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Healthy sales; material cost concerns persist

* Nestlé India (NEST) reported sales in line with our estimates. Growth of 9.6% in 3QCY21 on a base of 10.1% in 3QCY20 indicates a healthy demand trend.

* In a welcome new disclosure, the quarterly press release now has commentary on segmental growth, and growth for the quarter seems to be broad based across the four key segments.

* On a high EBITDA margin base, operating profit and PAT growth came in tepid at 5.9% and 3.2%, respectively, especially as material cost inflation led to the lowest gross margin in 17 quarters in 3QCY21. The press release indicated commodity costs pressures are likely to persist.

* Valuations at 60.8x CY23E EPS do not leave any room for any upside from a one-year perspective. We maintain our Neutral stance.

Sales in-line; margins better than expected

* NEST reported net sales growth of 9.6% YoY to INR38.8b (in-line). Domestic sales grew 10.1% YoY, driven by high-single-digit volume and mix growth; export sales grew 1.3% YoY during the quarter. We peg volume growth for the quarter at ~8%.

* EBITDA / PBT / Adjusted PAT grew 5.9%/4.6%/3.2% YoY to INR9.5b/INR8.4b/INR6.2b (v/s our estimate of INR9.1b/INR7.8b/INR5.8b).

* Gross margins contracted 240bp YoY to 55.7% on higher commodity prices, particularly edible oil and packaging materials, partly offset by better realizations.

* As a percentage of sales, lower staff costs (-40bp YoY to 10%) and other expenses (-110bp YoY to 21.2%) led to EBITDA margin contraction of 90bp YoY to 24.5% (est. 23.5%) in 3QCY21. Lower staff costs (as a percentage of sales) are favorable against the base quarter, which was impacted by the incentives offered to production manpower in light of COVID.

* 9MCY21 sales / EBITDA / adj. PAT grew 10.6%/10.5%/7.1% YoY to INR109.7b/INR27.2b/INR17.5b.

* The board of directors has declared a second interim dividend of INR110 per share. The first interim dividend of INR25 per share was paid in May’21.

Segmental highlights

* Prepared Dishes and Cooking Aids: Continuing momentum and improved availability helped achieve good growth despite the high base effect (build‐ up after 2QCY20). Maggi Noodles and Maggi Masala‐ae‐Magic posted healthy growth. On the other hand, Maggi Sauces saw somewhat muted growth due to decreased in‐home consumption, a high base, and increased competitive intensity.

* Milk Products and Nutrition: The Toddler range (Ceregrow, Nangrow) and Milkmaid posted strong double-digit growth.

* Confectionery: Power brands KitKat, Munch, and Milkybar registered high double-digit growth, aided by media campaigns, attractive consumer promotions, and distribution drives.

* Beverages: Strong double-digit growth was seen in Nescafé Classic, led by increased penetration, visibility actions, and the sustained generation of demand input.

Key highlights from press release

* Nestlé India’s ninth factory in Sanand has been built, equipped, and made up to standard entirely during the pandemic period. Over 60% of the factory workforce comprises women.

* E‐commerce: The channel is expected to continue its growth journey, and NEST is gaining increasing traction in this space.

* Organized trade: A decrease in the pandemic intensity and an increase in vaccination coverage contributed to broad‐based growth across the Food & Beverages category especially Coffee & Confectionery.

* Out of Home (OOH): The OOH channel is on the recovery path with the gradual opening up of hotels, restaurants, offices, and malls. There are signs of a return to pre‐pandemic levels of business traction in some geographies, categories, and channels.

* Exports: Maggi Noodles and Polo have been introduced in the Middle East markets recently. Crunch Wafer has been introduced in ASEAN markets.

* Commodity outlook:

* The price outlook for key commodities such as wheat, coffee, and edible oils remains firm to bullish. On the contrary, packaging material costs continue to increase amid supply constraints and rising fuel and transportation costs.

* Input prices are expected to see a bullish trend both globally and (to some extent) locally.

* Fresh milk prices are expected to remain firm with a continued increase in demand and rise in feed costs to farmers.

* A recent announcement saw import duties being scrapped on edible oils. If this continues next year, beyond Mar’22, it could have a positive impact with regard to muting food inflation pressures.

Valuation and view

* There is no material change to our CY22E and CY23E EPS forecasts.

* The long-term narratives for NEST's 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 60.8x CY23E EPS are, however, expensive and do not offer any upside from a one-year perspective. We value the company at 60x CY23E EPS to arrive at our TP of INR19,100. We maintain our Neutral stance.

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