Nestle’s pricing power to play rescue act in trying times | Mint

Nestle’s pricing power to play rescue act in trying times

Nestlé’s shares continue to trade at premium valuations despite 12% drop in the stock YTD (REUTERS)
Nestlé’s shares continue to trade at premium valuations despite 12% drop in the stock YTD (REUTERS)


  • In CY21, gross margin dipped y-o-y, but lower ad spends helped Ebitda margin improve
  • Costs outlook is firm in CY22, but Nestle’s strong pricing power should help

Akey takeaway from Nestlé India Ltd’s CY21 annual report released recently is that advertising & sales promotion (A&P) costs as a percentage of sales has dropped further. The company follows a January to December financial year. Nestlé provides the A&P details in its annual report only. The ad spends-to-sales ratio has seen a consistent decline in recent years.

“While the covid-19 pandemic in CY20 understandably led to a 70 basis points (bps) decline year-on-year (y-o-y) in ad spends-to-sales ratio, we were not expecting a further decline in CY21 (to 5.5%)," said Motilal Oswal Financial Services’ analysts in a report on 21 March.

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“With incremental pressures on gross margin, there is a risk that either Ebitda margin may be under incremental pressure or the ad spends-to-sales ratio can decline further in CY22," they said. Ebitda is earnings before interest, taxes, depreciation, and amortization.

Even so, Nestlé India enjoys strong pricing power, which can be expected to come to its rescue in these trying times. The company made calibrated price hikes to battle commodity cost inflation in 2021. Gross margin dipped 50 bps y-o-y to 57%, while savings in employee cost and ad spend resulted in Ebitda margin expansion of 20 bps to 24.3%.

However, the road ahead is rough. Storm clouds are looming in terms of rising commodity prices, Nestlé said while declaring its Q4CY21 results. In 2022 as well, the company is exposed to raw material inflation in dairy and edible oil, and a potential rise in wheat prices.

Nestlé is, however, relatively better placed. “Costs have risen across the board for the fast-moving consumer goods sector, but Nestlé’s margin pressures are not as severe as of peers such as Hindustan Unilever or Godrej Consumer Products. Being a packaged food company, Nestlé’s exposure to crude and palm oil related raw materials is far lower and the prices of these raw materials have jumped significantly since the start of the Russia-Ukraine war," said Varun Singh, analyst, IDBI Capital Markets and Securities Ltd.

Nevertheless, given the persisting cost inflation worries, Jefferies India has built in a near two percentage point y-o-y drop in gross margin for 2022. “Ebitda decline is likely to be lower at ~170bps, which in-turn would mean single-digit Ebitda growth in 2022," said Jefferies’ analysts in a report.

For perspective, over 2019-21, on a two-year CAGR basis, Ebitda growth is 11%. CAGR is short for compound annual growth rate.

Meanwhile, Nestlé’s shares declined by almost 12% so far in 2022, but valuations are pricey. The stock trades at 64 times estimated earnings for 2022, Bloomberg data shows. Analysts reckon its premium valuations are likely to continue given consistent delivery on growth in the past and the appeal of the packaged foods industry in general.

Nestlé’s facility in Sanand, Gujarat, which is part of the 2,600 crore capital expenditure planned for the next few years, became fully operational in 2021 and would aid revenue growth. Furthermore, there is potential for high dividend payouts in the upcoming years. In 2021, the dividend payout ratio stood at 83%, based on the adjusted earnings per share.

A key monitorable would be project Rurban, through which Nestlé is planning to expand its presence to semi-urban and rural areas. It aims to cover 120,000 villages by 2024. The milk products and nutrition segment, which accounts for 43% of 2021 revenue, has seen a drop in volumes over the last two years, because of rising competition and higher input costs in dairy. As such, an improvement in this segment would bring cheer.

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