How Investors can Analyze a Blue Chip stock?

Not long ago someone advised me to buy a blue chip stock we better known as ‘Nestle India’. I was not convinced that whether this advice will work in my investment-benefit. Investors needs to particularly skeptical before buying a share. It is much better to be critical before investing in share than to regret the doing after possessing one. So I followed this logic and decided to analyze ‘Nestle’ to check its fundamentals and value its market price (undervalued or overvalued). In order to evaluate the fundamentals of nestle I started asking some most logical questions.

1.      Are the product of Nestle desired by its customers?

In order to answer this question, we first need to know what are the products of Nestle.

-          Milk Products & Nutrition

• Dairy Whitener
• Dahi, Ghee, Milk & Yoghurts
• Milkmaid etc.

-          Beverages

• Nescafe
• Nestea

-          Food Products & Chocolates

• Maggie
• Kit kat
• Munch
• Milkybar
• Bar One etc.

Now we know that what a fabulous range of products Nestle has and for sure customers each one of them.

2.      Who are the Top Managers of Nestle India?

Chairman & Managing Director
Antonio Helio Waszyk is a Brazilian, joined Nestle India as CMD in Oct’09. He is working in Nestle Group since 1977.

Director Finance
Shobhinder Duggal is working as Director Finance in Nestle India since 2004. He is a qualified Chartered Accountant.

Director Technical
Mr. Christian Schmid is working as a board of director since Aug’2010.  He is responsible for manufacturing operations of the company.

All the above people associated with Nestle India have been associated with Nestle, Switzerland (parent company) since quite some time. They all have proved their worth in the group and destined to serve this group to future prosperity of Nestle India.

3.      What does the technical Indicators talk about its present market price?

Simple moving average, Rs 4223 (30 days),  Rs 4261 (50 days), Rs 4113.79 (150 days), Rs 3976 (200 days). The current trend shows that the market price of stocks is in a rising trend. Current market price (as on 2011-Oct-27) is Rs 4282.

52Week High Price for this stock is Rs 4517. It means that the stock has a possibility to rise further high.
52Weel Low Price for this stock is Rs 2720. The share saw its bottom in Aug’2010. So in a year the market price has almost doubled. It is a sign that the share may be moving towards overvalued levels.
The market cap of this stock is Rs 41,285 which brings it among the top 50 stocks in terms of market capitalization.
P/E ratio of this stock is 46.31 which is for sure hints at overvalued limits. Comparing it with Industry P/E ratio (which includes companies like Britannia, Glaxo Smith Con, Kwality etc) the value is 38.86. So compared to its peers this share looks like overvalued.
Price to Book Value ratio is 48.26 which is too high. Hints are share being too overvalued.

The first look at these indicators tells us that the share may be overvalued. But its financial reports (fundamental analysis) needs to be looked into before making a conclusion.

4.      How strong is the Financial Strength of the company?

Looking in the balance sheet of Nestle India the first thing that I noticed that the share capital of the company has been at the same level since last five years at Rs 96.42 crore (since Mar’2007). It is good that company has not diluted the shareholders value by issuing more shares in the market in the name of fund generation.

The reserves of the company has been continuously increasing since 2007 from levels of Rs 292.47 crore to Rs 759 crore at the rate of 27% per annum. Subsequently it resulted in net worth increase of Nestle India at the rate of 27% CAGR since last five years. This is a very healthy growth.

Company has been able to keep the debt levels to Zero. This is outstanding. In 2007 the debt levels of the company was Rs 16 crore. By year 2008 the debt levels was brought down to zero levels and it continues till today. This shows that what kind of competitive advantage is enjoyed by Nestle India that it can manage the cash flow without resorting to debts. Outstanding.

In last five years, the gross block (fixed asset) of the company has increased from Rs 1058 Cr. Levels in 2007 to Rs 1854 Cr. Levels in 2011. The CAGR of fixed assets is at a moderate rate of 15% per annum. Compare this with increase in EPS levels from Rs 32.68 to Rs 84.91 at a rate of 27% per annum (CAGR). It means the company is feeding in more and generating better earnings. This is possible only in outstanding companies.

Current ratio (current asset / current liability) of this company for last five years is maintained at an average level of 0.66. This ratio confirms that the company’s current assets is less than companies current liabilities since last five years. This is not a good fundamental indicator.

But simultaneously looking at the companies’ cash flow statement, it will become clear that where the current assets of the companies are getting consumed. One thing is clear that the company is profitable and hence the ‘net cash from operating activities’ has always been positive. But the companies cash generated from operations is getting hugely consumed in ‘investing’ and financing activities’. This is a good sign.

The book value per share has consistently increased in last five years from Rs 40.33 to Rs 88.72 at the rate of 22% per year. This is a very healthy fundamental indicator.

5.      How is the company’s growth prospects and profitability levels?

As Nestle India makes products that can be categorized as consumer products, it is very important to scrutinize the profitability levels of this company. The competition in this segment is very severe so if the company is able to show growth with high profitability it is ideal for investing. For Nestle India the companies EPS levels has risen from Rs 32.68 to Rs 84.91 at a rate of 27% per annum (CAGR). The companies P/E ratio at current market price is 46.31, it means PEG ratio will be 46.31/27 = 1.71. Value of PEG ratio above 1.5 indicates overvalued levels.

The company has been able to increase its sales turnover from Rs 2819 Cr. to Rs 6260 Cr. in five years. The company’s sales has increased at the rate of 22% CAGR considering that the company has seen the worst financial crisis of recent times in year 2008/2009.

The operating profit of the company has increased from Rs 532 crore to Rs 1253 Cr levels in five years at the rate of 24% per annum. The operating margin of the company has been consistent at 19% levels since last five years. In this era of increasing inflationary pressure (above 8%), still the company has been able to maintain its operating margins. This is a phenomenal competitive advantage.

Since last five years the company has been maintaining dividend payout of 71% of its reported net profit. This indicates that the company has reached a level of maturity and is confident of maintain its earning levels in future.

6.      Is the present market price undervalued or overvalued?

Virtually all technical indicators discussed above are showing that the market price of this stock has already crossed the overvalued levels. But Simple Moving Average (SMA) has shown a trend an up-trend of market price of this stock in medium term. But as the stock is already overvalued, may the yield may not be as desired.

In terms of dividend yield, the company has paid following dividend per shares in last five years

From the above tabulate dividend yielding pattern it is clear that though the EPS and Dividend Payout has almost doubled in last five years but the yield has been hovering around an average market of 1.5%. It shows that the share is in high demand and currently it is hovering around overvalued limits. But on the positive side the market price of stock has also been growing at a staggering pace from Rs 1136 levels in 2006 to Rs 3795 levels in 2010 at a rate of 35% per annum. So for long term investor who are interested for capital appreciation, this stock may be a good bet. The companies product rage is unique and seeing the present demand patters, it looks like the sale and operating margin trend will continue to grow for Nestle India at least for next five years.

Conclusion

-          The company has a great product range
-          The company is run by efficient managers
-          The companies technical indicator hints at stocks being trading at overvalued levels currently. But SMA hints that the market price may continue to move up in future.
-          The companies’ Balance Sheet (financials) are very strong.
-          The companies’ profitability levels are outstanding
-          The company is paying 70% of its earnings as dividends to shareholders. This is a good practice for income generating investors.

At the end I will like to conclude that Nestle India is a share that has great potential of giving capital appreciation to its investors. Though Dividend Yield will never be a big attraction for Nestle India, but considering capital appreciation, this stock can be a good buy below Rs 3500 levels. The holding time shall not be less than 5 years.

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