Nestlé India faces margin issues after unattractive June quarter

MUMBAI
: Shares of Nestlé India Ltd have fallen around 3% since it announced its June quarter (Q1FY25) results on Thursday. The numbers represent a significant slowdown in the packaged food company’s growth, with revenue growing just 3.3% year-on-year. This is the lowest since the Maggi crisis in 2015 (excluding the Covid quarter in June 2020), said analysts at Kotak Institutional Equities. Nestlé maintained that the external operating environment faced challenges such as lower consumption growth, concerns over ongoing food inflation and volatile commodity prices.

In Q1FY25, sales volume and mix grew by 1% — the lowest in many quarters. In comparison, Hindustan Unilever Ltd, which also announced June quarter results this week, saw underlying volumes grow by 4% in Q1, significantly better than the 2% growth it saw in each of the previous three quarters. “The trends are different from peers, which saw sequential growth in Q1, led by rural, though this may not be strictly comparable due to Nestlé’s higher urban exposure and unique portfolio mix,” Jefferies India said in a July 25 report.

Nestlé said five of its top 12 brands posted double-digit growth. Encouragingly, its beverage business posted strong double-digit growth, despite the hot summer in many parts of the country. Ready meals and kitchen aids also maintained their growth momentum, with innovation contributing about 30% to growth in the quarter, the company said. E-commerce also grew at double-digit rates, accounting for 7.5% of domestic sales. The company continued its RUrban strategy of expanding its distribution footprint, adding more than 800 new distribution touchpoints in Q1, and increased its village footprint by 5,000 to about 205,000 villages in the last quarter.

Profitability Concerns

On the profitability front, lower raw material costs meant that gross profit margins rose by 283 basis points year-on-year to 57.6%. One basis point is 0.01%. However, cost pressures are mounting with commodity prices like coffee and cocoa remaining at record highs. Additionally, cereals and grains are going through structural cost increases due to higher minimum guaranteed prices. At the same time, milk, edible oils and packaging prices are relatively stable. Against this backdrop, margin pressure cannot be ruled out in the coming months. To address this, the extent of price increases that Nestlé India is willing to absorb becomes crucial to assess how margins will fare.

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But expectations have cooled. Jefferies analysts have cut FY25-28 earnings per share estimates by 3-8% to factor in the shortfall in Q1 and inflationary headwinds seen in coffee over the past few months. “A weak start to the year is driving a 2% cut in revenue estimates, with some margin adjustments, resulting in a 2-3% decline in FY25-27 earnings per share estimates,” Kotak analysts said.

Nestlé India stock investors have had a tough ride so far in 2024 as the stock has underperformed the Nifty FMCG index, the sector benchmark. The stock is trading at around 70 times FY25 earnings, as per Kotak estimates. Valuations are high. Despite the company’s execution prowess, the pace of recovery is key to determine the stock’s further gains.