Our recent upgrade note on Nestle highlighted our confidence in company’s double-digit revenue growth momentum (volume-led) and potential margin gains; Q1CY18 performance is in line on revenue and beat our higher-than-consensus Ebitda margin estimate. We like Nestlé’s renewed volume obsession and expect the accelerated growth momentum to sustain, backed by faster execution, higher contribution from NPDs (new product development) (to enter breakfast cereals this year), GST-led price cuts and new ‘cluster-based’ marketing approach. Benign input cost scenario, sustained premiumisation benefits and operating leverage are likely to drive robust earnings growth.
5-6% upgrade in EPS estimate (led by margin beat) coupled with higher target multiple (48x Mar-20 vs. 46x) drives TP toRs 10,100. Buy stays.
Q1CY18 – Stellar quarter, margin tops higher-than-consensus estimate
Nestle reported a stellar quarter with 10.5% y-o-y revenue growth (a tad below our estimate) led by 11% net domestic revenue growth (underlying revenue growth adjusted for GST changes was higher at 13.4%, we estimated 11-12% volume growth—broad-based growth across categories, as per management commentary) and 6% growth in exports revenue. Ebitda at `7.5 bn grew 35% y-o-y (4% above estimates) led by solid 470 bps y-o-y jump in Ebitda margin at 25.8%.
While bulk of margin expansion was led by gross margin (up 300 bps y-o-y due to lower agri-input prices and portfolio premiumisation), sustained benefits from GST-tailwinds and tight cost control led to 155 bps y-o-y savings in other expenses. Recurring PAT at `4.24 bn was up 38% y-o-y (4% above our estimate) aided by 50% y-o-y jump in other income partially negated by 195 bps jump in effective tax rate (quantum of income tax holiday for Samalkha factory Unit II reduced from 100% to 30%).
Entry into breakfast cereals market
Nestle has announced that it is set to expand its foods portfolio by introducing breakfast cereals from Nestlé’s Cereal Partners Worldwide (CPW) joint venture to the Indian market. We note CPW is a 50:50 JV between Nestlé and General Mills, with a network of 17 factories, four R&D centres and 4,600 employees across the world. The company has not specified which cereals will initially be introduced, but CPW’s product range includes cereals from brands such as Cheerios, Shreddies and Shredded Wheat. As per reports, breakfast cereals is a `15-20 bn market dominated by MNCs like Kellogg’s and PepsiCo apart from presence of local players like Bagrry’s and Marico.
On a solid foundation of CY17, we expect, revenue growth to accelerate to 13.5% CAGR on 12% volume CAGR over CY17-19E aided by (i) sustained momentum in Maggi noodles portfolio (likely to cross pre-crisis level in CY18) and (ii) acceleration in non-Maggi noodles portfolio aided by higher contribution from NPDs. Key underlying drivers include sustained innovation drive, ‘cluster-based’ approach to marketing/distribution and GST-led price cuts (near-term tailwind). Benign raw material inflation trend, strong operating leverage, sustained premiumisation benefits and GST-led tailwinds are likely to aid solid 340 bps expansion in Ebitda margin over CY17-19e to 25.6% (Q1CY18 margin at 25.8%).
Underlying momentum to support premium valuations
Double-digit volume-led revenue growth (bake in 12% volume CAGR over CY17-19e), robust earnings growth (27% EPS CAGR) and superior RoCE profile (to inch up to 65-75% levels over CY18-19e versus 45-55% level over CY15-17) are likely to support Nestlé’s premium valuations.