Nestlé investors may take a break

Valuations are expensive; analysts have trimmed EPS estimates by 2-4% for CY20-23

Shares of Nestlé India declined 5 per cent in intraday trade on Wednesday after the coffee-to-ready-to-cook foods company’s operational performance in the December-ended quarter (Q4) missed Street expectations. It recovered some of the losses and ended the trading session with a cut of 2.8 per cent.

According to analysts, the near-term outlook for the stock appears unexciting.

Revenues of the company, which follows the January-to-december accounting year, in the fourth quarter missed consensus estimates, mainly on account of a slower-than-expected recovery in out-of-home consumption and lower export revenues, besides lower-than-expected profitability.

It’s noteworthy that demand for out-of-home consumption products saw a sequential improvement, but remained below pre-covid levels. Similarly, sales from exports dropped 8 per cent over the previous year due to lower coffee exports.

Domestic revenue growth, while steady at 10 per cent, led by 7 per cent volume growth, was lower on a sequential basis and also lagged most of its peers during the same period, said market experts.

This, coupled with higher costs, hurts the company’s operational performance. Employee expenses witnessed a sharp rise, led by higher incentives in view of Covid and finalisation of long-term compensation arrangement for most factory employees; other expenses were higher driven by an increase in marketing spends. This restricted earnings before interest, tax, depreciation and amortisation (Ebitda) growth to only 9 per cent, while the Ebitda margin remained flat, versus analyst estimates of 28 per cent Ebidta growth and 330-basis point margin expansion.

Overall, net sales were up 9 per cent YOY at ~3,433 crore, versus analysts’ expectation of ~3,510 crore; the net profit remained flat at ~469 crore against the estimate of ~561 crore.

Yet, analysts remain impressed by the company’s full-year performance. “The packaged food category continued to perform well and e-commerce continued its stellar growth (more than 100 per cent growth in CY20), contributing 4 per cent of domestic revenues. Maggi, Kitkat, and Nescafé (in-home consumption) posted double-digit growth during the year, capitalising on the reduced mobility among consumers,” said Varun Lohchab, research analyst at HDFC Securities.

Going forward, analysts believe Nestlé India is well positioned to deliver healthy volume-led growth, aided by widening distribution reach, especially in the rural markets, new product launches, and capacity expansion plans.

Rural accounts for about 25 per cent of Nestlé’s total sales — one of the lowest among consumer companies in India. With rural growth outpacing urban by two times, headroom for the company to deepen penetration in the hinterland is significant, said Abneesh Roy, research analysts at Edelweiss. To this end, the company has doubled its reach from 45,000 to 90,000 villages in the past 18 months, and has also tweaked its portfolio to stay relevant in those markets.

Nestlé is also investing heavily in capacity expansion and plans to augment its manufacturing capacities and set up a state-of-the-art greenfield project in Sanand, Gujarat, for the ready-to-cook food, coffee, confectionery, and milk and nutrition categories.

“This investment reflects high confidence in its ability to grow in compound double digits for several years,” said Roy.

Even as most analysts remain bullish over the long-term prospects of the company, they have revised their earnings per share (EPS) estimates lower by 2-4 per cent for CY21-CY23, factoring in the miss in Q4 and higher overhead expenses.

Moreover, as analysts at Motilal Oswal Securities said, valuations at 59x CY23 estimated EPS appear to completely factor in upside from a one-year perspective. In other words, while there is little room for an error, the stock returns may also be muted in the near term.

Experts thus believe that only patient investors should accumulate on dips.