Nestle India Q2 Review: Analysts Bet On Long-Term Growth Amid Inflationary Headwinds

Analysts expect Nestle India Ltd. to report healthy growth in the future even as the maker of Maggi noodles missed April-June earnings estimates amid rising costs.

Nestle India's profit fell in the second quarter but it beat sales forecast as volume growth improved on the back of uptick in rural markets and "double-digit" growth in mega, metro and smaller cities.

The company, however, flagged significant cost pressures with inflation in 2022 seen at five times the 3% annualised rate seen over 2018-2020.

"In such a situation, the engine of growth continues to be penetration-led volume growth," Suresh Narayanan, chairman and managing director at Nestle India, said while addressing investors in a post-earnings call.

The company, he said, is focusing on protecting growth instead of raising prices to maintain its profits margins. It increased prices hikes in the range of 8.5% to offset the impact of 15% inflation in 2022.

Narayanan said while there have been early signs of softening in edible oil prices and packaging, commodities including green coffee, wheat, fuel, and fresh milk are are at an all-time high. That suggests Nestle India's profit from operations may remain under pressure in short term.

The company said it logged "strong" growth across the categories in the June quarter led by confectionary, beverages, prepared dish and cooking aids and milk products and nutrition category.

Here's what analysts made of Nestle India's Q2 CY22 results:

• Maintains 'neutral' rating with a target price of Rs 19,500, implying a potential upside of 2%.

• The long-term narratives for revenue and earnings growth are highly attractive even as near-term margin outlook remains challenging as the company continues to face commodity cost headwinds.

• With ad spend-to-domestic sales ratio falling for four consecutive years up to CY21 to 5.5%, the second lowest in the last seven years, the buffer to protect operating margin erosion from gross margin pressures may not be available without constraining volume growth.

• The acquisition of Purina PetCare’s India business and launch of ‘Gerber’ nutrition brand are good moves. However, both will take time to scale up.

• The packaged food segment offers immense growth opportunities in India, especially for a company like Nestle that has a strong pedigree and distribution strength.

• Successful implementation of its volume-led growth strategy in recent years provides confidence in execution as well.

• Nestle's valuation at 63.6x CY23E P/E is expensive and does not offer any significant upside from a one-year perspective.

Dolat Capital

• Upgrades rating to 'accumulate' with a target price of Rs 22,130, implying a potential upside of 16%.

• Inflationary pressures will continue to hit profitability in the near term but consumer adaptability and cost stabilisation would help improve margins by the end of CY23E.

• Purina acquisition in the pet category to aid growth. As Nestle India has strong distribution reach—five times that of Purina—the company would be able to grow the pet food business at a fast pace.

• Launching Gerber brand in India would be a good complement to Nestle India's existing baby products but increasing competition in the category remains a challenge.

• Considering growth challenges for other key baby products and health supplements, the performance in coming quarters would be watched closely.

Nirmal Bang

• Maintains 'accumulate' rating with a revised target price of Rs 19,605 from Rs19,370 earlier, implying a potential upside of 2.6%.

• Revenue surprised positively while margin took a bigger hit than expected.

• Domestic sales picked up pace in Q2 with the top line growing 16.4% YoY compared with 10.2% in Q1.

• The structural story for Nestle remains strong in the fast-growing packaged foods space in India.

• Nestle can continue to deliver strong growth going forward, with share gain in its core categories, led by distribution expansion, strengthening of its position in rural areas (contributes 20-25% to domestic topline) and tier 2/3 cities and new product launches (backed by R&D capabilities and faster growth in the premium portfolio).

• These factors, along with market leadership in 85% of its categories, lend enough pricing power to combat inflationary pressure, drive premiumisation besides maintaining a decent volume growth.

• Addition of new categories (Pet Care and Toodler Nutrition segments) adds to the long-term growth and margin trajectory for the company.

• The brokerage remains confident that the company will be able to sustain its healthy earnings growth trend.

HDFC Securities

• Maintains 'reduce' with a target price of Rs 17,000, implying potential downside of 11%.

• Ebitda margin was below expectations even as growth was broad-based, with Maggi, Milkmaid, Nescafe and all key confectionaries outperforming.

• The company’s RURBAN strategy supported growth in the rural market.

• The brokerage remains positive on out-of-home products and sustained growth for in-home products.

• With a rich valuation, the absolute upside is limited in the medium term.

• Raw material cost continues to be elevated, which poses a risk to the Ebitda margin in the near term.