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Nestle India Ltd.’s (NEST) reported weak set of numbers in 1QFY25. Domestic sales grew just 4.2% with one-fourth of it coming through a combination of volume & mix. This trend is expected to improve in coming quarters. Also, it is important to note that while the company has made huge efforts on rural distribution expansion, but its rural mix at 20-25% remains lower compared to peers. Hence, rural recovery benefit will be lower for NEST in the coming quarters. Gross margins surprised us with a 90bps QoQ improvement, but higher overheads meant that EBITDA margin improvement was restricted (~80bps below our estimate). Key commodity inflation and volatility might have an incremental impact on performance in the near-term. The stock currently trades at ~75x/64x FY25E/FY26E EPS. Since, we haven’t baked the benefit from the new JV with Dr. Reddy’s and introduction of Nespresso in our estimates, we continue to assign a slightly higher multiple of ~62x and roll-forward to Sep’26E EPS, arriving at a revised target price (TP) of Rs2,515 (Rs2,420 earlier). Assign NEUTRAL rating.

Result Highlights

* Headline performance: NEST’s June’24 revenues (incldg. OOI) grew by just 3.3% YoY to Rs48.1bn (vs est. Rs51.2bn). EBITDA grew by 4.1% YoY to Rs11bn (vs est. Rs12.1bn). Adjusted PAT (APAT) grew by 4.7%YoY to Rs7.3bn (vs est. Rs8.2bn).

* Domestic sales grew 4.2% YoY to Rs46.1bn (vs est. Rs48.6bn) led by volume+mix growth of ~1%. Exports (~3.8% of sales for the quarter) were down by 7.2% YoY to Rs1.8bn (vs est. Rs1.6bn).

* Margins: Gross margin sequentially up by 90bps (+280bps YoY to 57.6% vs. est. of 55.8%). Rise in other overheads (up 200bps YoY), and staff cost (up 70bps YoY), meant that EBITDA margin was lower than our estimate at 22.9% (up 20bps YoY; vs. est. 22.7%).

* Other highlights:

(1) Commodity commentary: Unprecedented headwinds in Coffee and Cocoa with all time high prices and an ongoing price rally. Cereals and grains are going through a structural cost increase backed by MSP. There is relative stability in milk prices, packaging and edible oils.

(2) Nestle has added over 800 new distribution touchpoints that includes cash distributors, re-distributors and wholesale hubs. It has also added 5,000 villages in this quarter taking the count to 205,000 villages.

(3) E-commerce channel grew in double-digit, contributing to 7.5% of domestic sales.

View & Valuation

On a high earnings base, we believe earnings growth over next two years would be driven by (1) Capacity addition led push. (2) Sweating assets of distribution expansion done in non-urban markets. Company’s initiative on distribution reach and products catering to RURBAN portfolio is strengthening its position in rural areas but contribution remains low at 20-25% of domestic topline; (3) Pick-up in R&D led innovations, which will also lead to faster growth in the premium portfolio. Addition of new categories (Pet Care, Toddler Nutrition segments and Nespresso [to be launched by the end of 2024]) and JV with Dr. Reddy (JV is expected to become operational by 2QFY25) will add to medium-to-long term earnings. Over next two years, we are now building ~9% EPS CAGR (on a normalized FY24) led by ~9% revenue CAGR and no major change in EBITDA margin at 23.5-24%. The stock currently trades at ~75x/64x FY25E/FY26E EPS. We have not baked in the benefit from the new JV with Dr. Reddy’s and introduction of Nespresso in our estimates, we continue to assign a slightly higher multiple of ~62x and roll-forward to Sep’26E EPS, arriving at a revised TP of Rs2,515 (Rs2,420 earlier). Assign NEUTRAL rating.

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