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Decline in ad spends-to-sales ratio remains concerning

NEST’s CY22 annual report highlights its underlying strengths and the company remains one of the strongest revenue growth opportunities in the Indian Consumer universe. The key takeaways are as follows:

* The company’s overall volume growth in CY22 stood at only ~5%, as it was adversely impacted by a sharp dip in volumes towards the end of the year. Given the unfavorable operating environment, NEST’s volume growth was healthy and better than its peers. The company does not disclose volume growth in its interim results. In CY22, the company witnessed strong volume growth in Beverages (up ~14% YoY) and Chocolate and Confectionery (up ~12% YoY). On the other hand, volume growth was muted in the case of Prepared Dishes and Cooking Aids (up 5.7%, lowest since the Maggi crisis in 2015). Since Prepared Dishes constitutes ~61% of total volumes v/s ~32% of sales, the company’s overall volume growth was adversely impacted.

* Volumes in Milk and Nutrition (M&N, 41%/23% of total sales/volumes) were flattish in CY22, continuing with its disappointing trend. The segment has been reporting flattish volumes/decline in volumes for the past four out of five years. Volume growth has been robust across the other segments. Prepared Dishes and Confectionery segments have clocked double-digit volume CAGR since 2016, when Mr. Suresh Narayanan took charge. M&N tonnage in CY22 was in line with CY09 levels.

* Ad spends (not shared in interim results) were down ~10% YoY on an absolute basis. While other staples peers have also cut their ad spends, for NEST, ad spends as a percentage of sales stood at 4.3% in CY22, the lowest in over three decades. It had last been at 4.4-4.5% levels in the CY11-CY13 period, when NEST was underinvesting in the business. Given that the company has been registering double-digit revenue growth over the last few years, driven by higher investments in ad spends, the decline in ad spends-to-sales ratio is disappointing. It is in fact the fifth consecutive year of dip in ad spends to sales. Rising commodity costs could have contributed to the drop in ad spends (gross margin dipped 280bp YoY) and with the management expecting continued pressure on raw materials, ad spends-to-sales ratio needs to be monitored.

* Amid the COVID-19 pandemic, the management’s prime focus was on its core business; however, the company still managed to maintain a healthy pace of launches as compared to its peers. Since CY16, NEST has launched over 110 products.

* Valuations are expensive at 54.4x CY24E EPS, preventing us from turning constructive on the stock. We have a Neutral rating on the stock.

Healthy volume growth in Beverages and Confectionery

* NEST reported a healthy 14.6% YoY sales growth in CY22, but its volume growth stood at only ~5%, adversely impacted by high inflation toward the end of the year. Healthy volume growth in Beverages (up ~14% YoY) and Chocolates and Confectionery (up ~12% YoY) was offset by muted volume growth in larger categories such as Prepared Dishes and Cooking Aids (~5-6% YoY) and flat volumes in M&N. Over CY19-CY22, M&N registered a 1.2% decline (pre-Covid period) in volume on CAGR basis, Prepared Dishes, Beverages, and Confectionery clocked a volume CAGR of 9.6%, 2%, and 8.3%, respectively, leading to ~6% overall volume CAGR over the same period. On the other hand, sales CAGR for these segments stood at ~6%/15%/10% and 17%, respectively.

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