Volumes to drive Nestle's top line, but margin gains may not be easy

The logo of Nestle on display
In 2018, Nestlé India — the third-largest fast-moving consumer goods company by market value — clocked a 13 per cent rise in net operating revenues, its highest in the last seven years, led by robust volumes. The double-digit revenue growth is likely to sustain in the medium term for Nestlé, which follows the January-December financial year. 

According to the analysts at Nirmal Bang, a positive consumption environment, coupled with the management’s focus on profitable growth led by volume, innovation, and cost management, will enable Nestlé to deliver above-average earnings growth in the medium term. However, this could pinch near-term profitability and so the overall earnings growth of the maker of Maggi noodles and KitKat. 

Nestlé’s earnings before interest, tax, depreciation and amortisation (Ebitda) margin stood at peak levels of over 23 per cent in calendar year (CY) 2018, aided by benign prices of raw materials, indicating that significant upsides from hereon may not be easy in the term. 

Further, to perk up sales of new launches and innovative products, the company would have to increase its advertising spends. Increase in distribution network would also add to costs. 

Part of this is also visible in its performance for the quarter ended December 2018 (Q4), wherein a 418 year-on-year (YoY) basis point (bps) expansion in other expenses amid increase in demand-generating activities (read promotional spends) for existing and new products led to a 150 bps YoY contraction in Ebitda margin to 19 per cent. 

The pain could get aggravated with a likely increase in input prices due to factors such as rise in minimum support price of commodities such as sugar. 

According to Antique Stock Broking, prices of key raw materials like skimmed milk and wheat have risen by 10-15 per cent during first two months of 2019. This could weigh on gross margin of Nestlé. 

Though some analysts believe the company has strong pricing power, the same could be confined by competitive intensity, not only from organised players, but also from unorganised ones. Cost management, however, should help mitigate some of this pressure on profit margins.

Analysts thus, foresee only a 45-49 bps rise in Ebitda margin in CY2019 and CY2020 to around 24 per cent levels. This would be way lower than the 224 bps expansion in Ebitda margin in CY2018. 

Rajeev Anand, analyst at Narnolia Financial Advisors, has lowered net profit estimates for the next two years by 4 per cent each amid higher spending on launches, relaunches, and cost related to distribution expansion.

The entire consumption environment is very supportive for companies like Nestlé, which should also help accomplish the management’s focus on propelling its volume base with the abovementioned efforts. However, a few analysts are sceptical of volume growth in the near term. 

“On a high base of 2018, we expect volume growth to see some moderation and, also affected by recoup in Maggi (loss or slowdown in sales) and no significant success in new launches,” says Nitin Gupta, analyst at SBICAP Securities.

The silver lining is the improving rural consumption ahead of the upcoming general election. Nestlé earns around 25 per cent of its revenues from rural pockets.

Thus, the company is expected to clock, at least, high single-digit volume growth in CY2019, compared to 10-11 per cent in the last two years.

As for investors, the stock is currently trading at 47 times its CY2020 estimated earnings; around 7 per cent premium to Hindustan Unilever’s and 9 per cent to its close peer, Britannia Industries’ FY20 estimated earnings. 

Nestlé’s management was unavailable for comment.


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