Nestle India (NEST IN) Altius, Citius, Fortius

INSTITUTIONAL EQUITY RESEARCH Nestle India (NEST IN) Altius, Citius, Fortius INDIA FMCG Company Update We attended Nestle analyst meet yesterday and came pretty impressed with 1) management agility on doing required (innovation, focus on new channels, withdrawing new products if not getting traction) for driving growth within existing categories, 2) foray into fast-growing new categories (breakfast cereals, nutrition supplement category) and satisfactory reply from management as why Pet care business has been launched thorough Nestle SA (Parent), which had been concern area for us and 3) adopting cluster based approach for driving distribution related efficiencies. We upgrade to BUY from Neutral with revised TP of Rs 12, (55x Sept-2 EPS) vs Rs 1,875 (5x Sept-2 EPS) earlier Core categories NPD / channel expansion to continue: Management highlighted core categories continue to see healthy traction owing to market share gains (in noodles, beverages category), new product launches (65% of the launches got decent traction) and further expansion into newer channels (e-commerce, out of home market). Nestle has withdrawn 11 new launches out of 39 launches made so far (which were introduced post new MD s induction in August,215) from the market, as the products were either ahead of time or there was miscommunication from the company s side on actual purpose/intend of the product. Contribution of NPD to total sales has increased from 2.8% in 1HCY17 to 3% in 1HCY18. Foray into fast growing new categories: Nestle entry into breakfast cereals (market size expected to reach Rs 32 bn in 22 from Rs 21 bn in 217) and health/nutrition supplements category (market size of Rs 15-2 bn) seems to be encouraging as it has right to win in these categories. We were fully satisfied with management s reply - capabilities/skills, nature of business and route to market are completely different for Pet care business from core FMCG business and therefore launched thorough Nestle SA (parent) ; not thorough listed Indian arm. Nesplus breakfast cereals (customized product/formulation), despite being product of global JV between Nestle SA and General Mills has been incubated in Nestle India as local management has required expertise in this line of business Cluster based distribution approach to unleash next leg of growth Nestle has decided to create 15 distribution clusters within India (something similar HUL did in 214 thorough Winning In Many India approach). HUL saw healthy traction (gross sales grew 9.4% Cagr over FY14-16) post it transformed from four branch structure to 14 cluster approach. We believe Nestle is also likely to follow the suit as granular understanding of customer profile, competitors and products will enable local management to devise strategy which could drive growth in semi-urban/ rural areas (Nestle Rural contribution is only c15-2% vs Industry contribution of c35-4%). Scarcity Premium within F&B space to support rich valuations : We had got too bogged down by rich valuations despite strong business outlook and downgraded our rating to Neutral from BUY post 2QCY18 results and we believe post analyst meet, it is too difficult to pin down the impact of fresh qualitative factors into financials nos; although we have tried our level best 1) management new found aggression with regards to foray into newer categories 2) re-jigging distribution structure, thereby empowering local team to take required action to combat competition and 3) success of new product launches in existing categories. Hence, we increased our PE multiple from 5x to 55x to incorporate the above mentioned observations and upgrade our rating to BUY from Neutral with revised TP of Rs 12, vs 1,875 (5x Sept -2 EPS) earlier. 22 August 218 BUY (Upgrade) CMP RS 1,888 TARGET RS 12, (1%) COMPANY DATA O/S SHARES (MN) : 96 MARKET CAP (RSBN) : 137 MARKET CAP (USDBN) : 15 52 - WK HI/LO (RS) : 1888/641 LIQUIDITY 3M (USDMN) : 8.3 PAR VALUE (RS) : 1 SHARE HOLDING PATTERN, % Jun 18 Mar 18 Dec 17 PROMOTERS : 62.8 62.8 62.8 FII / NRI : 12.4 12.1 11.9 FI / MF : 7.9 8.1 8.1 NON PRO : 5. 5.1 4.8 PUBLIC & OTHERS : 12. 12. 12.4 KEY FINANCIALS Rs mn CY18E CY19E CY2E Net Sales 114,213 129,651 147,547 EBIDTA 26,9 3,639 35,811 Net Profit 15,431 18,438 21,81 EPS, Rs 16 191 226 PER, x 64.5 54. 45.7 EV/EBIDTA, x 36.8 31. 26.3 ROE, % 39.9 46.1 52. Debt/Equity (%).9.9.8 PhillipCapital India values your support in the Asiamoney Brokers Poll 218. We appreciate your vote. Vishal Gutka (+91 22 6246 4118) vgutka@phillipcapital.in Naveen Kulkarni (+91 22 6246 4122) nkulkarni@phillipcapital.in Preeyam Tolia (+91 22 6246 4129) ptolia@phillipcapital.in Risks to our call 1) Sharper than expected inflation in RM index 2) Nestle not getting desired traction as far as new launches / foray into new categories is concerned. Page 1 PHILLIPCAPITAL INDIA RESEARCH

