Nestle India’s Q1 provides comfort, but high costs pose risk to margins

With more people staying indoors due to the second covid wave, in-home consumption of packaged foods is expected to be good. Nestlé India Ltd is likely to benefit from this trend in the foreseeable future.

On the other hand, inflation in key raw materials poses a concern for gross profit margins. However, some analysts point out that Nestlé may not be too severely impacted vis-à-vis other consumer firms.

Nomura Financial Advisory and Securities (India) Pvt. Ltd’s analysts said in a report on 20 April: “While Nestlé is witnessing recent escalation in key commodities, we note that agri-basket inflation is still lower versus crude basket. And with Nestlé’s greater skew towards agri inputs and superior pricing power, we believe its gross profit margin will be relatively less impacted versus peers.”

Emkay Global Financial Services Ltd said inflation in key input prices appears manageable (for Nestlé) and can be largely offset by modest price hikes.

In the March quarter (Q1CY21), Nestlé’s gross margin expanded by 223 basis points year-on-year (y-o-y), helped by a drop in raw material costs as a percentage of revenue, as commodity prices were lower y-o-y, particularly for milk and its derivatives. One basis point is 0.01%.

Accordingly, Nestlé’s gross profit increased by around 13% y-o-y, faster than its revenue growth. Even so, revenues for the March quarter are in line with analysts’ expectations. Total operating revenues rose by 8.6% y-o-y to around ₹3,611 crore.

In Q1, Nestlé derived as much as 95% of its overall revenues from domestic sales, which grew 10.2% y-o-y driven by volume and mix. Domestic performance is encouraging considering that the first quarter of 2020 had seen similar growth and, therefore, the base isn’t particularly favourable.

Further, export sales fell by about 13% y-o-y owing to lower shipments to affiliates. According to Nestlé, while demand in the out-of-home channel further improved in the March quarter, it continues to be impacted by the pandemic. Analysts expect out-of-home consumption to be impacted by covid-led restrictions.

To be sure, Nestlé’s overall growth prospects are expected to be better comparatively. The pricey valuations of Nestlé India shares suggest that investors are capturing a good share of the optimism from a near-term perspective. The stock trades at almost 58 times estimated earnings for calendar year 2022, according to Bloomberg data. Nestlé follows the January to December financial year. So far this calendar year, the Nestlé India stock has declined by 7%, though it is still up by around 2% from its pre-covid highs seen in February 2020.