Volume driven strategy could sustain growth for Nestle, say analysts

Valuations however leave little room for gains on the upside

Nestlé delivered an encouraging performance in the March 2023 quarter. Sales were up 21 per cent year-on-year (YoY) to Rs 4,830 crore (Rs 4,260 crore in the previous quarter) with domestic and export sales up 21.2 per cent and 24.9 per cent YoY respectively while net profit rose 25.8 per cent YoY. However, the gross margins contracted 149 basis points YoY to 53.8 per cent on higher raw material prices, particularly milk and its derivatives, as well as wheat flour and edible oil. The operating profit grew 19.7 per cent YoY to Rs 1,110 crore while the operating profit margins contracted by 24 basis points YoY to 23 per cent. Net profit grew 25.8 per cent YoY to Rs 750 crore.

Despite margin contraction, the performance is commendable given steady inflation across the range of food commodities Nestlé processes. Volumes were up, and the company succeeded in passing on some of the higher raw material costs. There were also signs inflation may moderate in coffee (down 2 per cent QoQ) but palm oil is up 6.4 per cent QoQ and milk (which overall contributes 40 per cent to raw material costs) is strongly inflationary.

Some of the key factors driving the results include deeper expansion in tier-II and III towns and villages tweaking the portfolio. The company may continue to aggressively expand its distribution network, even if that impacts free cash flow. It delivered growth across both rural and urban geographies as well as metros.

The management highlighted that fresh milk, fuel and coffee remain inflationary, while there are early signs of softening in edible oils, wheat and packaging materials. They also highlighted it is looking at cost-control measures to partly offset inflationary impact.

There was broad-based growth including volume growth across categories like prepared dishes and cooking aid, milk products and nutrition, confectionery and beverages while pet foods continue to build momentum. The recent acquisition of India’s pet care business from the global parent could add to the top line. The low unit pack Maggi could gain traction in rural markets. Every product group delivered double-digit growth for the fourth quarter in a row.

There are strong growth opportunities through the medium term. The switch in strategy to seek volume growth even at the cost of some margin erosion seems to be working. If consumption recovery is underway and food inflation does moderate, the volume driven strategy could work out.

The entire category (FMCG) is expensive, and Nestlé with its MNC pedigree and its low float (around 16 per cent with non-institutional public with 63 per cent held by parent) is no exception. The stock has always traded at over 50 times price earnings ratio. Despite being a reliable dividend payer and the apparent growth acceleration, the high valuations could put a ceiling on returns in terms of capital gains. However, the share gained 1.5 per cent to Rs 20,970 after the results were declared. Some analysts have “reduce” recommendations purely on valuations. Valuations range from Rs 18,500 (well below current market price) to Rs 23,000.