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We see subdued earnings in the very near-term

Nestle India Ltd.’s (NEST) continued to report weak set of numbers for the second consecutive quarter versus expectations. Domestic sales grew just 1.2% due to muted consumer demand. We believe underperformance in Maggi (ex-Masala-Ae-Magic), Milk & Milk Nutrition (ex-Milkmaid) and Munch, among the bigger portfolio, impacted domestic sales in 2Q. Going forward, while the sector is expected to gain from improving rural growth, NEST with rural mix of 20-25% remains at the lower end among its peers. Hence, rural recovery led volume push will be lower for NEST. Gross margins remained under pressure with 100bps QoQ contraction largely led by high commodity prices especially for coffee & cocoa. Higher other overheads (+210bps YoY) driven by increase in advertising & marketing investments, meant that EBITDA margin was down 150bps YoY (~160bps below our estimate). Key commodity inflation + volatility will continue to put pressure on profitability in the near-term. Over next 2-years, we are now building ~9% EPS CAGR (on a normalized FY24) led by ~8.7% revenue CAGR. The stock currently trades at ~72x/62x/56x FY25E/FY26E/FY27E EPS. We assign multiple of ~60x and roll-forward to FY’27E EPS, arriving at a revised TP of Rs2,550 (Rs2,515 earlier). Maintain NEUTRAL rating.

Result Highlights (Standalone)

* Headline performance: NEST’s 2QFY25 revenues (incldg. OOI) grew by 1.3% YoY to Rs51bn (vs est. Rs53.4bn). EBITDA de-grew by 5% YoY to Rs11.7bn (vs est. Rs13.1bn). Adjusted PAT (APAT) de-grew by 9.4% YoY to Rs7.6bn (vs est. Rs8.9bn). Reported PAT up 8.6% YoY to Rs9.9bn.

* Domestic sales grew 1.2% YoY to Rs48.8bn (vs est. Rs51.1bn). Exports (~3.8% of sales for the quarter) were up by 3.1% YoY to Rs1.9bn (vs est. Rs2bn).

* Margins: Gross margin was down sequentially by 100bps (flat YoY to 56.6% vs. est. of 57.1%). Overheads were slightly higher than our estimate: Staff cost down 40bps YoY, but other expenses were up 210bps YoY. This meant that EBITDA margin was down 150bps YoY to 22.9% (vs. est. 24.5%).

* 1HFY25: Revenues, EBITDA and APAT up 2.3%, down 0.8% & down 2.9% YoY, respectively. Gross margin up by 140bps YoY to 57.1% while EBITDA margin is down 70bps YoY to 22.9%.

* Other highlights:

(1) Commodity commentary: Commodity prices remain elevated specially for coffee and cocoa, with prices of cereals and edible oils also being accentuated with recent developments. There is relative stability in milk prices and packaging so far.

(2) E-commerce delivered high double-digit growth, which was the highest in the last seven quarters contributing to 8.3% of domestic sales.

(3) New products now contribute to approximately 7% of sales. Eight new projects are also in the pipeline

View & Valuation

We expect near-term earnings growth to remain under pressure. On a high earnings base, we believe earnings growth over next two years would be driven by (1) Capacity addition led push. (2) Sweating of distribution assets in non-urban markets. NEST’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) Continued R&D led innovations leading to maintenance of growth in premium portfolio. Addition of new categories will only add to medium-to-long term earnings. Over next two years, we are now building ~9% EPS CAGR (on a normalized FY24) led by ~8.7% revenue CAGR. The stock currently trades at ~72x/62x/56x FY25E/FY26E/FY27E EPS. We assign multiple of ~60x and roll-forward to FY’27E EPS, arriving at a revised TP of Rs2,550 (Rs2,515 earlier). Maintain NEUTRAL rating.

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