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Improvements encouraging for long-term growth

Maintain Neutral on expensive valuations

Nestlé’s (NEST) CY20 annual report highlights its underlying strengths, which makes it one of the strongest topline growth opportunities in the Indian Consumer universe.

Key takeaways are as follows:

* Barring 2QCY20, where all Consumer companies, especially those with their own manufacturing facilities, faced supply-chain issues due to the sudden COVID-led lockdown, the company reported 10-11% sales growth in three quarters in CY20. This means that for four consecutive years (excluding revival from the CY15 Maggi crisis in CY16) the company reported double-digit, or close to double-digit, sales growth, which is better than peers. Sales growth in CY20 was led by volumes (2.6% volume growth out of 8.1% gross sales growth) and mix, and was broad based with: a) close to eight-year high sales growth in Milk and Nutrition (its largest segment at 46% of sales, which surpassed overall sales growth with 8.8% growth in CY20), b) another year of double-digit (11.8%) growth in Prepared Dishes, and c) healthy (6.7% YoY) sales growth in the Chocolates and Confectionery segment despite being more discretionary and urban trade dependent, both of which were weak for large parts of CY20. Encouragingly, the annual report also states that the company is finally witnessing market share gain in this category.

* The pace of new launches, while lower than preceding years due to the management’s focus on the core, amid the COVID-19 pandemic, was still healthy compared to peers. Since CY16, NEST has launched 80 (including nine in CY20) new products. In a recent analyst meet (Feb’21), the company stated that these products contributed a healthy 4.3% of sales in CY20 v/s 3.4% in CY19. With 40-50 products in the pipeline, the pace of new launches is likely to remain healthy going forward.

* Ad spends at 6% of domestic sales (down 70bp YoY) has been close to elevated levels in recent years, unlike peers who reported a sharper decline to save costs.

* The business has been improving its efficiency over the years. While the number of employees has remained flattish in the last five years, sales per employee have consistently improved to ~INR17m per employee in CY20 from ~INR12m in CY16. Similarly, net FATR increased to ~5.5x in CY20 from ~3x in CY16. There has been a slight increase though in NWC days (up three days on an average basis from negative three days in CY19 to nil days in CY20 and up by four days on a year-end basis from negative two days to two days, with inventory days increasing slightly). FCF/PAT conversion remained robust at 94% in CY20.

* Valuations are expensive at 59x CY22E EPS, thus, preventing us from turning constructive on the stock.

Broad based growth led by volume and mix

* Growth across segments was broad based, led by volume growth (2.6% volume growth out of 8.2% sales growth) and mix improvement, as its largest segment, Milk and Nutrition – a higher realization category grew faster than overall gross sales growth of 8.1%.

* Barring Beverages (~11% of CY20 sales), other segments reported strong growth including 8.8% growth in its largest category –Milk and Nutrition (46% of CY20 sales, close to its highest growth since CY14). However, there was some disappointment as realization contributed to this entire growth given that volumes were flat (down 0.4%).

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