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Building blocks in place for healthy growth

The decline in ad spends-to-sales ratio is concerning given the elevated commodity cost ahead

NEST’s CY21 annual report highlights its underlying strengths and one of the strongest revenue growth opportunities in the Indian Consumer universe. The key takeaways are as follows:

* Overall volume growth of ~11% in CY21 was healthy, with strong growth in Beverages (up ~18% YoY) and Prepared Dishes and Cooking Aids (Maggi, up ~16% YoY). Since Prepared Dishes constitute ~60% of total volumes v/s ~31% of sales, overall volume growth is very healthy in years when this segment performs very well.

* Volumes in Milk and Nutrition (M&N, 43%/25% of total sales/volumes) fell 2.7% YoY in CY21, clocking another disappointing year for NEST’s largest segment by sales. This continues the trend of flattish volumes in this segment in three out of the past four years. While volume growth has been robust across the other three categories since Mr. Suresh Narayanan took charge, M&N volume in CY21 was marginally lower than CY14 levels.

* Sales growth in the M&N segment in CY21 was subdued ~1.9%, taking some sheen off the excellent performance in the other three segments, all of which clocked an impressive sales growth (between 15% and 21% YoY) in CY21.

* Ad spends (not shared in interim results) were flat YoY. As a percentage of sales, it was at the second lowest level in the last seven years. Given the higher investments in ad spends in the past years, which contributed to double-digit revenue growth in recent years, the decline in ad spends-to-sales ratio is disappointing. With rising commodity costs (which the management believes is here to stay), the ad spends-tosales ratio needs to be monitored over the next couple of years.

* Amid the COVID-19 pandemic, the pace of launches, while lower than preceding years due to the management’s focus on the core business, was still healthy compared to its peers. Since CY16, NEST has launched 90 products.

* FATR was impacted by ongoing capex and increase in ROU assets, but net working capital days remained under control. Gross FATR (including ROU) fell to 2.9x in CY21 from 3.2x in CY19, while gross FATR (excluding ROU) fell to 3.2x from 3.5x. NWC days was flat to marginally negative in the last four yearsfrom eight-to-fifteen days earlier.

* Valuations are expensive at 59.5x CY23E EPS, preventing us from turning constructive on the stock. We maintain our Neutral rating.

Strong volume and sales growth led by non M&N segments

* NEST reported healthy (~11%) volume growth in CY21, with sales growth of 10.2%. Segment-wise details are not shared in its quarterly result and were a mixed bag, with double-digit volume growth in Beverages (up 18% on the back of a 21% decline in CY20), Prepared Dishes (up 16% on a 7% base), and Chocolates and Confectionary (up ~11% on ~3% base). Sales growth was even better with all these categories (which together constitute 57% of overall sales) growing between 15% and 21%.

* M&N (the largest segment at 43% of sales and 25% of volume) continued to disappoint with a decline of ~3% in volume and flattish (1.9%) sales growth.

* Even though Prepared Dishes contribute only 31% to sales, it constitutes 60% of volumes. NEST needs to maintain its mid-teen momentum on a 16.4% base if M&N continues to underperform. M&N volumes have continued to decline over the past 10 years after seeing some revival in CY18 and CY19.

* While the management did not attribute any reasons for the decline in its annual report, it did mention increased competitive intensity in the segment, especially in the milk sub-segment of M&N.

Ad spends-to-sales ratio to see a notable decline

* As a percentage of domestic/net sales, A&P expense fell 60bp/50bp YoY to 5.5%/5.2%. This has been the fourth consecutive year of decline in ad spends-tosales ratio.

* The latter was the second lowest in the last seven years in CY21.

* While the COVID-19 pandemic in CY20 led to a 70bp decline in ad spends-tosales ratio, we were not expecting a further decline in CY21.

* With incremental pressures on gross margin, there is a risk that either EBITDA margin may be under incremental pressure or the ad spends-to-sales ratio can decline further in CY22.

Launches and digitalization

* One of the most interesting aspects of NEST in recent years is the pick-up in the pace of launches.

* The company has seen a healthier launch pipeline since CY16 as compared to the past. While launches slowed down in CY17-18 v/s CY16 levels, CY19-21 saw a much more robust show.

* NEST has launched over 90 products since CY16, with 20 projects in the pipeline.

* Digitalization is a growth accelerator and will continue to be so in the future. Leveraging the power of data and analytics is part of its business strategy. It has a multi-intelligent data analytics system that sources internal and external data to converge insights that trigger swift and decisive business actions.

Channel expansion

* NEST set out on its RURBAN strategy by: 1) using a healthy mix of customized portfolios, 2) direct distribution, 3) enhancing its distribution infrastructure, 4) deployment of resources, 5) regional and localized communication, 6) enhancing its visibility by participating in village haats, and 7) building a consumer connect.

* Through Project RURBAN, it reached out to small towns with a population of less than 100,000 and large villages with a population greater than 2,000 with an eye on long-term growth opportunities.

Sustainability and efficiency

* From CY06 to CY21, it reduced the usage of energy/water/wastewater generation/specific direct GHG emissions by ~ 43%/~52%/~67%/57% for every tonne of production.

* Renewable energy: Key renewable energy projects contributed to GHG savings. This was implemented through higher purchase of solar power for the Choladi and Nanjangud factories and replacement of fossil fuel with clean fuel for steam generation at the Bicholim factory.

* EPR (Extended Producer Responsibility) Initiative: NEST has engaged with various waste agencies for end-to-end management of plastic waste. In CY21, it achieved an EPR of 23,600MT through plastic waste management.

Valuation and view

* There is no material change to our CY22 and CY23 EPS forecasts.

*The long-term narratives for revenue and earnings growth are highly attractive. The Packaged Foods segment in India offers immense growth opportunities. 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.

* Valuations at 59.5x CY23E P/E are, however, expensive and do not offer any significant upside from a one-year perspective. We value the company at 60x Mar’24E EPS to arrive at our TP of INR18,700. We maintain our Neutral stance.

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