Investment Highlights

• We maintain our UNDERWEIGHT call on Nestle (Malaysia) (Nestle) with an unchanged fair value (FV) of RM114/share, based on a DCF valuation with a WACC of 4.7% and terminal growth rate of 2.0%.

• We make no changes to our earnings forecasts as Nestle reported 1Q22 core net profit of RM205mil (+83% QoQ, +17% YoY), accounting for 34% of our FY22F earnings and 36% of consensus’.

• We deem this as broadly in line with expectations as the first quarter is normally seasonally stronger for the group. As a comparison, over the past 3 financial years, its first quarter accounted for 31%–36% of the group’s full-year net profit. The stronger YoY earnings are mainly attributed to recovering demand following the reopening of the economy.

• The group’s 1Q22 revenue improved to RM1,693mil (+15% QoQ, +17% YoY) as domestic sales grew 14.9% YoY while export sales rose 25.3% YoY. The revenue growth was underpinned by the stronger performance of the food & beverage (F&B) and out-of-home business (under Nestlé Professional) following the pick-up in broader economic activities including the resumption of hotel, restaurant & café (HORECA) sales channels.

• The group’s gross margin improved 2.5% points sequentially to 34%, likely due to better operating leverage following the stronger sales. However, it remained below the average of 36% for the previous 8 quarters and pre-pandemic level of 37%–39%, affected by higher commodity prices i.e. sugar, milk powder, coffee bean and wheat.

• We believe inflationary pressure will continue to exert a downward squeeze on Nestle’s profitability in the near term, capping its earnings recovery potential. The Ukraine-Russia conflict adds to cost pressures after driving energy (crude oil and gas) and commodity prices (especially wheat, barley, and sunflower oil) much higher amid exacerbating supply chain issues. Anecdotally, Brent crude oil price jumped 13% while the wheat price increased by 49% since the Russian invasion of Ukraine started on 24 February 2022. The easing of input costs will likely be in phases rather than immediate as global supply chains readjust.

• Valuation-wise, the stock is trading at a rich 52x 2022F PE, well above its 5-year historical average of 45x. Given the potential downside risk of the group’s earnings, we believe this is unjustifiable.

Source: AmInvest Research - 27 Apr 2022