Nestle India: Higher growth rates imperative to sustain high valuation

Nestle has been focusing on "RURBAN" and expanding its distribution reach. E-commerce continued to deliver double-digit growth

Nestlé India had a weak April-June quarter (Q1) of FY25 with meagre 3.3 per cent year-on-year (Y-o-Y) revenue growth, well below the long-term average of 14 per cent. The Gross Margin expanded 280 basis points (bps) Y-o-Y to 57.6 per cent but raw material prices are seeing inflation, with coffee, and cocoa prices at record highs, besides cereals and grains. Operating costs are up 11 per cent and Ebitda margin rose 40 bps to 23.3 per cent. The Ebitda grew 5 per cent Y-o-Y to Rs 1,120 crore.

Nestlé has been focusing on ‘Rurban’ strategy and expanding its distribution reach. E-commerce continued to deliver double-digit growth. Nestlé added 800 distribution touch points and increased its village coverage by 5,000 to 205,000 villages. Growth was higher in Rurban markets. Packaged food penetration has improved in Tier-II and rural markets.

The sharp deceleration in revenue growth in Q1FY25 – net revenue was up only 3.3 per cent Y-o-Y to Rs 4,810 crore – was due to weak show in both domestic sales and exports. Domestic sales grew 4.2 per cent Y-o-Y to Rs 4,610 crore with some volume growth and a better product mix, but exports contracted 7.2 per cent Y-o-Y to Rs 180 crore.

Growth was across segments, though low. Five of the top 12 brands did clock double-digit growth. Beverages delivered double-digit growth while prepared dishes maintained momentum, with innovations contributing 30 per cent of growth. Masala-Ae-Magic and Kitkat saw double-digit growth. Maggi Korean Noodles received a positive response from consumers. The confectionery segment remains the top performer with strong distribution, and Munch made regional inroads. Munch also entered a movie partnership.

Beverages saw robust growth with Nescafe Sunrise gaining traction in South India and Nescafe solidified its leadership position, increasing its market share and household penetration. In Petcare, Felix wet cat food received positive feedback from trade and cat parents. The Out-of-Home (OOH) is seeing healthy growth, driven by portfolio transformation, innovations, increased market penetration, and premiumisation.

The e-commerce mix was 7.5 per cent, and grew at double digits. The profit before tax grew 6.9 per cent Y-o-Y to Rs 1,020 crore and adjusted profit after tax increased by 5.1 per cent Y-o-Y to Rs 740 crore. The portfolio is relatively safe from local competition and operating costs are growing slower than with most FMCGs. The Ebitda margin may reach 25 per cent by the FY25 end and be sustained through FY26.

Nestlé has acquired 49,000 equity shares of Rs 10 each in “Dr Reddy’s and Nestlé Health Science" (formerly Dr Reddy’s Nutraceuticals) from Dr Reddy’s Labs. Following this, Nestlé now holds 49 per cent of the share capital, while DRL retains 51 per cent.

The Nestlé India stock has always traded at very expensive valuations. Post-results, it is down 2.6 per cent over two sessions and at Rs 2,478.70 trades at 67x PE for FY25. The slowdown in growth is a cause for concern and so is raw material inflation. The Ebitda margins could grow and positive growth across all segments is encouraging. But the deeper distribution reach will need to translate into faster revenue growth to give investors comfort at these valuations, along with recovery in export growth.

According to Bloomberg, 13 out of 32 analysts polled post Q1 are bullish on the stock, 14 have ‘neutral’ ratings, and 5 are bearish. Their average one-year target price is Rs 2,620.50, indicating less than six per cent upside potential.