HOLD. Nestle. Good Performance Irrespective of GST Pangs. Target Price: Rs6,624. Institutional Equity Research. 2QCY17 Result Update July 27,2017

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1 2QCY17 Result Update July 27,2017 Market Cap. (Rs bn) 657 Free Float (%) 37.3 Shares O/S (mn) 96 Good Performance Irrespective of GST Pangs Nestlé India has reported a good set of numbers for 2QCY17 in spite of trade pipeline correction in June prior to GST roll-out. While net sales increased by 6.9% YoY to Rs23.9bn (vs. our estimate of Rs22.8bn), EBITDA fell by 5.9% YoY to Rs4.6bn (vs. our estimate of Rs4.3bn). Net profit for the quarter post provision for contingencies grew by 9.7% YoY to Rs2.6bn beating our estimate of Rs2.3bn. The headline numbers are strong irrespective of GST impact and we expect Nestlé to report decent numbers in coming quarters as well on the back of strong brand equity, rich new product funnel, trade up-stocking post GST roll-out and pricing power. Expecting Nestlé to report 13.1% revenue and 14.3% earnings CAGR through CY16-18E, we revise our recommendation on the stock to from REDUCE with a Target Price of Rs6624, based on 40x June 19 earnings. Volume-led Top-line Growth Domestic revenues grew by 8.4% YoY in the quarter aided by improved volumes, lower base, strong performance of Maggi and better realisations. While revenue growth in April and May was higher, primary sales suffered in June, as the trade resorted to inventory de-stocking due to concerns arising from treatment of input tax credit in post-gst scenario. Export sales fell by 12% YoY in 2QCY17 due to lower exports of milk and milk-products to Bangladesh and Middle East. Higher Milk Prices Impact Margins Gross margins for the quarter fell by 270bps YoY to 54.8%, primarily due to 21% YoY and 13% YoY rise in milk and SMP prices, respectively. Employee cost as a % of sales rose by 50bps YoY due to lower topline growth on account of GST issues. Other expenses declined by 60bps YoY to 25.6%. Thus, the resultant EBITDA margins softened 260bps YoY to 19.2%. Tax rate rose by 290bps YoY to 33.2%, mainly due to expiry of 10 tax holiday on products from Samalkha (Haryana) factory. Outlook & Valuation With a view to reducing dependence on limited brands, Nestlé has broadened its portfolio over the past one year by introducing over 30 new products and variants across categories. While raw material inflation remains high, we expect good monsoons would have benign impact on milk prices and this coupled with the Company s pricing power should aid gross margins. We expect Nestlé to post net sales of Rs103.8bn and Rs117.2bn and net profit excluding contingencies of Rs12.6bn and Rs14.9bn in CY17E and CY18E, respectively. Based on adjusted EPS of Rs154.1, the stock currently trades at 44.2x CY18E earnings. Considering improved demand outlook, we revise our recommendation on the stock to from REDUCE with a Target Price of Rs6624, based on 40x June 19 earnings. Share price (%) 1 mth 3 mth 12 mth Absolute performance (4.3) Relative to Nifty (3.6) 1.9 (21.5) Shareholding Pattern (%) Mar'17 Jun'17 Promoter Public Year Stock Price Performance Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 Jun-17 Jul-17 Note: * CMP as on July 27, 2017 Key Financials (Rs mn) CY15 CY16 CY17E CY18E Sales 81,233 91, , ,203 EBITDA 15,946 17,958 19,713 23,171 Adj. Net profit 11,558 11,376 12,597 14,853 Adj. EPS Rs) DPS (Rs) P/E (x) P/B (x) EV/EBITDA (x) ROE (%) Dividend yield (%) Research Analyst : Sameer Deshmukh Contact : (022) sameer.deshmukh@relianceada.com 1

2 Risks to the view ff Increased competitive intensity in all key segments ff Higher input costs due to spiralling inflation in agricultural commodities Exhibit 1: Trend in Domestic Sales Exhibit 2: Trend in Export Sales Domestic sales Rs bn Export sales Rs bn Exhibit 3: Trend in Gross Margins Exhibit 4: Trend in EBITDA Margins 59% 56% 56% 3 25% 2 15% 15% 18% 24% 22% 19% 18% 21% 55% 5% 54% Gross margins EBITDA margins Exhibit 5: Trend in milk prices Exhibit 6: Trend in SMP prices % 38% 31% 33 24% 25% 16% 15% 16% 18% 18% 7% 12% 6% - -7% Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 Jun-17 Jul ,500 7,000 6,500 6,000 5,500 5,000 3% -1% 1% -3% -3% Jan-16 Feb-16 Mar-16 Apr-16 May-16 11% Jun-16 19% 19% Jul-16 Aug-16 8% 8% Sep-16 Oct-16 12% 14% Nov-16 Dec-16 23% 22% 22 19% Jan-17 Feb-17 Mar-17 Apr-17 Jun-17 7% Jul-17 25% 2 15% 5% -5% Milk price Rs/ltr % change yoy SMP prices Rs/25kg % change yoy 2

