Nestle: Stock offers good opportunity for medium to long-term investors

Strong resilient portfolio, along with recent ready-to-eat launches and focus on rural distribution, indicate good growth potential

Shares of Nestlé India have not only seen some correction in the recent past, but have also significantly underperformed the sector and benchmark indices.

The disappointing performance in the June quarter (Q2) has added to the pressure, given that the stock has shed 7 per cent since the results were announced last month, while Nifty FMCG index has risen 1.6 per cent during this period.

The underperformance is more stark over a longer time period. Nestlé India’s stock is down over 

10 per cent since April 27, compared with an over 24 per cent rise in the Nifty and 8 per cent gain on the Nifty FMCG index.

Apart from Q2 results, other reasons for this are profit-booking after a strong rally seen since September last year and rebound from March lows, and shift in investor preference towards other sectors.
 

However, the risk-reward metric for the stock has turned favourable with this correction, given the company’s initiatives. Secondly, the key overhang of a pricey valuation has also been addressed to some extent.

The owner of popular consumer product brands such as Maggi, KitKat, Munch, Nescafé, and Milkmaid, among others, follows a January-December accounting period.

 

 

“The Nestlé stock has significantly underperformed benchmark indices. We believe Nestlé’s valuations have become more favourable on a risk-adjusted basis,” analysts at PhillipCapital said in their recent report, while upgrading the stock to ‘buy’ from ‘neutral’.

Even after the correction, the stock, at about 64x its one-year forward valuation, is currently trading at 21 per cent premium to its long-term historical mean. Some analysts, however, do not see this as a major concern, given the company’s strong growth potential.

Varun Singh, analyst IDBI Capital, says, “Nestlé is among the best business franchises, with a strong product portfolio. We believe the stock’s current valuation is reasonable.” Many analysts foresee up to 14 per cent upside in the stock from the current levels.

While Nestlé’s portfolio has a large chunk of essential products, which are resilient in the current uncertain or volatile economic situation, its prepared dishes/ready-to-eat segment has steady growth potential. The company’s milk and nutrition and prepared dishes and cooking aid products (Maggi), which account for around three-fourth of its domestic revenue, are seeing healthy traction.

In fact, PhillipCapital’s analysts also highlight that their channel checks with distributors suggest demand for Nestlé’s key categories (noodles, coffee, and babyfood) exceeds supply. The company’s recent launches in the ready-to-eat Indian food category (Maggi Poha and Upma) should bode well.

According to Axis Securities’ analysts, Nestlé’s brands — Maggi 2-Minute Noodles, Maggi Pazzta, Maggi Upma, Maggi Poha, NesPlus — are sweetly positioned to ride the growth opportunity for ready-to-eat/ready-to-cook instant food, led by Covid-19 disruptions. Axis Securities has recently initiated coverage on the stock with a ‘buy’ rating, saying growth outlook over the medium- to long-term appears fairly promising.

Further top line support would stem from Nestlé’s rising focus on expanding rural footprint, which would push up contribution of rural revenue from around 20-25 per cent at present.

This apart, benign input costs, mainly wheat, milk, and related materials (over 50 per cent of cost pie), would provide good earnings support in the near term.

In Q2, despite strong demand in the food segment, Nestlé’s domestic sales grew 2.6 per cent at a time when players like Britannia had posted 26.4-per cent net sales growth. 

Nestlé’s pre-tax profit was down 1 per cent year-on-year to Rs 652.3 crore. Though supply-chain disruptions have hurt the overall performance, the company’s factories are operating at pre-Covid levels now. Expect the numbers to improve. Overall, the stock offers good opportunity for medium- to long-term investors.