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MOSL: NESTLE INDIA (Sell)-Results miss estimates, higher RM costs impact margins

​Nestle India: Results miss estimates, higher RM costs impact margins

(NEST IN, Mkt Cap USD10.2b, CMP INR6787, TP INR5740, 15% Downside, Sell)

• Net sales were up by only 6.9% YoY (est. of +16%) to INR23.9b (Ind-AS). EBITDA (Ind-AS) was down 6.1% YoY (est. of +10%) to INR4.4b. Adj. PAT was down 11.8% YoY (est. of +5.4% YoY) to INR2.5b (Ind-AS).
  
• Weak base makes revenue performance disappointing: The base quarter was weak as Maggi was still recovering in terms of sales and market share. Overall gross sales grew 7.3% YoY in 2QCY17, but net sales growth was weaker owing to end of tax holiday at the Pantnagar unit from June 2016.
  
• EBITDA margin shrinks 260bp YoY: Gross margin contracted 270bp to 54.8% (est. of -150bp), which management attributed to rising cost of milk derivatives. Staff costs increased 50bp YoY due to adoption of long-term approach of compensating most factory employees in line with industry practice. Other expenses, however, were down 70bp YoY. Consequently EBITDA margin shrunk 260bp YoY (est. of -100bp) to 18.6%.
  
• Valuation and view: We have cut our EPS by 3%/4% for CY17/CY18E to model the revenue and margin miss. It has now been over five long years of abysmal volumes. While recent new product launches and rebuild of Maggi noodles should support volumes, double-digit volume-led sales growth seems long time away. Nestle is no longer the business it was before CY11 (it used to report consistent double-digit volume growth with over 100% RoCEs) and may never be so. Considering that valuations are rich at 50.8x CY18E EPS, we maintain Sell with a revised target of INR5,740 (INR5,990 earlier; 39x June'19 EPS, 25% discount to three-year avg. multiple).