Nestle India's Q2CY19 results (Outperformer) - Superior execution continues…

Q2CY19 result highlights

• Nestle India’s net sales were up 11.4% yoy to Rs29.8bn (est: Rs29.2bn), EBITDA grew by 7.9% yoy to Rs6.8bn (est: Rs6.6bn) and PAT grew by 9.7% yoy to Rs4.37bn (est: Rs4.25bn).
• Domestic sales grew by strong 13.1% yoy driven by volume and mix and positively influenced by sales to CSD and sale of surplus fat. Export Sales declined by 13.9% due to lower exports of coffee to Turkey. We estimate domestic volume growth at 8% for the quarter and the impact of surplus fat to be around 1-2%.
• Gross margins fell 130bp yoy (down 20bp qoq) to 58% driven by commodity inflation largely in milk and its derivatives. Staff cost increased by 10.4% yoy and other expenses increased by 9.1% yoy largely due to increase in A&P spends behind strong new product pipeline. EBITDA was up 7.9% (including contingent provisions & CSR) with a margin decline of 70bps yoy at 22.8% (est. of 22.5%).
• Depreciation expense decreased by 1% yoy. Other income increased by 13.2% yoy, Interest expense increased by 5.9% yoy, resulting in PAT growth of 9.7% yoy.

Key positives: Healthy domestic sales despite high base.

Key negatives: Higher input cost led contraction in gross margins.

Impact on financials: Factoring lower gross margins, we cut CY20E PAT by 1.4%.

Valuations & view

Nestle reported yet another quarter with healthy domestic volume growth (despite high base and moderation in demand environment).  We are factoring 13% domestic sales CAGR over CY18-20E, highest among consumer staples led by sustained growth in core brands coupled with healthy pace of innovation. While input costs environment remains challenging, we believe, Nestle is better placed to offset the impact of the same given its ability to drive price/mix improvement. Further, leverage benefit on account of healthy volume trajectory should help sustain margins and drive industry leading earnings growth (we expect 17.4% earnings CAGR over CY18-20E). Given continued superior execution in a challenging environment, premium valuations (59x/49x CY19/20E earnings) are likely to sustain. Maintain OP, with revised price target of Rs12,405 (50x June 21 EPS).