result of recall of Maggi from market. In the same year, their investments in fixed decresed by 3%. This increased the current assets component in the total assets compared to non-current assets in 2015 over 2014. 

Total Liabilities Total liabilities as % of total assets was the highest in 2011 and the lowest in 2014. In 2011, Nestle invested heavily in fixed assets due to the capacity expansion projects for which they borrowed US $ 136 million from Nestle SA for 5yrs under ECB approval from RBI, India. Whereas in 2014, Nestlé paid of their ECB loans as a result their long term liabilities



Total Equity

There was a steady increase in total equity of Nestle from 2010 to 2014. However, the value of equity as percentage of asset is 33% in 2010 and is 29% in 2011 because the value of assets owned by Nestle in 2011 is higher than 2010. The equity in 2015 reduced by Rs. 1937 lakhs causing the value of equity as a percentage of assets to reduce to 46%.

3.4 Trend Analysis of Balance Sheet 

Total Assets While the total assets and total long term assets of Nestle in 2015 was less than that in 2013 by 3.7% and 10.26% respectively, the total current liability increased by 7.73%. The main cause for this was the increase in inventories by 11.53% compared to 2013 due to the recall of Maggi from the market and also short term investment also increased by



Total Liabilities Total current liabilities in 2010, 2011 and 2015 was higher than the value in 2013 by 23.93%, 8.93% and 9.54%. However, the effect of long term liabilities caused the total liabilities in all the years from 2010 to 2015 be a value less than 2013. Nestle was expanding their capacity in India during this period and had borrowed US $ 136million from Nestle SA for the same

4. Financial Forecasting Nestle India saw a 20% decline in 2015 Q2 sales, after Maggi was pulled off from the shelves due to safety concerns. The cost of removing Maggi from the market led to a one-time exceptional loss of Rs.4.52bn which is 1.5 times the average profit in 2014. However, Maggi is only a small part of their business and the negative effect of recall on sales growth was temporary to Q2. By the end of 2015, the sales of Nestle rose by 4.5% from June which was higher than the average forecast of 4.3% by the analysts.[4] However, the company could not meet the long-term target of 5-6% yearly growth, due to foreign exchange rate fluctuations and the noodle recall and thus ended with a sales less by 17% compared to 2014 yoy. According to the market report by Reuters India, the sales of Nestle is expected to grow at a rate of 3 -5% in 2016 signalling a difficult year ahead for Nestle. The forecasted Balance sheet and Income statement for year ending Dec 31, 2016 is given below,

4.1 Pre-forecasting Ratios Nestle India has its presence in almost all segments of the FMCG Industry. They mainly operate in Food processing and dairy products segments. In these segments, Hatsun Agro Products and Vadilal are their main competitors. In this section, we analyse the post forecast ratios of Nestle India with the ratios of Hatsun Agro Products and Vadilal for the past years from 2011 – 2015. The comparison table is given below.

Nestle’s capital structure is mainly equity driven. Thus in comparison with the 2 competitors, Nestle India has the least Debt/Equity ratio over the past 5 years, indicating more financial stability compared to its peers. Thus we can interpret that Nestle has a better solvency. Performing liquidity analysis, we see that in 2011 Nestle has the highest Current ratio (0.88) but the however, quick ratio is the least (0.38) compared to its peers. Although current ratio is the measure of companies ability to repay short-term liabilities using its current assets, this measure can often be misleading as current assets also includes inventories. Thus we can see that Nestle’s liquidity position in 2011 was poor compared to peers. However from 2013 to 2015, Nestlé had higher current ratio and quick ratio which implies that over the years Nestlé has improved on their inventory management. Another interesting observation is that although in 2015, Nestle witnessed the Maggi ban issue, they were able to maintain their liquidity position compared to the peers. Coming to profitability ratios, we see that Nestle India has maintained an almost constant gross profit margin of above 50%, which is ideal. It is also much above the profit margin of its peers. However, its operating profit margin has decreased over the years showing decrease in operating efficiency even though sales have been increasing. However, still it is comfortably above its competitors. Net profit margin is almost constant at about 12%, except in 2015 where it came down to 6.93% due to the Maggi ban. The management efficiency ratio show a concern. Return on equity has fallen down considerably in the last 5 years from 75% in 2011 to 41% in 2014. The equity of Nestle has increased much more than its income resulting in the fall of ROE. This indicates that they are losing their competitive edge. The increase in equity is due to increase in retained earnings. This is consistent with their capital structure where they don’t depend on liabilities. The average payable days have increased from 23 to 33 days yet it is much better than its peers. Since, the food processing industry is mainly cash based, the average collection period is less than 4 days, comparable to the peers.

