Investment Highlights

• We upgrade our call to HOLD from UNDERWEIGHT on Nestle (Malaysia) with a higher fair value (FV) of RM134.00/share (vs. RM117.00/share previously). Our FV is based on a DCF valuation with a WACC of 4.7% and an increased terminal growth rate of 2.5% (previously 2.0%). There is no adjustment to our FV for ESG based on our 3- star rating (Exhibit 8).

• Although we have reduced Nestle’s FY21F net profit by 12% to account for the impact of Covid-19 in 2QFY21, we believe that in the long term, Nestle’s prospects are intact, underpinned by stable demand for household products.

• Our terminal growth rate is adjusted to take into account the positive long-term outlook of Nestle’s plant-based food segment and its recent investment in digitalizing and automating its services, which we believe is a step towards lowering operating costs.

• We also reckon that in the long run, Nestle is positioned to take advantage of the switch in consumers’ preference for longer shelf life goods that require minimum preparation as the working demographic rises. We expect that a renewed interest in healthy lifestyle may also boost Nestle’s health food contributions.

• No dividend was declared during the quarter under review.

• Nestle’s 1QFY21 core net profit came in below expectations at RM175mil, accounting for 25% and 28% of ours and consensus expectations respectively. In prepandemic periods, 1Q earnings account for almost 36% of fullyear earnings, largely due to the festive season and lower operating expenses within the quarter.

• Thus, we reduce our FY21F forecasts by 12%. This is to account for weaker-than-expected consumer sentiment as the resurgence in Covid-19 cases is driving down outof-home (OOH) activities and HoReCa demand.

• Additionally, we are wary of rising raw material prices and currency fluctuations. Rising sugar, milk powder coffee bean and wheat prices are likely to depress gross profit (GP) margins to 35% for the year. Prior to the pandemic, GP margins hovered between 37% and 39%.

• The USD has risen against the MYR since Jan 2021, peaking at US$1.00:RM4.1505 on 30 March 2021. About 50% of Nestle’s raw materials are denominated in USD, though this is somewhat offset by export sales that contribute almost 20% of revenue.

• FY22F’s forecasts are unchanged but we tweak FY23F’s up by 3%. We believe that the pent-up demand will provide an edge to FY23F’s earnings. With air travel not expected to recover anytime soon, we predict consumers will overcompensate by splurging more than normal. In Nestle’s case, its stands to benefit from a surge in HoReCa demand as well as more consumers purchasing high-margin “masstige” (prestige for the masses) products (e.g. Magnum ice-creams and premium coffee).

• We are positive on the long-term prospects of Nestle’s foray into alternative meats. The group has already expanded its distribution channel of its alternative meats to restaurants, retail stores and online platforms. Its new Harvest Gourmet brand has inked deals to supply to global and regional restaurant chains such as KyoChon and Carl’s Jr.
   
• Revenue improved by 1.0% YoY and 5.8% QoQ to RM1.4bil in 1QFY21, driven by a robust growth in Nestle’s F&B business. This was driven by robust in-home consumption and the successful introduction of new products. On a negative note, OOH sales were weak. We believe that restrictions on in store-testing may have affected sales.
   
• EBITDA fell by 7% YoY to RM283.6mil in 1QFY21 while EBITDA margin fell by -1.8 ppts, largely as result unfavourable movements in the commodity market and an additional RM22mil of Covid-19-related operating expenses. On a QoQ basis, EBITDA rose by 21% in 1QFY21 while EBITDA margin rose by 2.5 ppts. We are not optimistic on the outlook for EBITDA margins in the coming quarters as raw material prices are still trending upwards.

Source: AmInvest Research - 28 Apr 2021