Can Nestle's rural push turn around its fortunes? Here's what analysts say

Nestle India's recently launched strategy of product innovation and deeper penetration in the rural areas bodes well for the stock of the firm, according to analysts, who see an up to 17 per cent upside for it from current levels.

The shares of the FMCG major have underperformed the market with a 12 per cent decline on a year-to-date (YTD) basis. During this period, the Nifty has jumped 3 per cent while the Nifty FMCG index has dipped 5 per cent, as per ACE Equity data.

Going ahead, however, the fortunes are expected to look up as Nestle, at its analyst meet, unveiled a strategy to aggressively pursue expansion in the rural areas, increase capacity and focus on new product launches.

While the longer-term narrative for Nestle's revenue and earnings growth remains extremely attractive, near-term concerns on valuations cannot be ruled out. In this backdrop, Nestle was trading nearly a per cent higher at Rs 16,191 on the BSE on Monday.

Impact on growth & margin

The firm, typically known for its urban-centric business model, is aiming to reach an unprecedented 120,000 villages by 2024, backed by rural-focused SKUs. From 1,000-odd villages in 2017, Nestle grew its presence to 89,000 by 2019. During the period, the share of the rural market in its sales grew from less than 15 per cent to 25 per cent. The firm posted a 10 per cent top-line growth in 2020. While urban markets delivered 6 per cent growth, the rate in the rural areas was double – at 12 per cent. READ MORE

However, it had to slow down its product innovation in 2020 due to higher focus on protection of core brands in a muted demand environment. But the management has now indicated that more than 40 new products in the pipeline. The company has launched 80 new products in the last five years with 75 per cent success rate.

"Success of new launches and growing salience in rural India can provide an upside to Nestle's PAT estimates," said Prabhudas Lilladher as it upgraded the stock to 'Accumulate' from 'Hold' with a target price of Rs 17,364.

The firm is also focussing on capacity expansion to meet the rising demand. It will be expanding its existing facility at Samalkha (Haryana), apart from setting up a new plant in Sanand (Gujarat). The company in its Q3FY20 results had announced a capex of Rs 26 billion over two - three years, highlighting the management's confidence and intent to drive volume-led growth.

According to Kotak Institutional Equities (KIE), capacity expansion coupled with footprint expansion augurs well for sustained double-digit top-line growth, if not acceleration.

Those at Antique Broking, too, share this view and believe Nestle is setting a platform for healthy double-digit growth in revenue during the next 5 years. It has a 'Buy' rating on the counter with a target of Rs 18,852.

Operating leverage-led margin expansion in the medium-term is another positive. "The inflation in milk and SMP may impact margins in the near term. However, cost-saving initiatives (project Shark) along with operating scale is expected to aid margins in the long-term," Antique Broking said.

According to KIE, Nestle is one of the best long-term plays in the rapidly growing Indian packaged foods industry. "It offers a combination of healthy volume, premiumization-led top-line growth and margin expansion potential if the company steps up focus on cost structure optimisation," it said.

The brokerage upgraded the stock to 'Add' with a fair value of Rs 17,150 as it believes the risk-reward has turned favourable following time-correction over the past 12 months.

Despite the positives, analysts do caution against the valuation at which the stock is trading at and believe the positives remain priced in from a near-term perspective.

"Valuations at 55x CY22E EPS appear to factor in an upside from a one-year perspective. We value the company at 60x December 2022E EPS to arrive at our target price of Rs 17,500 and maintain Neutral stance," analysts at Motilal Oswal Securities said.