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Result in line; gross margin pressure higher than expected

Nestlé India (NEST)’s 1QCY22 numbers were largely in line with our estimates, with an overall sales growth of 10.2% YoY v/s our estimate of 12%. Domestic sales rose 10.2% YoY while exports declined marginally by 1% YoY.

Gross margin pressure continued; it contracted 310bp YoY and 160bp QoQ to 55.4% (at 19-quarter low) v/s our expectation of 56.5%. According to the management, material cost pressure is here to stay for the time being and hence we believe it may adversely affect operating margin going ahead.

While we like the longer term investment case for NEST driven by its high topline growth potential, expensive valuations and commodity cost concerns warrant a Neutral rating on the stock, in our opinion

Domestic sales growth momentum continues

NEST reported net sales growth of 10.2% YoY to INR39.8b (largely in line). Domestic sales grew 10.2% YoY driven by volume and mix whereas export sales dipped marginally by 1% YoY during the quarter. According to our calculation, volume growth should be around 6-7% YoY in 1QCY22.

Gross margin contracted 310bp YoY to 55.4% due to the ongoing commodity cost pressures.

EBITDA remained flat YoY at INR9.3b (est. INR9.2b) likely due to lower ad spends (ad spends not reported separately). PBT came in line at INR8.1b.

Adj. PAT was in line with our estimate of INR6b (flat YoY) in 1QCY22.  Other income decreased 27.7% YoY to INR214m during the quarter, indicating lower yields.

The Board has declared an interim dividend of INR25 per share amounting to INR2.4b.

Key highlights from the management commentary

Outlook on commodity costs: Cost outlook for key commodities such as edible oils, coffee, wheat, and fuel remains firm to bullish while the cost of packaging materials continues to increase amid supply constraints, and rising fuel and transportation costs. Input costs are likely to be higher both globally and locally. Fresh milk costs are expected to remain firm with continued increase in demand and rise in feed costs to farmers.

NEST’s key brands continued to perform well with Maggi Noodles, KitKat, Nestlé Munch, Nescafé Classic and Sunrise reporting double-digit growth in 1QCY22.

NEST posted robust e-commerce performance as the channel grew 71% YoY (driven by new emerging formats such as ‘quick commerce’ and ‘click & mortar’ for the channel) and now contributes 6.3% of domestic sales.

Growth of Maggi Sauces and Maggi Masala-ae-Magic growth was impacted by high base and a gradual shift from in-house cooking to out-of-home consumption.

Long-term growth story intact; near-term valuation expensive – Neutral

Raw material pressures have led to 2.0% and 1.2% reduction in NEST’s CY22 and CY23 EPS, respectively.

The long-term narratives for revenue and earnings growth are highly attractive. The Packaged Foods segment offers immense growth opportunities in India. This is particularly true for a company such as NEST, which has a strong pedigree and distribution strength. The successful implementation of its volume-led growth strategy in recent years provides confidence in execution as well.

Nevertheless, as highlighted in our annual report note as well as commodity cost note, NEST is facing commodity cost headwinds and with four consecutive years of ad-spends to sales decline up to CY21 (to 5.5% of domestic sales in CY21, second lowest in the last seven years) the buffer to protect EBITDA margin erosion from gross margin pressures may not be available without constraining volume growth.

NEST’s valuation at ~61x CY23E P/E is expensive and does not offer any significant upside from a one-year perspective. We value the company at 60x Mar’24 EPS to arrive at our TP of INR18,450. With 1% potential upside, we maintain our Neutral rating on the stock.

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