4.2 Post Forecasting Ratios In this section, Neslte’s financial position is analysed by calculating the ratios for the forecasted financial statements of 2016 and is compared with the ratios in 2015 to predict its future performance.

From the above table. It is clear that the solvency position of Nestlé will almost remain unchanged in 2016 compared to 2015. Expanding the capacity would not be of preference in 2016, rather they would prefer to concentrate on attaining the stability in market by restoring the brand perception of their customers which would help them boost their sales in 2016 compared 2015. However, the liquidity position of Nestle seems to be worrying. The Maggi ban in 2015 had led to a decline in net sales by 17.2% and domestic sales by 18.3% due to which Nestlé net income reduced by almost 100% in 2015 from 2014. Thus in 2016 to regain its position, Nestlé will have to make full use of its assets to generate more sales and hence will not be in a position to repay its short-term liabilities using these current assets. The profitability and growth ratios also is forecasted to remain unchanged in 2016, if Nestlé achieves a growth rate of 5% as predicted. Assuming that Nestle will continue its current operational efficiency, the inventory days, accounts payable days, receivable days is forecasted to remain almost the same. Asset turnover ratio compared to 2015 is predicted to improve by 0.24 in 2016. This indicates that Nestle will be concentrating on making full use of its assets to generate sales revenue. This higher asset turnover ratio compensates for the low liquidity forecasted. Return of equity, return on assets and return on capital employed is forecasted to improve drastically (approx. 4%, 6%, 13% respectively) in 2016 which is an indication that the temporary sales loss caused by Maggi ban can be overcome in the coming year if Nestlé continues its current operations and achieves the predicted growth rate of 5%. Overall Nestlé’s financial position in 2016 seems to be promising for its attempt to attain stability in market. Adopting aggressive methods to push sales and expand

capacity is not suggested in 2016 given that the customers trust has hit hard due to the Maggi ban. Aggressive methods could give a wrong message to customers about Nestlé’s products and thus might hit hard on sales. Thus continuing the current modest approach would help Nestlé achieve the forecasted financial position 2016.

5. Dividend Policy Nestle had A F Ferguson & Co. as its auditors. As on 31-Dec-2015, the company has a total of 96,415,716 shares outstanding.

For the year ending December 2014, Nestle India has declared an equity dividend of 630.00% amounting to Rs 63 per share. The company has a good dividend track report and has consistently declared dividends for the last 6 years. Nestle follows almost fixed dividend policy. For the financial year ending Dec’2014, the nestle dividend increased to 63 rupees per share from 48.50 rupees per share. In financial year ending Dec’2015 the price fell to rupees 30 per share owing to Legal proceedings faced by Maggi. This boils down to lower dividends. Nestle typically pays out half of it profits as dividends to its shareholders. In all likelihood, the pay-out would be lesser this year. Every time the company announces its quarterly results, the stock could take a knock. This would unsettle plans of opportunistic investors who are tempted to buy the blue chip now. The stock has dropped 22% in the past three months and has come off its peak valuation of 62 times of earnings hit in January this year. Currently the market price of Nestle India’s share is the highest of past 6years with a value of Rs. 5490/- whereas the EPS is the lowest which is around Rs.58.42/-. Thus the P/E Ratio of Nestle increased to 93.97 from 43.07 in D ec 2014 (i.e., an increase of more than 200%). High P/E Ratio implies that Nestle India has opportunity to grow, however the FMCG Industry as a whole has a P/E Ratio of only 33.17. This indicates that the market is regaining its faith in Nestle after the Maggi ban incident and thus Nestlé has to live up to this high expectations by substantially increasing its earnings, or the stock price will need to drop. Financial Year Industry P/E Ratio Nestle P/E Ratio Industry Dividend Yield Dividend Yield

