High cost inflation, weak domestic revenue may hurt Nestle's topline growth

Domestic sales grew by 10 per cent in Q4, but gross margin contracted by 217 basis point to a 10-quarter low of 56.5 per cent

Nestle India (Nestle) continued to outperform its peers such as Britannia in December 2019 quarter (Q4), but it also witnessed relatively higher inflationary pressure. And, the latter could prove to be a party-spoiler for the company. Nestle follows January-December accounting period and announced its Q4 numbers on Thursday post market hours.

While the packaged food and beverage major’s net sales grew by 8.8 per cent year-on-year to Rs 3,131 crore, profit before tax (PBT) surged 17.7 per cent year-on-year to Rs 615 crore in Q4. Both these parameters, however, were a tad below Bloomberg consensus of Rs 3,143 crore and Rs 631 crore, respectively. Net profit growth of 38 per cent was also largely driven by lower corporate taxes. Thus, the latter may not be strictly comparable.

Nestle’s 10 per cent year-on-year growth in its domestic sales (95 per cent of revenue) in Q4 is noteworthy in light of the poor consumption environment. Success of new launches and lower exposure to rural markets (25 per cent of revenue) are supporting Nestle’s topline growth. The caution however is, that year-on-year domestic revenue growth has been continuously drifting down since past 5 quarters, thanks to weakening consumer sentiment. Domestic revenue growth was 17.5 per cent in September 2018 quarter.

Beyond the good, albeit slowing topline growth, Nestle continues to witness inflationary pressure, mainly related to milk, which is 45 per cent of its raw material costs. In Q4, its gross profit margin shrunk by a whopping 217 basis point year-on-year to 56.5 per cent, the lowest in last 10 quarters. Notably, strong operating leverage fully negated the gross margin impact at the Ebitda (earnings before interest, tax, depreciation and amortisation) level. Nestle’s Ebitda margin improved by 22 basis point year-on-year to 20.9 per cent in Q4.

As per the management, the trend of higher commodity prices witnessed in recent quarters is likely to continue in the near future. While analysts at Prabhudas Lilladher estimate Nestle’s Ebitda margin to contract by 40 basis points in CY2020, others expect Nestle’s select price hikes and operating leverage to support margins. Thus, it would be interesting to see how this plays out.

Overall, while Nestle’s sharp focus on new launches with higher marketing spends suggests that its structural growth story remains intact, investors could await some correction in the stock given its rich valuation of 57 times CY2021 estimated earnings.