Volume growth momentum continues 2 18 16 18. Volume gr (%) 14 12 11.3 11.5 1 8 7.7 8.9 6.9 6 4 2 Q1CY17 Q2CY17 Q3CY17 Q4CY17 Q1CY18 Q2CY18 Nestle makes healthy gains in Noodles, Pasta and Beverages categories Category Brand MAT (Jul 16-Jun 17) MAT (Jul 17-Jun 18) Change (yoy) Instant Noodles Maggi 58.7 59.7 1 bps Ketchups & Sauces Maggi 24.4 22.3-21 bps Instant Pasta Maggi 61.4 67.6 62 bps Infant Formula Lactogen & NAN 4.9 4.6-3 bps Infant Cereals Nestle Cerelac 96.4 96.3-1 bps Tea Creamer Every Day 45.7 45.3-4 bps Chocolates Nestle 14.5 14.2-3 bps White & Wafers Kitkat, Munch, Milky Bar 62.5 61.4-11 bps Instant Coffee Nescafe 47.2 49.4 22 bps Maggi s portfolio rebuilt brick by brick 18 16 14 12 1 1 115 121 Maggi Noodles (Sales Index) 143 142 132 124 18 138 154 8 6 4 2 Q1CY16 Q2CY16 Q3CY16 Q4CY16 Q1CY17 Q2CY17 Q3CY17 Q4CY17 Q1CY18 Q2CY18 Page 2 PHILLIPCAPITAL INDIA RESEARCH

Prepared dishes, beverages saw healthy volume growth Category Volume growth (%) Contribution (%) Milk Products & Nutrition 4.6 48 Prepared Dishes 12.8 28 Confectionery 6.1 13 Powdered & Liquid Beverages 9.2 11 Entry into fast growing categories Breakfast Cereals Health/Nutrition supplements Source: Company New product launches calendar Month Product Category Aug-18 Maggi Special Masala Noodles Noodles Jul-18 NESPLUS -Kokos, Choco-Burst Fillows, Strawberry Burst Fillows, Nutty Breakfast Cereals Honey Mar-18 Munch - Crunch-O-Nuts Chocolates Feb-18 Kitkat - Strawberry Duo Chocolates Sep-17 Kit Kat Dessert Delight Chocolates Aug-17 Maggi Nutri-Licious noodle Noodles Iron-fortified Maggi Noodles to make maggi healthier under simply Noodles good 22 initiative Nestle A+ Grekyo (Blueberry Greek Yogurt/ Greek Style Curd) Yogurt May-17 Maggi Masala (AmritsariAchari, MumbaiyaChatak, Super Chennai, Noodles Bengali Jhaal) Mar-17 Milo Ready to Drink Beverages Oct-16 Nescafe Ready to Drink Beverages Nestle A+ Pro-Grow Milk & Nutrition Maggi CUPPA Masala/Chilly Chow/ Hot Heads Noodles Maggi No Onion No Garlic Masala Noodles Aug-16 Maggi Hot Head, Noodles Nescafe Sunrise Insta- Filter Beverages Apr-16 Nestle A+ Grekyo Yogurt Yogurt Page 3 PHILLIPCAPITAL INDIA RESEARCH