3 Exhibit 7: Result Summary (Rs mn) 2QCY17 2QCY16 % yoy 1QCY17 % qoq 1HCY17 1HCY16 % chg Net Sales 23,865 22, ,757 (3.6) 48,622 45, Consumption of RM 10,791 9, ,939 (1.4) 21,729 19, (% of Sales) Staff Costs 2,531 2, , ,992 4, (% of Sales) Advertising Other Expenses 6,114 5, ,345 (3.6) 12,361 11, (% of Sales) Total Expenditure 19,436 17, ,745 () 39,083 34, Operating Profit 4,430 4,718 (6.1) 5,012 (1) 9,540 10,241 (6.9) OPM Depreciation (3.9) 867 (1.4) 1,721 1,781 (3.4) EBIT 3,575 3,829 (6.6) 4,145 (13.8) 7,819 8,461 (7.6) Interest (4.7) Other Income (1.5) 1, PBT 3,915 4,132 (5.3) 4,495 (12.9) 8,509 8,925 (4.7) (% of Sales) Provision for Taxation 1,311 1, ,428 (8.1) 2,739 2,844 (3.7) (% of PBT) PAT (recurring) 2,604 2,947 (1) 3,068 (15.1) 5,770 6,082 (5.1) Extr. Income/(Expense) - (320) - - (118) Provision for contingencies (31) Reported PAT 2,634 2, ,068 (14.1) 5,702 5, PATM Equity shares (mn) EPS (Rs) (14.1) Source: Company RSec Research 3

4 Profit & Loss Statement Y/E Mar (Rs mn) CY14 CY15 CY16 CY17E CY18E Net Sales 98,063 81,233 91, , ,203 Total operating income 98,063 81,233 91, , ,203 % chg 8.2 (17.2) Total Expenditure 76,968 65,287 73,634 84,087 94,032 Cost of Materials 45,240 34,689 38,797 44,517 49,923 Advertising Exp (Incl Promotion) 4,455 5,252 5,670 6,476 7,038 Personnel 7,722 8,374 9,860 11,141 12,590 Others 19,552 16,972 19,308 21,953 24,481 EBITDA 21,094 15,946 17,958 19,713 23,171 % chg 10.5 (24.4) (% of Net Sales) Depreciation& Amortisation 3,375 3,473 3,536 3,570 3,998 EBIT 17,719 12,473 14,422 16,143 19,173 % chg 12.3 (29.6) (% of Net Sales) Interest & other Charges Other Income 1,359 1,621 2,139 2,431 2,720 (% of PBT) Recurring PBT 18,936 14,062 16,526 18,525 21,843 % chg 13.8 (25.7) Extraordinary items (70) 5, PBT (reported) 19,006 9,053 16,218 18,525 21,842 Tax 5,897 2,504 5,150 5,928 6,990 (% of PBT) PAT (recurring) 13,109 6,550 11,068 12,597 14,853 % chg 18.8 (50.0) (% of Net Sales) Basic EPS (Rs) Fully Diluted EPS (Rs) % chg 29.6 (19.2) () Balance Sheet Y/E Mar (Rs mn) CY14 CY15 CY16 CY17E CY18E Share capital Reserves 27,408 27,214 29,173 33,640 39,210 Net worth 28,372 28,178 30,137 34,604 40,174 Total borrowings Deferred tax 2,227 1,729 1,542 1, Total liabilities 30,795 30,085 32,011 36,182 41,402 Gross block 50,090 51,174 52,600 53,600 54,600 Less: Depreciation 18,323 22,195 25,305 28,875 32,873 Net block 31,766 28,979 27,295 24,725 21,726 CWIP 2,448 2,308 1,882 1, Investments 8,118 13,249 17,494 17,494 17,494 Current assets 15,863 16,269 21,390 34,295 48,602 Inventories 8,441 8,208 9,432 11,058 12,241 Debtors ,118 1,263 Cash 4,458 4,996 8,800 20,133 33,087 Loans and advances 1,972 2,281 2,179 1,986 2,011 Current liabilities 11,383 12,095 13,120 15,546 17,625 Provisions 16,017 18,625 22,929 26,018 29,377 Net current assets (11,537) (14,451) (14,659) (7,268) 1,600 Total assets 30,795 30,085 32,011 36,182 41,402 4

5 Cash Flow Statement Y/E Mar (Rs mn) CY14 CY15 CY16 CY17E CY18E Adjusted Net profit 11,847 5,633 11,068 12,597 14,853 Depn and w/o 3,375 3,473 3,536 3,570 3,998 Deferred tax 73 (498) (187) (296) (349) Change in working cap 1,088 3,451 4,013 3,942 4,086 Operating cash flow 16,383 12,058 18,430 19,813 22,587 Capital expenditure (60) (804) (574) (350) (350) Investments 393 (5,131) (4,244) 0 0 Investing cash flow 333 (5,935) (4,818) (350) (350) Free cash 16,716 6,123 13,612 19,463 22,237 Dividend (7,117) (5,681) (7,374) (8,129) (9,284) Fresh equity Debt/Preference shares (11,699) (18) Financing cash flow (18,816) (5,699) (7,220) (8,129) (9,284) Others (936) 114 (2,588) 0 0 Net change in cash (3,036) 538 3,805 11,333 12,954 Opening cash 7,494 4,458 4,996 8,800 20,133 Closing cash 4,458 4,996 8,800 20,133 33,087 Key Ratios Y/E Mar CY14 CY15 CY16 CY17E CY18E Valuation Ratio (x) P/E (on FDEPS) P/CEPS P/BV Dividend yield (%) EV/Sales EV/EBITDA Per Share Data (Rs) EPS (Adjusted) EPS (Reported) Cash EPS DPS Book Value Returns (%) RoCE RoE Turnover ratios (x) Asset Turnover (Gross Block) Inventory / Sales (days) Receivables (days) Payables (days) Working capital cycle (ex-cash) (days) (10) (18) (14) (16) (17) 5

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