Earnings Report /
Sri Lanka

Nestle Lanka: 2Q CY21 - Increased reliance on essential categories in CY21E

  • Price increases on essential categories to drive top line in CY21E

  • Pressure on raw material costs in the near-term; margins impacted

  • We downgrade NEST to a HOLD with a revised TP of LKR 1,260/share

Asia Securities
16 August 2021
Published byAsia Securities

We revise our CY21E estimates downwards; however maintain our target multiple of 18.0x CY21E earnings and arrive at a target price of LKR 1,260/share (-13.1% to old; -0.4% upside). Including a CY21E dividend of LKR 66.00/share, we derive a total return of +4.8%. HOLD. NEST reported an EPS of LKR 15.71 for 2Q CY21, marginally above our estimate of LKR 14.88/share for the quarter. Revenues came in at LKR 10.1bn, down 11.8% QoQ (+22.4% YoY) amidst travel restrictions during the second half of the quarter. EBIT came in at LKR 1.2bn with margins down 3.3pp QoQ (-0.9pp YoY) to 11.8% mainly due to the trickle-down impact of rising raw material costs. Looking ahead, we revise our expectations for CY21E downwards due to the challenging operating environment and expected negative impact of rising inflation on discretionary consumer spending. Further, rising raw material costs and operating expenses will remain near-term concerns. However, with its key products falling under essential items, NEST will continue to benefit from relatively steady demand and the ability to pass on cost increases to safeguard margins to some extent.

Price increases on essential categories to drive top line in CY21E

Revenues came in at LKR 10.1bn, down 11.8% QoQ (+22.4% YoY) as travel restrictions were imposed to contain the 3rd wave of COVID-19. However, we believe that strong sales during the April festive season and stockpiling of essentials such as coconut milk powder helped mitigate this impact to an extent. Looking ahead, we believe a number of factors have significantly changed the operating environment since the beginning of the quarter. These include 1) the onset of the 4th wave, 2) rising food inflation levels and 3) fuel price increases which, combined, will exert pressure on disposable incomes. Despite this, we factor in low single digit volume growth for CY21E given the essential nature of NEST’s key products. In addition, such products provide the company more flexibility to pass on cost inflation through increased prices. Therefore, we continue to factor in double-digit revenue growth for CY21E, driven mainly by higher prices during the remainder of the year.

Pressure on raw material costs in the near-term; margins impacted

Gross margins declined 5.5pp QoQ (-1.1pp YoY) to 30.1%, mainly due to rising raw material prices in our view. This impact trickled down to EBIT margins which declined 3.3pp QoQ (-0.9pp Yoy) to 11.8%. Looking ahead, we expect fresh milk farmgate prices to remain elevated during CY21E amidst shortages of imported milk powder. However, following a bumper harvest, our channel checks indicate that coconut prices will remain low during 3Q CY21E. Prices are expected to increase from 4Q CY21E onwards, while the potential drop in yields from a chemical fertiliser ban remains a key near-term concern. As mentioned above, NEST can pass on rising costs through price increases on its essential categories. However, we revise our margin expectations downwards as 1) the entire cost impact cannot be passed on, 2) selling and distribution expenses will pick up, targeting increasingly price conscious consumers and 3) admin expenses will remain high due to the current pandemic situation. We note that the lower 18.0% tax rate will continue to support the bottom line and aid YoY comparisons over the remainder of CY21E.

We downgrade NEST to a HOLD with a revised TP of LKR 1,260/share

The stock is down 0.8% YTD and up 16.6% YoY. In addition, it is currently trading at 18.1x CY21E EPS in line with our target multiple. We maintain our target multiple of 18.0x CY21E EPS, however downgrade our earnings estimates and arrive at a target price of LKR 1,260/share (-13.1% to old; -0.4% upside). Including a dividend of LKR 66.00/share, we derive a total return of +4.8%. HOLD. Shortly after the acquisition of an additional 0.39% stake by the parent company Nestle S.A. in June 2021, NEST reached our previous target price of LKR 1,450/share. The price has trended downwards since then and has reached its lowest P/E band. Key catalysts: 1) continued relaxation of the ban on chemical fertilizer, 2) progress on the vaccination drive leading to improved sentiment and removal of mobility restrictions and 3) resumption of demand from the HORECA channel.