Benign commodity costs drove margin expansion; however lately some commodities (wheat, sugar and milk) have started seeing inflationary trends which may halt margin gains in medium term 3 25 2 15 1 5-5 -1-15 -2-25 -12 -.4-8 Commodity Inflation H1'CY18 23-21 Milks Wheat Coffee Palm Oil Sugar DWP MSK Palm Kernel -14 1-6 Source: PhillipCapital India Research Raw material mix Palm kernel, 3% Others, 17% DWP, 4% MSK, 4% Milk, 37% Sugar, 6% Palm oil, 7% Green Coffee, 1% Wheat Flour, 12% Source: PhillipCapital India Research East (due to high salience to milk category) has a larger share Region wise domestic sales contribution (%) 1.2 E-com contribution to domestic sales (%) 1.1 South, 24% East, 31% 1.8.7.6.4 North, 27% West, 18%.2 H1'CY17 H1'CY18 Source: PhillipCapital India Research Page 4 PHILLIPCAPITAL INDIA RESEARCH

Region wise comparable growth 18% 16% 14% 16.2% Region wise comparable growth (%) - H1'CY18 13.6% 14.6% 12% 1% 1.4% 8% 6% 4% 2% % East West North South Source: PhillipCapital India Research Two-year forward P/E Band EV/EBITDA band 14 Rs P/E 12 6x 16 Rs mn EV/EBITDA 14 4x 1 8 6 4 45x 3x 15x 12 1 8 6 4 3x 2x 1x 2 2 Source: PhillipCapital India Research Estimate Page 5 PHILLIPCAPITAL INDIA RESEARCH

