High inflation may spoil Nestlé’s party

Structural growth story intact but valuation remains too pricey

Nestlé India (Nestlé) continued to outperform its peers such as Britannia in the December 2019 quarter (Q4), but also witnessed relatively higher inflationary pressure. The latter could prove to be a party-spoiler.

Nestlé follows a January-december calendar and announced its Q4 numbers on Thursday after market hours. While net sales grew 8.8 per cent yearon-year (YOY) to ~3,131 crore, profit before tax (PBT) surged 17.7 per cent YOY to ~615 crore in Q4.

Both these parameters were below a

Bloomberg consensus of

~3,143 crore and ~631 crore, respectively.

Net profit growth of 38 per cent was also driven largely by lower corporation taxes.

Thus, the latter may not be strictly comparable.

Nestlé’s 10 per cent YOY growth in domestic sales (95 per cent of revenue) in Q4 is noteworthy, in light of the poor consumption environment.

Success of new launches and lower exposure to rural markets (25 per cent of revenue) are supporting Nestlé’s top line growth.

The caution, however, is that YOY domestic revenue growth has been continuously drifting down since past five quarters, thanks to the weakening consumer sentiment.

Domestic revenue growth was 17.5 per cent in the September quarter.

Beyond the good, albeit slowing top line growth, Nestlé continues to witness inflationary pressure, related mainly to milk, which constitutes 45 per cent of its raw material costs.

In Q4, gross profit margin shrunk by a whopping 217 basis points (bps) YOY to 56.5 per cent, the lowest in the last 10 quarters.

Notably, its strong operating leverage fully negated the gross margin impact at the Ebitda (earnings before interest, tax, depreciation and amortisation) level.

The firm’s Ebitda margin improved by 22 bps YOY to 20.9 per cent in Q4.

The management said that the trend of higher commodity prices, seen in recent quarters, is likely to continue.

While analysts at Prabhudas Lilladher estimate Nestlé’s Ebitda margin to contract by 40 bps in CY20, others expect the company’s select price hikes and operating leverage to support margins.

Therefore, it would be interesting to see how this plays out.

Overall, while Nestlé’s sharp focus on new launches with higher marketing spends suggests that its structural growth story remains intact, investors could await some correction in the stock, given its rich valuation of 57 times its CY21 estimated earnings.