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Our longstanding neutral stance is intact

Domestic revenue growth of 10% YoY as steady though unexciting – recovery in some categories (mainly out-of-home) appears to have been partly offset by reduced in-home consumption for select products. We see near-term (increased) challenges due to inflationary inputs while execution on growth pillars continues.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 9.6% / 5.9% / 5.2% YoY in 3QCY21 with improved 2-year CAGR performance of 10% (versus 8% in 2Q). Domestic sales grew 10% YoY. This performance was driven by volume and mix-led broad based growth. Exports sales saw some deceleration (+1.3% YoY) as the performance continues to be volatile. Nestle highlighted key products such as Maggi Noodles, Kitkat, Munch, Masalaa-eMagic posted strong growth. We believe that infant nutrition business would have underperformed (at company level). Nestle highlighted (1) strong recovery in organised trade/MT and (2) good recovery in OOH categories. Besides increasing rural focus (highlighted in last interaction), Nestle is also ramping up focus in emerging channels of e-commerce and hyperlocal.

* Multi-quarter low gross margins due to RM pressure: Gross margin contracted 240bps YoY to 55.5% (17-quarter low) due to inflationary RM pressure – management highlighted inflation concerns for most inputs such as wheat, coffee, edible oils, dairy prices as well as packaging materials. It is looking to drive cost control measures to partly offset inflationary impact. However, the EBITDA margin contraction was restricted to 90bps YoY with lower staff costs (down 50bps) and other expenses (down 110bps). We note that Nestle had seen higher operating cost structures last year (including incentives to factory workers) due to Covid-led disruption. We believe Nestle could also look to rationalise marketing expenses due to inflationary pressure.

* Valuation and risks: We cut our earnings estimates by ~3-4% for CY21-22E; modelling revenue / EBITDA / PAT CAGR of 14 / 17 / 17 (%) over CY20-22E. Maintain HOLD rating with DCF-based target price of Rs19,500 (was Rs20,000 earlier). Key risks are consumption slowdown linked to economic performance.

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