Financials Income Statement Y/E Mar, Rs mn CY17 CY18E CY19E CY2E Net sales 99,525 114,213 129,651 147,547 Growth, % 1 15 14 14 Total income 99,525 114,213 129,651 147,547 Raw material expenses -43,269-49,124-55,252-62,664 Employee expenses -1,175-11,452-12,827-14,418 Other Operating expenses -24,439-27,628-3,933-34,655 EBITDA (Core) 21,643 26,9 3,639 35,811 Growth, % 1.1 2.2 17.8 16.9 Margin, % 21.7 22.8 23.6 24.3 Depreciation -3,794-3,97-4,133-4,359 EBIT 17,849 22,11 26,56 31,452 Growth, % 11.6 23.8 19.9 18.7 Margin, % 17.9 19.4 2.4 21.3 Interest paid -919-928 -938-947 Other Non-Operating Income 1,769 1,858 1,951 2,48 Pre-tax profit 17,822 23,31 27,519 32,553 Tax provided -6,141-7,6-9,81-1,742 Profit after tax 11,681 15,431 18,438 21,81 Net Profit 11,681 15,431 18,438 21,81 Growth, % 9 32 19 18 Net Profit (adjusted) 11,681 15,431 18,438 21,81 Unadj. shares (m) 96 96 96 96 Wtdavg shares (m) 96 96 96 96 Balance Sheet Y/E Mar, Rs mn CY17 CY18E CY19E CY2E Cash & bank 14,574 38,2 45,246 53,61 Debtors 89 1,15 1,152 1,311 Inventory 9,25 1,326 11,722 13,34 Loans & advances Total current assets 25,15 5,23 58,782 68,923 Investments 19,789 5,853 5,853 5,853 Gross fixed assets 33,584 35,584 37,584 39,584 Less: Depreciation -7,423-11,33-15,463-19,822 Add: Capital WIP 942 942 942 942 Net fixed assets 27,13 25,196 23,63 2,74 Total assets 73,626 82,836 89,281 97,63 Current liabilities 14,53 15,471 16,994 18,759 Total current liabilities 37,843 42,614 47,688 53,569 Non-current liabilities 1,577 1,577 1,577 1,577 Total liabilities 39,42 44,191 49,265 55,146 Paid-up capital 964 964 964 964 Reserves & surplus 33,242 37,868 39,24 41,14 Shareholders equity 34,26 38,644 4,16 41,917 Total equity & liabilities 73,626 82,836 89,281 97,63 Estimates Cash Flow CY17 CY18E CY19E CY2E Pre-tax profit 17,822 23,31 27,519 32,553 Depreciation 3,794 3,97 4,133 4,359 Chg in working capital 4,799 3,345 3,541 4,14 Total tax paid -6,475-7,6-9,81-1,742 Cash flow from operating activities 18,178 22,682 26,111 3,274 Capital expenditure -1,714-2, -2, -2, Chg in investments -2,232 13,936 Cash flow from investing activities -1,36-2, -2, -2, Free cash flow 16,872 2,682 24,111 28,274 Debt raised/(repaid) 2 Dividend (incl. tax) -9,98-1,991-17,66-19,91 Cash flow from financing activities -9,966-1,991-17,66-19,91 Net chg in cash 6,96 9,691 7,46 8,364 Valuation Ratios CY17 CY18E CY19E CY2E Per Share data EPS (INR) 121.2 16. 191.2 226.2 Growth, % 8.8 32.1 19.5 18.3 Book NAV/share (INR) 354.8 4.8 415. 434.7 FDEPS (INR) 121.2 16. 191.2 226.2 CEPS (INR) 16.5 2.6 234.1 271.4 CFPS (INR) 198.9 216. 25.6 292.7 DPS (INR) 86. 95. 15. 175. Return ratios Return on assets (%) 17.3 2.5 22.1 24. Return on equity (%) 34.1 39.9 46.1 52. Return on capital employed (%) 21.4 25.2 27.2 29.7 Turnover ratios Asset turnover (x) 3.9 5. 6.3 8. Sales/Total assets (x) 1.4 1.5 1.5 1.6 Sales/Net FA (x) 3.5 4.4 5.4 6.7 Working capital/sales (x) (.) (.) (.) (.) Fixed capital/sales (x).5.4.4.4 Working capital days (12.8) (11.1) (9.7) (8.5) Liquidity ratios Current ratio (x) 1.8 3.2 3.5 3.7 Quick ratio (x) 1.1 2.6 2.8 3. Interest cover (x) 19.4 23.8 28.3 33.2 Dividend cover (x) Total debt/equity (%) 1..9.9.8 Net debt/equity (%) (41.6) (97.9) (112.2) (127.1) Valuation PER (x) 85.3 64.5 54. 45.7 Price/Book (x) 29.1 25.8 24.9 23.8 EV/Net sales (x) 9.9 8.4 7.3 6.4 EV/EBITDA (x) 45.4 36.8 31. 26.3 EV/EBIT (x) 55. 43.4 35.9 3. Page 6 PHILLIPCAPITAL INDIA RESEARCH

Stock Price, Price Target and Rating History 11 1 9 B (TP 12) 8 7 6 S (TP 547) S (TP S 543) (TP S (TP 545) 545) B (TP 543) S (TP 59) S (TP 6) B (TP 77) B (TP 84) B (TP 84) 5 S (TP 45) 4 3 2 J-15 S (TP 547) S-15 O-15 D-15 J-16 M-16 A-16 J-16 J-16 S-16 O-16 D-16 J-17 F-17 A-17 M-17 J-17 A-17 O-17 N-17 J-18 F-18 A-18 M-18 J-18 Rating Methodology We rate stock on absolute return basis. Our target price for the stocks has an investment horizon of one year. Rating Criteria Definition BUY >= +15% Target price is equal to or more than 15% of current market price NEUTRAL -15% > to < +15% Target price is less than +15% but more than -15% SELL <= -15% Target price is less than or equal to -15%. Page 7 PHILLIPCAPITAL INDIA RESEARCH

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