NSRGY - Nestle: Cautiously Optimistic About FY23

2023-04-26 12:01:11 ET

Summary

• Nestle reported impressive 1Q23 results with top-line growth of 9.3%, beating consensus expectations.
• Nestle's improved RIG and better pricing contributed to the beat, with all regions performing well, and North America's RIG improving since hitting rock bottom in 4Q22.
• Nestle's valuation is relatively cheap when compared to peers.

Description

Nestle ( NSRGY ) is a well-known, trusted company. Milk, chocolate, candy, coffee, etc. are just some of the many items it produces and sells. On the 25th, Nestle announced impressive 1Q23 results , including top-line growth of 9.3% LFL, 210bps above consensus. Better RIG is the primary factor in the beat, while better pricing also contributed. All regions performed well, but I think it's important to highlight that North America's RIG has improved since it hit rock bottom in the 4Q22. Greater China missed with a weak Lunar New Year, but the strong showing in Confectionery and Nutrition indicates a possible timing benefit. Furthermore, out-of-home growth accelerated to high-teens from the mid-single digits seen in 4Q22. Management's reiteration of its prior projections of 6-8% growth and 17-17.5% margin is also encouraging. Given Nestle's strong start to the year, I think it's highly likely that the company will achieve these goals, especially the higher end of the margin guide. In particular, the decline in COGS inflation has increased transparency and set the company on track to meet the high end of its margin guidance. Given the improved visibility into FY23 results and the cheap valuation relative to the average valuation of peers, I recommend a buy rating.

1Q23 Results Details

The most notable aspect of these earnings is the drop in RIG was lesser than anticipated, at 0.5%. The Americas, AOA, and Greater China all performed above expectations, which helped propel volume growth. Developed markets saw an organic sales increase of 8.6% in 1Q23, while emerging markets saw an increase of 10.3%. Waters had the lowest growth rate at 3.1%, followed by Pet care at 15.7%, and confectionery at 13.5%. In terms of distribution channels, out-of-home is on the upswing again. Lastly, Nestle mentioned that in the second half of this year, they and PAI Partners will officially form a joint venture to run their frozen pizza business in Europe.

Outlook

Despite the impressive performance in 1Q23, my outlook for the year as a whole is more cautiously optimistic. On the one hand, 1Q23 was stronger than expected, and the sequential improvement in RIG is encouraging news for the future. On the other hand, after hearing the call's management's comments, I'm not getting my hopes up too high. Management has stated that it will carefully examine 2Q23 sales before making any changes to guidance. Still, I think this cautious outlook will work well in the current market as long as market expectations are kept in check (i.e., no major surprises that will cause the stock price to drop). The combination of a rebound in out of home sales and the expected continued negative impact of SKU reduction in 2Q23 is what I think management means when it says RIG will be slightly negative for the half year. Furthermore, I would advise caution regarding the trend in Europe, where additional price increases due to inflation may not see the same volume. The flip side of this is lower inflation, which is good news for Nestle's margins this year.

Demand Profile

Consumers' dedication to Nestlé's brands is on full display in the company's ability to maintain strong volume despite significant pricing measures taken in the face of severe cost inflation. In the wake of extraordinary growth during lockdowns, when consumers ate more meals at home, there is now a more resilient volume trend. While I am concerned about the winter months, European consumers have certainly held up remarkably well. Although the impact of Europe's price hikes on the quarter is still unknown, they may serve as a catalyst for upward revisions to consensus estimates if the second quarter results turn out better than expected. The outlook for Nespresso and Nestle Health Science, too, is brighter beginning in 2H23. Now that Nespresso has weathered the storms of tough competition, the business unit can finally begin to display its true underlying growth. Management has also stated that they anticipate growth for Nestle Health Science in the high single digits for the second half of FY23 on the back of a recovering market.

Disposals

Announcing yet another sale this week demonstrates Nestle's ongoing efforts to realign the business with shifting consumer preferences, despite signs that the pace of Nestle's portfolio transformation has slowed since the arrival of Ulf Mark Schneider as CEO in 2017. This time, Nestlé said it would sell off its pizza operations in Europe . Given the cutthroat nature of the pizza market, I see this as a sensible move. In this market, customers show little allegiance to the dominant brands. On the other hand, Nestlé continues to sell pizzas in the United States thanks to its sizeable cost advantage over private label rivals.

Valuation

Nestle currently trades at 22x NTM PE, which is in line with peers such as Emmi, AAK, Kerry Group, and Danone. Nestle is relatively cheap in this peer group, given its larger revenue base ($12 billion), high net margin, and better growth prospects over the next two years. As a result, I believe the current valuation is reasonable.

Summary

Nestle's 1Q23 results were impressive, with top-line growth of 9.3%, beating consensus expectations. RIG and better pricing contributed to the beat, with all regions performing well, and North America's RIG improving since hitting rock bottom in 4Q22. The company's reiteration of its prior projections of 6-8% growth and 17-17.5% margin is also encouraging. Despite a cautious outlook for the year as a whole, Nestle's dedication to its brands and ongoing efforts to realign the business with shifting consumer preferences bode well for the future. Overall, I recommend a buy rating as I find Nestle's current valuation is reasonable and relatively cheaper when compared to its peers.

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