Highlights

• Nestlé’s 1Q16 top line grew by 2.8% to RM1.314bn yoy (1Q15: RM1.278bn), on the back of robust domestic and export sales. Despite PAT growing a commendable 17.5% yoy in 1Q16, management was quick to reign in expectations and expects growth to normalize as 1Q16 benefited from the earlier timing of CNY in 2016 and FX gains. Whilst it’s too early to call a recovery in consumer sentiments, management believes that consumer sentiment has started to normalize.

• In terms of market share, as a percentage of the total F&B basket/market in Malaysia, Nestle managed to gain a commendable 20 ppts in FY15 from 15.6% to 15.8% of total market share which includes categories that they are not present in.

• The price of raw materials, which accounts for approximately 50% of input cost, has been favorable to the group. Nonetheless management expects that prices of key commodities (Milk, Cocoa, Coffee) to be on a rising trend towards end of CY2016.

• On exports, management expects the double digit growth in exports to continue in the coming quarters of FY16. This is partly on the back of the innovation and renovation drive in which products produced in Malaysia are well received in key export countries (Philippines & Indonesia)

• Growth was also supported by the extra capacity that Nestle installed due to the capex commitments in previous year, e.g. extension of Maggi noodles line and Sri Muda plant. Capex for the next 3 years is expected to be in the range of RM130- 200m per annum which is expected to further drive their internal efficiencies drive, with end of line, packing & packaging and palletizing automation expected to be in the next phase of internal efficiencies drive.

• Nestle is committed to its Innovations&Renovation program as they look to continuously grow organically in the changing consumer and economic landscape. The groups I&R expense accounts for circa 10-11% of annual revenue and is expected to increase in future as their product lines are revamped in the face of changing consumer needs. The focus in 2016 will be on further improving its internal cost structures, maintaining the momentum its established for 2016 and building on the market share growth.

Risks

• Risks to the stock include prolonged depression in consumer sentiments, strong competition especially in the instant coffee segment and a potential failure in quality control or jeopardy of its Halal certification could endanger the stock rating.

Forecasts

• We update our forecast to take into account annual report numbers. Our FY16-17 EPS is raised by 8%-7%.

Rating

• We believe Nestle warrants a HOLD call as it is fully valued at the current price. Investors should have Nestle in their portfolio on the back of its defensive nature and it’s a proxy to Malaysia’s commendable growth track record.

Valuation

• We maintain HOLD call in view of the defensive nature of its business and shareholding profile. We increase out TP to RM77.80 as we roll over our DDM valuation forward. (WACC: 7.13%; TG: 3%)

Source: Hong Leong Investment Bank Research - 3 May 2016