All-round improvement continues
Maintain Neutral on fair valuations
Nestle’s (NEST) CY19 Annual Report highlights the company’s underlying strengths, which makes it one of the strongest top line growth opportunities in our Indian consumer universe. Key takeaways are as follows:
* Near double-digit sales growth (9.5%) for the third consecutive year (excluding revival off the 2015 Maggi crisis in 2016) was led by volumes (7.0% of 9.6% gross sales growth), and was also broad-based with (a) 5-year high sales growth in Milk and Nutrition (its largest segment at 46% of sales), and (b) 9-year high sales growth in the Chocolates segment.
* The pace of new launches, which has gathered momentum since 2016, continued to be strong. Since 2016, NEST has launched 71 new products, which are contributing 3.4% of sales.
* Ad spends at 6.7% of domestic sales was maintained close to 15-year high levels, and thus, supported sales growth and new launches.
* Negative working capital was witnessed for the second consecutive year after being in the positive territory over CY11-17. With the special dividend announced in CY19, the company’s RoE and RoCE have received significant boost.
* The board’s proposal of granting 5-year extension (up to Jul’25) to the current Managing Director (MD), Mr. Suresh Narayanan, is a welcome move.
* Valuations are expensive at 67x CY21E EPS, thus, preventing us from turning constructive on the stock.
Broad-based growth led by volumes
* Growth across segments was broad-based, primarily led by volume growth (7.0% out of 9.5% sales growth).
* Barring beverages (~12% of CY19 sales), other segments reported strong sales growth, including 8.9% in its largest category Milk and Nutrition (46% of CY19 sales; highest growth since 2014). CY19 was another year of double-digit sales and volume growth in Prepared Dishes (largely Maggi – 29% of sales). Since 2010, NEST has witnessed highest growth in the Chocolates and Confectionary segment in 2019 with over 15% volume/value growth along with market share gain for the first time in many years.
* In recent times, sales growth for many of NEST’s peers has come off; however, it is doing exceedingly well on this front. The same trend was also witnessed in the recently declared Mar’20 quarter results, where NEST’s performance was once again superior to its peers.
* With high category growth opportunity in foods and NEST’s focus on volume led double-digit growth backed by new launches, prospects of top-line growth remain bright. This would also be supported by ad spends, benefits of the cluster-based approach, distribution expansion and usage of analytics.
New products doing well, ad-spend support remains strong
* The company has launched 71 new products since 2016, which now contribute 3.4% of sales. Sales growth and support for new products comes from continued elevated levels of ad spends to sales, the second highest in the past 15 years at 6.4% of sales (barring the spike in 2015 as sales had collapsed due to the Maggi crisis).
Working capital improves; Special dividend boosts RoE further
* Net working capital days on an average basis improved further to -4 days and fixed asset turns of 5.6x was the best since CY10 levels.
* RoEs were further bolstered by payment of special dividend in CY19, thereby nearly halving shareholders’ funds last year. From CY20, NEST will be the only company in the sector – apart from HUVR – with RoEs at ~100% or higher.
Re-appointment of CEO and board evaluation
* NEST’s board has recommended Mr. Suresh Narayanan’s re-appointment as MD for a further 5-year term (1st Aug’20 to 31st Jul’25), which is a positive development as Mr. Narayanan has been at the helm of the company’s transformation. NEST was suffering from a lumbering pace of top line growth even before the Maggi crisis, but was transformed to one of the fastest growing companies (on both top line and earnings) under Mr. Narayanan’s leadership.
* In another interesting move and a rather unusual one for India, NEST’s board of directors held an annual performance review for each of its sub-committees. A leading HR consultancy firm was hired for compiling the report and feedback.
Remarkable improvement/ targeted changes in sustainability efforts
* NEST has done remarkably well to reduce energy consumption by 49%, water usage by 54%, CO2 emissions by 58% and waste-water generation by 59% during CY04-19.
* Importantly, from a food-safety perspective, special focus was accorded to upstream raw material vendors for products such as wheat flour, sugar, tomato and chili paste in its own factories to ensure the right quality and a compliant product.
* From a packaging perspective, the company has begun transitioning to mono material (designed for better recycling), a process that has been initiated in two key brands ‘Maggi’ and ‘Munch’ in 2019. By 2025, the company’s vision is to ensure 100% reusable/recyclable packaging. NEST has also spearheaded efforts to ensure that none of its product packaging (including plastics) ends up in landfills or as litter by 2025.
Valuation and view
* The longer-term narrative of NEST’s top line and earnings growth remains extremely attractive. Not only is the successful implementation of NEST’s growth strategy in recent years a positive, but also the packaged food segment in India offers immense growth opportunities. This is particularly true for a company with strong pedigree and distribution strength.
* In the near term, the stock offers far better resilience on top line v/s peers due to the nature of its portfolio and superior efficiency. On earnings, it is likely to be the only stock in our coverage universe with close to double-digit growth in the current year.
* However, current valuations of 80x CY20E EPS and 67x CY21E EPS appear to be completely factoring in the upside for the next one year. We value the company at 60x Mar’22E EPS to arrive at a TP of INR16,385. Maintain Neutral.
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