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A tad underwhelming on a supportive base

Domestic revenue growth of 14% was unexciting (below consensus as well as ISEC estimates) in the context of a supportive base (2-year CAGR: +8%). While gross margins were supportive, higher logistics costs and normalisation of marketing spends (in our opinion) weighed on EBITDA margins. We believe growth in infant nutrition was slightly lower – our primary research work with ISEC Pharma team (link) indicated likely lower birth rates in CY21, a potential headwind for the segment. Expansion plans seem to be on track with Rs10bn of the proposed Rs26bn already invested.

Our long-term positive view is intact driven by (1) structural tailwind from increasing consumer propensity to consume packaged foods, (2) continued investment behind brands, (3) renewed focus on distribution expansion, particularly rural and e-commerce and (4) significant increase in capex (Rs26 bn planned over CY20-23 which is = cumulative capex of CY12-19). Stock rating stays at HOLD, for now.

* Double-digit domestic revenue growth: Revenue / EBITDA / recurring PAT grew 14% / 9% / 11% YoY. However, on a 2-year CAGR performance was actually unexciting (favourable base due to Covid disruption) – both revenues and EBITDA were up just 8%. Domestic sales grew 13.7%. This performance was driven by volume and mix-led broad based growth. Exports sales increased 17.7% again on a weak base (2QCY20: down 9%). Nestle highlighted key products such as Maggi Noodles, Kitkat, Munch, sauces, Masalaa-e-Magic posted strong double-digit growth. We believe that infant nutrition business remained weak. Besides increasing rural focus (highlighted in last interaction), Nestle is also ramping up focus in emerging channels of e-commerce and hyperlocal. E-commerce grew by 105% (CY20: +111%) and contributed ~6.4% of domestic revenues, still headroom to grow; hyperlocal (quick commerce channel) also grew 147% YoY.

* Higher gross margins offset by increase in opex: Gross margin expanded 60bps YoY to 56.8% due to higher realisations and mix benefit partly offset by RM pressure – inflationary oil and packaging materials while wheat and dairy prices are largely supportive. However, other expenses increased 280bps partly due to (1) higher logistics costs and (2) normalisation of marketing spends, in our opinion. Staff cost was down 120bps (base quarter had higher incentives due to COVID). This translated into a 100bps contraction in EBITDA margin. PBT grew 8% due to lower other income (down 7% YoY on lower yields).

* Balance sheet and cash flows: Two key highlights: (1) Rs10 bn of the announced (last year) Rs26 bn capex (spread over 3-4 years) has been invested, (2) June-end inventory was up 22% compared to Dec-20 level. Management has highlighted this a planned increase; we reckon this could partly be due to some inventory stock-up.

* Valuation and risks: We cut our earnings estimates by ~4%; modelling revenue / EBITDA / PAT CAGR of 14 / 17 / 18 (%) over CY20-22E. Maintain HOLD rating with DCF-based target price of Rs17,500. Key risks are consumption slowdown linked to economic performance and keyman risk.

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