Growth trends likely to weaken ahead
* Nestle surprised positively with a resilient 11% sales growth, 14% ahead of expectations, indicating lower impact of lockdown on supply chain and likely benefits from consumer upstocking. PBT was flat while PAT grew 13% (5% ahead of estimates) on tax rate cut.
* Gross margins declined 220bps due to higher input prices; however, the recent softening in key input prices and the decline in competitive intensity signify a positive margin outlook going ahead. Our forecasts factor in a 210bps margin gain over CY20-22E.
* Nestle’s portfolio seems more resilient to the lockdown impact and less affected vs. peers, but compared with the strong Q1CY20 performance, Q2CY20 is likely to be weaker as per channel checks with a larger impact of lockdown and supply chain disruption.
* We increase CY20 forecasts by 3% but do not see upsides to CY21-22E. Valuations at 63x CY21E EPS appear expensive vs. other top large-cap peers with similar earnings trajectory (15% CAGR). Maintain Sell/UW in EAP with a TP of Rs15,000, based on 50x June-22E EPS.
Strong sales performance points to lower impact of lockdown on supply chain and likely benefit from consumer upstocking:
Nestle’s domestic sales increased 11%, driven by volumes and mix, implying double-digit volume growth. Maggi and chocolates recorded strong performance. E-commerce contribution grew significantly whereas out of home sector performance was subdued. Nestle’s strong sales growth for the quarter compared with the sales decline of its peers indicates lower impact of lockdown on its efficient supply chain as well as likely benefits stemming from consumer upstocking. Exports increased 13%, supported by lower comparables (9% decline in Q1CY19). While Nestle’s portfolio remains more resilient and less affected in Q1 than peers, our channel checks indicate Q2CY20 trends are likely to be weaker due to lower manufacturing and supplies.
Margin trends expected to improve: Gross margins declined 220bps on account of higher prices of milk and other agri inputs. The recent softening in milk prices and other inputs, decline in competitive intensity and cost efficiencies can drive gross margin improvement going ahead. Our forecasts already factor in a 210bps operating margin expansion over CY20-22E.
Valuations expensive for a similar earnings trajectory: We increase CY20E EPS by 3% but do not see upsides to CY21-22E EPS (unchanged). Sales growth trends are likely to be better than peers in the near term but valuation at 63x CY21E EPS is at a significant premium for similar earnings momentum (15% CAGR) compared with HUL. We hence maintain Sell/UW in EAP with a TP of Rs15,000 based on 50x Jun-22E EPS. Key risks: sharper decline in input prices and stronger recovery post disruption.
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