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Thriving not surviving; Valuations out of comfort

We participated in the Analyst/Investors Meet held by Nestle India’s (NEST) at Nestle House. Key pointers: (1) Branded packaged food market at ~$40bn is currently a small portion of the $800bn overall (Loose + Packaged) Food market in India, so growth opportunity remains strong. (2) 9MCY23 domestic tonnage growth stood at ~1.7% so growth largely driven by pricing+mix. (3) NEST will now be focusing more on sweating the distribution assets built over last few years. (4) There will be step up in innovations compared to last year, but it will now be more calibrated. (5) Inflation won’t be a big concern in near term. The stock is currently trading at 67x/61x CY24E/CY25E EPS and leaves little room for execution error. Based on target multiple of ~60x (3yr/5yr avg fwd. multiple ~69x/67x) and rolling forward to Sept’25 EPS, we now arrive at a target price (TP) of Rs23,420, thus downgrade our rating a notch to Reduce.

Analyst Meet – Key points: -

1) As far as Nestle is concerned, there are total 487mn addressable consumers which is likely to increase to ~700mn by 2030. As per market theory, consumption won’t be a problem but supply might become one. 2) Total (Loose + Packaged) Food market in India is $800bn, of which Packaged Food would be $100bn and further Branded Packaged Food to be ~$40bn. 3) The domestic volumes as of 9MCY23 stood at 430k tonnes vs 423k tonnes in 9MCY22, implying ~1.7% tonnage growth. Subdued near term volume growth can be seen as just a blip in the long-term curve if we compare it to the huge penetration led opportunity. 4) It is targeting to cover 1,20,000 villages by 2024 having a population of >2,000. Post that, company believes, distribution reach expansion in non-urban areas, atleast for now, is largely done and company will be now focusing on sweating the assets. 5) Over the 3 years, town class (TC) 1 to 6 growth was a 10.2% CAGR, slightly lower than other regions as it was impacted by inflation led pricing. 6) Going forward there will be step up in innovations compared to last year but innovations now would be more calibrated. 7) NEST has improved efficiencies in buying media. This along with increased mix of digital spends has helped them reduce A&SP as a % of sales. It has decided to invest in building brand equity vs short term promotions. 8) Management has pointed out concerns on green coffee prices. Rest of commodities are largely in comfortable zone. 9) Leadership transitioning now almost done. 10) The current royalty agreement will expire in June 2024. The review on royalty is still in front of the board

View and Valuation

CY23 earnings growth has been robust for NEST and we remain confident that NEST will be able to sustain its healthy earnings growth (better than peers) over CY22-25E led by (1) Strong capex over CY23-25. (2) Sweating assets of distribution expansion done in non-urban markets. This along with products catering to RURBAN portfolio is strengthening its position in rural areas (current contribution at 20-25% of domestic topline) & tier 2/3 cities; (3) Pick up in innovations (backed by R&D capabilities), which will also to faster growth in the premium portfolio). Addition of new categories (Pet Care and Toddler Nutrition segments) will add to the long-term earnings trajectory for NEST. We are now building strong 16.5% EPS CAGR led by 11.9% revenue CAGR and EBITDA margin expansion of ~240bps to 24.7% (driven by gross margin expansion of ~390bps to ~58%). But the stock is currently trading at ~76x/67x/61x CY23E/CY24E/CY25E EPS and leaves little room for execution error. Dividend payout remains high and return ratios are also best in the industry even while major capex is being done in CY23 and CY24 (~Rs13bn in CY23 and ~Rs20bn in CY24). There are minor changes to our CY23E/CY24E EPS, and we now introduce CY25 estimates. Based on target multiple of ~60x (3yr/5yr avg fwd. multiple ~69x/67x) and rolling forward to Sept’25 EPS, we now arrive at a TP of Rs23,420 (Rs22,380 earlier), thus downgrade our rating a notch to Reduce.

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