Nestle needs to sustain strong Q4 performance led by volume growth

Incremental market share gains in noodles, chocolates pose a challenge

Nestlé India shares surged over 4 per cent after its strong December quarter (Q4) results. Led by volume growth and strong sales of Maggi, domestic revenues increased about 11 per cent year-on-year (y-o-y) to Rs 25.89 billion. When adjusted for goods and services tax (GST)-related accounting changes, growth stood at 18 per cent.

Gains at the operating level were stronger, with gross profit margins increasing by 130 basis points (bps) to 58.9 per cent because of benign input costs of sugar, coffee and skimmed milk powder. This coupled with lower other expenses and benefits of leverage helped the company report 39 per cent growth in operating profit and 60 per cent growth in recurring net profit on a y-o-y basis. Thus, operating profit margins were up 350 bps to 24.8 per cent in Q4.

The Q4 results led to a 9-10 per cent earnings upgrade from brokerages for CY18 and CY19.

The key near-term trigger for the Nestlé stock will be gains from Maggi noodles, which reached 60 per cent market share after being stagnant at 58 per cent over the last few years. To broad-base its appeal, the company is positioning the product for adults with launches of Maggi Masalas of India and Maggi Nutrilicious.

Analysts at Prabhudas Lilladher said Nestlé would have to put in more effort to gain incremental share in the noodles segment, given competition from ITC, Capital Foods (Ching’s Secret), Patanjali and Hindustan Unilever (Knorr).

Including Maggi, the company launched over 15 new products last year. Nestlé has gained traction in the chocolates segment on the back of higher demand, but still trails market leader Cadbury.

Analysts at Kotak Institutional Equities said the company had delivered on its volume-centric growth strategy and had not been shy of taking a short-term margin hit to keep the volume momentum impact.

However, not all analysts were convinced. Analysts at Motilal Oswal Securities said while numbers in recent quarters had been good, they were back to base-quarter levels (or the pre-Maggi crisis level) as far as sales, Ebitda and net profit are concerned. Also, margins performance was the key reason for the recent earnings upgrade.

Even as analysts expect a compounded annual growth of 13.1 per cent in sales and 17.2 per cent in net profit over the next two years, they see limited upside for the stock.

Currently, the stock is trading at 46.3 times its CY19 earnings estimates. Given the recent uptick in prices, investors should await a better entry point or until there is proof that Nestlé can sustain healthy growth rates led by volumes and profitability.