Focus on volumes and launches will limit margin expansion; ‘Hold’ retained given stretched valuations and the earnings outlook.
NEST reported a mixed Q3CY19. Domestic net sales growth of 10.5% (est. volume growth of ~9% yoy) was commendable and showed no signs of slowdown. Net sales growth of 9.4% yoy was ~3% above our estimates. EBITDA margins (down 140bps yoy), however, were below estimates as gross margins declined by 210bps yoy due to input cost pressures. PBT growth of 4.2% yoy was muted. Given stretched valuations and modest earnings growth, we maintain Hold post recent downgrade.
Net sales up 9.4% yoy
Domestic net sales grew by a healthy 10.5% yoy (best growth among our staples coverage in the quarter) led by volume and mix. We estimate vol growth at ~9% which didn’t show any material signs of slowdown (1H vol growth ~11.5%). Growth continues to be led by the key brands, viz. Maggi, Kitkat, Munch along with scale-up and strong traction in launches of last 2 years. Company exports sales were down 7.1% yoy. As a result, overall net sales grew by 9.4% yoy.
EBITDA margins down 140bps
Gross margins were down 210 bps yoy and 70bps QoQ to 57.6% which are the lowest in last 2 years. Higher input costs were the key reasons for gross margin decline and management expects the impact to continue in the near term. Company is clearly prioritising volumes over margins with limited price hikes in overall portfolio which is a positive from medium term perspective. Other expenses were down 80bps yoy while employee costs were up 10bps yoy as a percentage of sales. Overall, EBITDA grew by 3% yoy which was ~3% below our estimates despite a beat on topline.
PBT up 4.2% yoy, PAT up 32% yoy
Other income declined due to lower average liquidity given special interim dividend resulting in PBT growth of 4.2% yoy. Adj PAT was up 32% yoy due to lower tax rate and one-time tax credit of Rs. 725mn pertaining to previous quarter. PAT was largely in line with our estimates.
Our view and PT
NEST is executing well with focus on broadening the product portfolio through new launches and improving growth traction in core categories like chocolates, noodles and infant nutrition. With higher salience to affluent urban consumers given the nature of product portfolio, it is relatively less impacted by the consumption slowdown. However, focus on volume growth and new launches will limit scope for margin expansion which will keep earnings growth trajectory muted vs consensus expectation, in our view.
Given sharp re-rating, valuations at 56.3x/49.1x CY20E/CY21E PE, appear full and we maintain Hold post our recent downgrade as we don’t find risk-reward attractive enough and absolute upside now looks limited over 12-18 month horizon.