2010 30.09

2011 26.50 84 38.49

2012 32.459 6 37.41

2013 32.850 2 43.16

2014 34.01 94 43.05

Current 33.1721 9 93.97

2.18%

1.92%

1.65%

1.45%

1.47%

1.56%

1.90%

1.26%

1.17%

0.97%

1.19%

0.55%

30.366

Nestle has always had a low dividend yield compared to the industry average. This can mean two things: (1) the share price is high because the market reckons that Nestle has impressive prospects and is not worried about the company's dividend payments, or (2) the company is in trouble and cannot afford to pay reasonable dividends. However, combining the effect of both dividend yield value and the P/E ratio of Nestle, it is evident that that option (1) is more appropriate. [5] The last bonus that Nestle India had announced was in 1996 in the ratio of 1:2. The share has been quoting ex-bonus from July 15, 1996. Nestle India has not split the face value of the share so far.

6. Working Capital Financing Policy Working capital of Nestle India is depicted in the graph below.

Working Capital 12000.00 10000.00 8000.00 6000.00 4000.00 Working Capital 2000.00 0.00 2010 2011 2012 2013 2014 2015 -2000.00 -4000.00 -6000.00

Financial Year

Ratios

Dec 2014 Dec 2013 Dec 2012 Dec 2011 Dec 2010

Current Ratio

0.53

0.65

0.54

0.55

0.62

Quick Ratio

0.25

0.39

0.22

0.27

0.27

29.60

34.80

31.60

29.51

31.28

4.34

4.44

3.45

3.40

57.93

57.52

50.89

39.40

0.0

Number of Days In 22.64 Working Capital

38.45

15.90

-8.63

-27.60

Dividend Payout Ratio 57.11

48.63

43.78

41.85

51.27

Inventory days

Turnover

Debtors days

Turnover 3.72

Days Payable

The company had negative working capital during 2010-2011. Also, it averaged negative working capital for most of the last decade. A negative working capital is a sign of managerial efficiency as FMCG industry is characterized by low inventory and

accounts receivables as it operates on an almost cash basis. It indicates that it may be collecting money from sale before it pays for goods which mean it has good cash flow. Conventionally, the FMCG Companies are famous for negative working capital due to efficient supply chain management. This industry has lower level of debtors, which are usually financed by creditors or suppliers. Also, Nestle’s turnover does not depend upon their production but upon the capability to sales. Similarly, development of SCM, ERP and JIT, etc. made effective management of inventory and resources, which significantly minimise the need of current assets.

References [1] Accelerating the Growth of Ecommerce in http://www.kantarworldpanel.com/ (February 25, 2016)

FMCG

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Global

News

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[2] What’s in Store for India’s FMCG Market? – Insights – Reports 2014 – Nielsen India (February 25, 2016) [3] Indian Express article “Nestle posts first loss in 17 years after Maggi ban” an article on Maggi ban issue dated July 30, 2015 http://indianexpress.com/article/business/business-others/the-maggi-effect-nestleposts-first-loss-in-17-years/ (February 25, 2016) [4] Reuters news article “Nestle tempers sales growth expectations in tough markets” dated Feb 18, 2016 http://in.reuters.com/article/nestle-resultsidINKCN0VR0KF (February 25, 2016) [5] Long term stock return study of Nestle India by Kunal Pawaskar on Capitol Orbit portal http://www.caporbit.com/nestle-india-a-long-term-stock-return-study/ (February 25, 2016) [6] Financial results – Stock and Financial – Investors - Nestle India webpage (February 24, 2016) [7] Annual Reports – Stock and Financial – Investors - Nestle India webpage (February 24, 2016) [8] Moneycontrol.com – for financial ratios of peers and Nestle’s current stock performance (February 27, 2016) [9] Bloomberg data for financial statements for years from 2010 to 2015 for Nestle India (NSE Listed) (February 23, 2016)