Investment Highlights

• We maintain our HOLD call on Nestle (Malaysia) with a lower DCF-derived (WACC: 5%, terminal growth rate: 2.0%) fair value (FV) of RM119 (from RM122/share), after revising our FY22F-FY23F earnings lower by 9%-15% to account for more conservative gross margin assumptions.

• Nestle’s 3QFY22 earnings of RM113mil (-34% QoQ, -24% YoY) fell short of our expectation but within consensus’. Despite reporting a healthy 3QFY22 revenue of RM1,683mil (+3% QoQ, +17%), the group’s profitability declined due a deterioration of gross margin and was further exacerbated by an increase in operating expenses.

• The company’s 9MFY22 earnings of RM488mil (+7% YoY) only accounted for 69% of our previous full-year FY22F estimate and 75% of consensus. As a comparison, the group’s historical 9M earnings account for 76%-80% over the past 3 years.

• The negative variance is mainly attributed to worse-than-expected inflation and higher commodity prices, which eroded Nestle’s margin. The company’s 3QFY22 gross margin contracted 4.3%-points QoQ and 7.2%-points YoY to 27.3%, despite demand for its products remaining robust.

• While some of the key commodity prices such as sugar, coffee bean and wheat have eased slightly as supply chains gradually readjust, they are still relatively higher compared to 2021 average prices (Exhibit 2-5).

• YoY, 3QFY22 revenue growth was underpinned by stronger performance of food & beverage (F&B) and outof-home business channels following the pick-up in broader economic activities. Notably, domestic (+13% YoY) and export sales (+30% YoY) performances improved during the quarter.

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

• At 42x FY23F PE, the stock is trading below its 5-year historical average of 53x. Even so, we believe the discount is justified given that the challenging operating environment currently poses a downside risk to prospective earnings. Also, FY22F-FY23F dividend yields are unexciting at 2%.

Source: AmInvest Research - 27 Oct 2022