Normalisation of outperformance in FMCG Sector: IIFL Capital Services

28 Sep 2023 , 10:38 AM

Analysts of IIFL Capital Services believe that HUL stock will outperform Nestle over the next one to two years. In the past two to three quarters, HUL’s sales have significantly underperformed Nestle’s by ~10ppts. A lot of this is due to higher pricing growth by Nestle, which will anniversarize and the growth differential will come down. On the back of Nestle’s higher sales, the valuation premium vs HUL has expanded to near an all-time high of ~30%. Analysts of IIFL Capital Services expect this to contract once the gap in performance narrows down in the next couple of quarters. Moreover, analysts of IIFL Capital Services expect HUL volume growth to improve to ~7-8% vs ~3-4% currently in the next two quarters, which will spur the stock price. In the past few years, Nestle’s growth has largely been distribution led, which is a driver with diminishing returns; while innovations have had limited success. HUL’s growth is less distribution-led and therefore, more enduring. 

Nestle has outperformed HUL: 

Nestle has outperformed HUL by 2%/0.7% in sales and Ebitda growth over the past five years. However, the outperformance over the past four quarters (incl. Sept quarter) has been higher at 7%/14% respectively. Over the past one year, Nestle stock price has outperformed HUL by 34% (25% return vs –7% for HUL). 

Outperformance driven by pricing; timing of anniversary lagging by ~2 quarters: 

In the recent past, Nestle’s wide outperformance was driven by higher pricing (10% for Nestle vs 5.6% for HUL). HUL pricing is already zero or negative in September quarter, while Nestle’s pricing this quarter would be ~7%, per analysts of IIFL Capital Services estimate; it will anniversarise gradually over the next couple of quarters. Moreover, analysts of IIFL Capital Services expect HUL’s volume growth to recover as it passes value to customers via price cuts. As a result, the sales / Ebitda growth differential, which is trending at 7%/14% over four quarters, will likely narrow to 3%/0% by the June quarter in 2024.

Sales drivers different: 

Nestle sales is driven largely by distribution. Over the past ~3 years, it increased villages/distributors/wholesalers by 85%/120%/14%. However, incremental gains from improved distribution will not be a big driver in the longer run. Nestle’s innovations have fallen short of their mark with only 5.4% of sales coming from SKUs launched after 2016 and launches such as Nesplus (breakfast cereals) and Milo (Ready to drink malt beverage) receiving limited success. On the other hand, HUL’s growth is not distributionled – HUL has, over the past two decades, created categories that analysts of IIFL Capital Services believe have stickier growth. 

Valuation premium near historic highs: 

Nestle’s valuation premium to HUL is 32% on consensus estimates and 27% on analysts of IIFL Capital Services numbers (they cut HUL estimates by ~4% in this note). Compared to this, long-term premium is ~15%. The high valuation premium is driven by a high growth premium in recent times. As growth premium normalises over the next few quarters, valuation premium will shrink too. Therefore, analysts of IIFL Capital Services believe that HUL could outperform Nestle over a ~1-2yr time horizon.