Innovation, new launches are strong brew for Nestle, say Edelweiss analysts

Though management indicated input cost pressure, price hikes and cost efficiency should help protect margins

Post the correction across fast-moving consumer goods (FMCG) space in the past one month, valuation (price-to-earnings ratio) of Nestle India (Nestle) too is down sharply to 41-42 times estimated earnings for the calendar year ending 2020 (CY20) from over 50 times earlier. Though the stock still looks pricey, analysts foresee a 15-25 per cent upside over a year amid healthy earnings potential. As seen in September 2018 quarter (Q3’CY18) results announced on Friday last week, innovation, new product launches and market share gains are likely to continue fuelling Nestle’s earnings in coming quarters.

Led by broad-based volume growth, Nestle’s net sales grew 16.9 per cent year-on-year to Rs 29.2 billion, the fourth consecutive quarter of year-on-year double-digit topline growth. Innovation remained a key theme. In terms of sales, share of innovation (new products/variants) has been continuously drifting up. Q3, too saw new products such as Maggi Special Masala noodles, Maggi Dip and Spread, KitKat Dessert Delight Brownie Kubes, Nescafe E coffee machine and NesPlus breakfast cereals. “Innovations are fuelling growth with 3.0 per cent contribution to H1CY18 sales (2.6 per cent in CY17, 1.5 per cent in CY16),” said Edelweiss analysts in their note. The topline was further supported by increasing marketing activities for brand strengthening, said Nestle.

Though increased branding activities led to a rise in advertising spend (reflecting in higher other operating expenses, which as a percentage of operating income was up by 152 basis points year-on-year), supportive input price trajectory (raw material cost as a percentage of net sales dropped by 285 basis points) helped improve the margin profile. The price of milk and sugar were benign during the quarter. Consequently, while gross profit margin of Nestle expanded by a good 285 basis points to 59.5 per cent, operating profit (EBITDA) margin moved up by 144 basis points to 24.7 per cent, on a year-on-year basis.

Going ahead, however, such gains may not come easily as the management has cautioned that the company is witnessing input cost pressure. Analysts though expect that there is room for selective price hikes and cost efficiency to protect margins. Jefferies, for instance, says Nestle has increased prices of its 100 gram Maggi Masala by about nine per cent in September.

In this backdrop, any correction could be a good entry point for long-term investors.