Nestle: Resilient margins amid rising cost pressure, higher base

The Nestlé stock was in demand on Wednesday, despite the company missing estimates for its March quarter (Q1) numbers (company follows January-December accounting period).

While positive management commentary on demand helped, the Street was also a bit surprised with the operating performance, given that many FMCG companies are sacrificing margins for volumes. Nestlé’s top line and net profit grew 9 per cent each year-on-year (YoY) to Rs 2,982.4 crore and Rs 463.3 crore, respectively — a tad lower than analysts’ estimates of Rs 3,055 crore and Rs 471 crore. 

Growth was volume-driven across segments. Although earnings before interest, tax, depreciation and amortisation (Ebitda) margin fell by 79 basis points (bps) YoY to 25.3 per cent on account of higher staff and input costs, the decline should be seen in light of last year’s high base, when the Ebitda margin had jumped 490 bps to a multi-quarter high of 26.1 per cent.

Analysts at Edelweiss Securities say: “Gross margin fell only 57 bps YoY despite elevated input costs, thanks to the company’s superior inventory management as well as a likely favourable product mix.”

Going ahead, the demand optimism brings some relief. “Nestlé still offers a stronger growth outlook as compared to its peers with its strong core portfolio, aggressive new product launches, and distribution expansion, all of which should help deliver better growth going ahead,” say analysts at Emkay Global.

However, questions over margin gains remain. Many analysts have lowered their earnings estimates by up to 3 per cent each. 

“We cut our CY19/20 (calendar year) EPS (earnings per share) estimate marginally by 0.6 per cent and 2 per cent. It is important to note that the gross margin and Ebitda gains in CY18 were propped up by low material costs, and thus, a high base effect will come into play,” says Motilal Oswal Securities. In CY18, Ebitda margin of 23.5 per cent was the highest in at least 15 years.

Prices of key input material such as wheat, sugar, cocoa, milk and milk-related products are also rising, and food inflation is expected to continue trending upwards. 

Further, new launches such as organic food products will require additional promotional activities initially. These could cap profit margins unless Nestlé is able to pass higher costs on to customers.

For now, the Street seems happy. The stock was up 1 per cent on Wednesday, and is trading at 52 times its CY19 estimated earnings. After results, the average target price of 21 analysts as per Bloomberg data is Rs 11,086.

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