While Ebitda margin expansion will slow down, CY18-20e EPS raised by 7% given 1HCY18 margin growth; TP up to Rs 11,800
NEST Q2CY18 revenue (up 12.3% YoY), EBITDA (up 43.4% YoY) and PAT (up 54.9% YoY) came in line with our expectations. 14.5% YoY LTL growth in the domestic sales which was volume led and broad based highlights steady delivery. While pace of gross and EBITDA margin expansion will slow down with RM inflation pick-up, we believe company can deliver an operating leverage-led modest EBITDA margin expansion helped by low-teen topline growth. Maintain Buy, PT Rs 11,800.
Topline growth steady: Nestlé like to like (LTL) domestic sales growth was robust with 14.5% YoY (led by an estimated ~12% YoY volume growth) coming on a base of 8.4% YoY. Traction in export business was decent which saw growth of 15.7% YoY though the same has come on a soft base of 12% YoY dip. Management has highlighted that it is witnessing broad-based volume growth across categories and the overall momentum in the market sustains.
Innovation: Nestlé continues to remain aggressive on innovation and its focus to grow topline. The company has entered the breakfast cereals category with the brand Nesplus; we believe that category holds strong potential provided Nestlé invests behind the same. The product was launched on the prime day sale of Amazon which helps in creating excitement behind the brand.
Sharp margin expansion: Nestlé gross margin expanded 456bps YoY helped by soft commodity prices. EBITDA margin expansion was sharp at 534bps YoY led by cost efficiencies as other operating expenses were down 79bps YoY. In CY19 and CY20, we expect modest margin expansion (60bps p.a.) largely led by operating leverage.
Price hikes? Management has cautioned about witnessing some headwinds in commodity prices. Our RM tracker suggests that still most of the key RMs for Nestlé remain benign. Still we believe that amidst improving demand scenario, absence of price hikes for couple of years and given higher share of urban for Nestlé, the company holds strong pricing power. Estimates and PT: We raise our CY18-20 EPS by ~7% to factor in higher 1HCY18 margin trajectory. We raise our PT to Rs 11,800 (on 52x Jun 20 EPS, ~20% premium to 10 year avg PE).
Our view: We have seen some improvement in NEST in-market execution and innovations over the last 12-18 months (though more still needs to be done on core categories like infant nutrition and chocolates). While the recent sharp price rise and valuation re-rating (stock now trading at 49x CY19E PE) limit absolute upside potential in NT, we maintain our rating. Key downside risks include a sharp RM increase limiting further margin expansion.