Strong volume-led growth adds sweetness to Nestle India; stock gains 3%

Analysts say double-digit earnings growth necessary to sustain pricey stock valuations

In an otherwise falling market, the stock of Nestlé India gained over 3 per cent on Monday to close at Rs 11,781 on the National Stock Exchange. 

What supported the Rs 369.50-increase in share price, besides the special interim dividend of Rs 180 per share (announced on Friday), are strong volume-led top line growth in the June 2019 quarter (Q2CY2019) and the company’s plan to add new manufacturing capacity. 

Notably, this comes at a time when the markets are unable to sense near-term consumption recovery and there is visible absence of capital expenditure by India Inc. Nestlé follows the January to December accounting year.

According to analysts at Edelweiss Securities, Nestlé’s plan to set up a production facility in Gujarat for its Maggi Noodles reinforces the confidence about the company’s strong revenue traction.

The maker of Maggi noodles, Kit Kat and Munch chocolates and Nescafe, among others, reported a strong 11.4 per cent year-on-year growth in net sales to Rs 2,983 crore. 

Nestlé said performance of key products such as Maggi, Kit Kat and Munch was strong during the quarter. In fact, the company’s geographical revenue share, which tilts more towards the urban market (around 75 per cent), provides some comfort as the demand pressure is more on the rural side. 

The trend of healthy top line growth is likely to continue even going ahead. Yet, investors should note that the overall consumption slowdown could limit Nestle’s top line growth.

Nevertheless, analysts still expect Nestlé to continue delivering around 12-13 per cent top line growth each in CY2019 and CY2020. Product innovations and renovation would further support the top line. In the June quarter, Nestlé launched Maggi Veg Atta Noodles, New Maggi Veg Oats Noodles and Nestea Iced Tea in tetrapaks, among others, in refreshed forms. 

Product enrichment can improve share of premium products in the overall sales.

Even in Q2 CY2019, higher commodity prices, mainly milk and faster growth of low margin fat products, weighed on the company’s gross profit margin. The latter moved down by 132 basis points year-on-year or YoY to 58 per cent. According to the company, Q2’s top line growth was positively affected by sales to canteen stores department or CSD and surplus fat (both relatively earn lower margins). Besides, milk prices which see a seasonal increase in the summer months, saw further upward pressure amid rising costs of animal feed.

However, control on operating expenses restricted downward pressure on earnings before interest, tax, depreciation and amortisation (Ebitda) margin, which slipped by 82 basis points YoY to 23.2 per cent. Net profit grew by around 11 per cent YoY to Rs 438 crore in Q2.

While the fundamentals outlook for Nestle appears healthy, the near-term overhang for the stock is its high valuation. The stock currently trades at 52 times its CY2020 estimated earnings. 

This is 18 per cent higher than its five-year historical one-year forward average price-earnings ratio (P/e) and 13 per cent higher compared to Hindustan Unilever’s FY21 estimated P/e. 

This leaves very little room for error for the company in terms of missing on investor expectations. Analysts at SBICAP Securities, for instance, believe that such rich valuations demand sustained healthy double-digit earnings growth from Nestlé.

Thus, how the company protects its earnings from high commodity prices and additional cost of new manufacturing capacity amidst slowing consumption trend would be the key going ahead.