Higher raw material costs dent Nestle's operational performance in Sept qtr

Nestle India’s September quarter (Q3CY21) performance was a tad below expectations, even though it saw double-digit growth, as inflation pressures dented both the profit margins and bottom line. The company follows a January-December financial year. 

Given higher costs, brokerages ha­ve cut their calendar year CY21-23 ea­rnings estimates by 2-6 per cent. The stock, which has gained 18 per cent since the beginning of May, was down marginally on Wednesday, as a result.

Brokerages do not expect much upside from these levels, given near-term margin pressures and stretched valuations. At the current price, the most expensive stock in the FMCG large-cap space is trading at 57 times its CY23 earnings estimates and continues to command a sizable valuation premium over peers. The Nifty FMCG average valuations are 36 times, while its top six rivals are trading at an average of just over 50 times.

The company continues to be consistent on the sales growth front, posting another 10 per cent plus growth in the domestic business. If the Q2CY20 quarter is excluded, the 10.1 per cent growth in Q3CY21 is the seventh consecutive quarter of double-digit growth.

Growth, according to the company, was aided by a recovery in organised trade, acceleration in e-commerce channel sales, and traction in the rural segment. Analysts at CLSA estimate volume growth in the quarter at 7-9 per cent and say that despite relatively higher pricing power, penetration efforts reduced pricing growth.

Within the Maggi portfolio, noodles, Masala-ae-Magic registered good growth on a high base, while sauces posted weak growth because of lower in-home consumption with the waning of the Covid-19 impact. Milk products (toddler range, Milkmaid), confectionery (Kitkat, Munch, Milkybar) and beverages (Nescafe) posted strong double-digit growth.

Despite steady growth on the top line, a surge in raw material (edible oil, packaging) prices led to 240 basis points (bps) dip in gross margin to 55.5 per cent, almost 200 bps lower than analyst estimates. Lower employee costs and other expenses helped contain the operating profit margin reduction year-on-year (YoY) to 85 bps at 24.2 per cent.

Larger peer Hindustan Unilever (HUL) too saw a dip in gross and operating margins of 140 bps and 40 bps, respectively. In addition to higher palm oil and crude oil prices, what dented HUL’s profitability were higher packaging and freight costs. Both firms highlighted a sustained rise in raw material costs and are looking at cost optimisation strategies to maintain margins.

While Nestle's Q3CY21 performance across key brands has been strong and prospects in the packaged foods business are bright, the stock captures most of the near-term upsides. Investors can look at the stock on dips for the long term to benefit from premiumisation, volume growth and pricing power that Nestle enjoys.