Investment Highlights

• We upgrade Nestle (Malaysia) (Nestle) to HOLD from UNDERWEIGHT with a higher fair value (FV) of RM122/share (from RM114/share), based on a DCF valuation with a WACC of 5% (from 4.7%, after updating our risk-free rate assumption) and unchanged terminal growth rate of 2.0%.

• We raise our earnings forecasts by 17% for FY22F, 15% for FY23F and 9% for FY24F, after imputing higher sales assumptions to reflect a faster and stronger-than-expected recovery in sales based on Nestle’s 1HFY22 performance.

• Nestle’s 2Q22 results were above expectations with a core net profit of RM170mil (-17% QoQ, +26% YoY). This brings 1H22 earnings to RM375mil (+21% YoY), accounting for 63% of our earlier FY22F earnings and 62% of consensus.

• The positive variance was mainly attributed to strongerthan-expected demand recovery following the reopening of the economy, partially offset by the deterioration in gross margin. Operating expenses were also reduced due to lower Covid-19-related expenses.

• Compared to the previous quarter, the group’s 2Q22 revenue was generally sustained at RM1,639mil (-3% QoQ) despite the absence of Chinese New Year seasonality.

• YoY, revenue growth was underpinned by a stronger performance of food & beverage (F&B) and out-of-home business channels following the pick-up in broader economic activities. The group’s domestic (+13% YoY) and export sales (+48% YoY) also improved.

• The group’s gross margin deteriorated by 2.4% points sequentially to 32% (vs. 37–39% pre-pandemic level) likely due to higher raw materials and logistics costs. Notably, some of the key commodity prices i.e. sugar, coffee bean and wheat eased slightly as supply chains gradually readjust. However, they are still relatively higher compared to the 2021 average price.

• Moving forward, despite the strong demand recovery, Nestle’s upside earnings potential likely will be capped by inflationary pressure, especially on key food commodities. Another key risk to earnings is the weakening of the MYR against the USD which could further exacerbate margin pressures.

• At 46x 2022F PE, the stock is trading below its 5-year historical average of 52x. We believe the discount is justified given that the challenging operating environment poses a downside risk to the earnings.

Source: AmInvest Research - 29 Jul 2022