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Double-digit volume growth an evidence of strategic success
Ad spend increase and WC days reduction - key positives; Valuations fair
Key takeaways from Nestle's (NEST) CY18 annual report:
* For the first time since CY10, Nestle posted double-digit overall volume growth on a reasonable base (barring CY16 and CY17, when the double-digit volume growth was led by recovery from the 2015 trough after the Maggi crisis).
* Clear preference for volume growth has also been demonstrated by the third consecutive year of decline in realization growth. Realizations declined by 0.4% in CY18, following a 2.8% decline in CY17 and 10.7% decline in CY16. This compares with realization CAGR of ~14% in the preceding five years, when volumes were extremely tepid.
* Another clear message of the NEST’s focus on the top line is the absolute ad spend increase of 44.2% in CY18. Ad spend to sales increased by 160bp YoY to 6.9% of domestic sales, the highest level since CY02. Nevertheless, we believe there is room for further increase in A&P to boost sales, given the elevated gross margins in recent years. CY18 gross margin at 59.4% is 530bp higher than CY14 levels (Note that the company does not share volume and ad spend details in its interim results).
* Net Working Capital (NWC) days’ reduction to -2 days (negative for the first time since CY10) and improving fixed asset turns are great from a ROCE perspective, particularly if dividend payout is increased further. ROCE was already healthy at around 50% in CY18.
* There is no material change to our EPS forecasts. While the narrative on Nestle is getting consistently better, valuations of 46.1x CY20 leave limited room for upside over the next year. Valuing the company at 49x Mar’21 EPS (in line with 3-year and 5- year average), we get a target price of INR11,800, 10% upside from CMP. Maintain Neutral.
Volume growth of 11.5% stronger-than-expected, Maggi and Chocolates segment lead the way
* While CY16 and CY17 volume growth could be attributed to recovery from the trough of the Maggi crisis (NEST completely emerged out of the crisis only in 2HCY16), 11.1% volume growth in CY18 (we were expecting 8.5%) was a positive surprise. Growth was led by continued strong volumes in the Prepared Dishes (Maggi) portfolio (54% of total volumes and 28% of total sales in CY18), which grew 14.5% YoY. Unlike preceding years, when the rest of the portfolio combined barely grew (between -7% and 3% growth in the preceding five years), CY18 saw a healthy 7.4% growth. Volume growth was particularly impressive in (a) the beverages segment (6% of total volumes and 14% of total sales in CY18), which grew 10.6% YoY (in line) on top of a similar volume growth number in CY17, and (b) the Chocolates & Confectionary segment (9% of total volumes and 12% of total sales in CY18), which witnessed remarkably strong volume growth of 14.7% in CY18 (expected 7%), the highest pace of growth for the category since CY10. Milk & Nutrition (31% of total volumes and 46% of total sales) remains the sole laggard on the volume growth front with 4.8% growth (in line), but even in this case, reported volume growth was at the highest level since CY10.
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