Earnings Report /
Sri Lanka

Nestle Lanka: 3Q CY22 - Poised to benefit from a recovery in consumption

  • Price increases to ease; volume recovery to drive revenues in CY23E

  • EBIT margins to remain above historic levels as opex normalises in CY23E

  • Higher interest costs in CY23E partly offset by increased interest income

Asia Securities
18 November 2022
Published byAsia Securities

We roll over valuations to CY23E and arrive at a fair value of LKR 1,200/share based on a 3-stage DCF model (+30.9% upside). Coming out of an uncertain period of price-driven growth, NEST stands to benefit from a more sustainable recovery in household consumption. Profit margins will normalise in CY23E; however, we expect NEST will be cautious in increasing expenditure which will support margins. Our target price corresponds to a P/E of 5.6x CY23E EPS, at a significant discount to NEST’s 5-year P/E multiple average of 20.5x. BUY.

Price increases to ease; volume recovery to drive revenues in CY23E

Revenues benefitted from successive rounds of price increases, up 18.0% QoQ (+87.5% YoY) to LKR 21.3bn in 3Q CY22. Despite NEST’s exposure to essential product categories, we believe volumes declined overall as household spending remained constrained. Heading into CY23E, we expect the pace of price increases to taper down barring further significant cost pressures. Amid a pickup in economic activity, we expect a recovery in volumes to become the main driver of revenue growth. This recovery will be more gradual; as such, we expect slower QoQ growth in CY23E relative to the sharp price-driven growth seen in CY22.

EBIT margins to remain above historic levels as opex normalises in CY23E

NEST has recorded significant movements in other operating income/expenses; however, we believe these are one-off items. Meanwhile, underlying performance reflects the impacts of rising cost inflation. Gross margins of 32.4% were down 3.0pp QoQ (-0.6pp YoY) in 3Q CY22. We believe this reflects utilisation of higher cost inventory and factor in a further margin decline in 4Q CY22E. Recurring operating costs have increased in LKR terms, however 1) revenue growth and 2) cost-saving initiatives have enabled NEST to achieve a reduction as a percentage of sales. Benefitting from these factors, we expect EBIT margins to trend downwards but to remain above their historic levels as spending normalises in CY23E.

Higher interest costs in CY23E partly offset by increased interest income

In CY23E, NEST will incur higher interest costs on its USD debt (USD 26.6mn at end CY21) amid 1) a sharp pickup in interest rates (3-month LIBOR up 444bps YTD) and 2) steep FX depreciation. However, we expect higher interest income to partly offset the impact. Given the challenging operating environment, we factor in a lower dividend payout in CY22E similar to CY21 levels. We expect NEST to return to a 100.0% payout in CY23E.

We use a 3-stage DCF model and arrive at a fair value of LKR 1,200/share

We use a 3-stage valuation to reflect the uncertain macro environment and roll over valuations to CY23E. This results in a fair value of LKR 1,200.00/share (+30.9% upside; +54.2% TSR). Our target price corresponds to an implied P/E multiple of 5.6x CY23E EPS which is significantly lower than NEST’s 5-year P/E multiple average of 20.5x. BUY. Key risks: 1) prolonged recovery in discretionary spending, 2) further constraints on mobility and economic activity and 3) further steep currency depreciation.