June-quarter miss, valuations may restrict upside in Nestle India

Brokerages have cut their profit estimates by 3-5 per cent

The stock of Nestle India, the fourth largest consumer company by market capitalisation, slipped by a per cent after its June quarter results came in lower than street estimates. This coupled with a cut in net profit estimates and higher valuations led to the weakness in the stock.

While the company posted a steady 14 per cent YoY growth driven by volume and product mix, this was on a weak base of 1.7 per cent and lower than consensus estimates. The ongoing trend of in-home consumption led to a double digit growth in noodles, chocolates and sauces. Contribution from e-commerce channels doubled over the year ago period and now constitute 6.4 per cent of domestic sales.

Given the impact of the lockdown, sequential sales were 4 per cent lower. Analysts at Motilal Oswal point out that two-year average growth of 7.8 per cent is lower than the 9-10 per cent growth reported in the last three quarters. On the growth front, the street will focus on investments by the company, product launches/innovations and rural penetration efforts.

The company indicated that it has completed a capital expenditure of Rs 1,000 crore as part of a Rs 2,600-crore programme spread over 3-4 years. This will help it meet capacity constraints in key segments such as Maggi, but also indicates the company’s confidence in the growth prospects.

The company has also increased its focus on the rural segment by increasing village coverage by 33 per cent through rural centric products. Analysts at Prabhudas Lilladher Research believe that this will result in strong long-term growth given rural and semi-urban markets are growing at 2-2.5 times that of urban and are contributing to about 20-22% of sales of Nestle. Further, innovations (new product development) continue to be strong with their contribution to domestic revenues increasing to 4.9 per cent in the first half of the current year (CY21).

While Ashit Desai of Emkay Global believes that the step-up in innovation and the distribution push seem good, he highlights that these steps are yet to drive further improvement in growth as per expectations.

Investors will also keep an eye out for margin movement given the sequential drop in gross margins by 150 basis points due to rise in palm oil and packaging material costs. While agri inputs such as sugar, milk and wheat have been stable in the June quarter, there could be pressure due to high palm oil and coffee prices.

Given the higher capex and margin worries, brokerages have cut their net profit estimates by 3-5 per cent for the CY21-23 period. Further, given valuations at 60 times CY22 earnings estimates, there may not be enough upside left from the near term perspective. Investors can consider the stock for the long term portfolio on further corrections.