Highlights

• Nestlé’s 1HFY16 top line grew by 5.4% to RM1.314bn yoy (1HFY15: RM1.278bn), on the back of robust domestic (+3.2% yoy) and export sales (+15% yoy) growth. PAT growth of 31.0% yoy in 1HFY16 evolved from Nestles internal efficiency drive coupled with favorable commodity prices and a lower effective tax rate.

• The price of raw materials, which accounts for approximately 50% of input cost has been favorable to the group. Nonetheless management expects prices of key commodities (Milk, Cocoa, Coffee and Sugar) to normalize towards end of CY2016 after several years of historic lows.

• Management are confident of being able to weather margin pressures arising from commodity price increases in 2HFY16 due to 1) forward looking hedging policy, and 2) lower conversion cost/tonne resulting from internal efficiency measures in the production line.

• Nestle continues to enjoy lower than statutory tax rates due to tax credits and incentives awarded due to their investments in the past two year. On that note, its Halal tax credits will only expire in 1Q18.

• Management stressed the importance of Halal as a main driver for export sales and continues to see sustainable growth rates in exports. We can expect export sales to grow 8-12% FY16. This is on the back of a lower base vs SPLY as exports only started to normalize in 3Q15 and the innovation drive in which products produced in Malaysia are well received in key export countries.

• In terms of A&P, Nestle will continue to invest in segments where there is opportunity for growth. Convenience is a major determining factor in the consumers purchasing decision; as such we can expect the group to focus on A&P expenditure on their RTD and Maggi Hot Cup line moving forward.

• Management believes that consumer sentiment has started to normalize .The focus in 2016 will be on further improving its internal cost structures, maintaining the momentum its established in 1HFY16 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 a jeopardy of its Halal certification could threaten the stock price.

Forecasts

• We adjust our forecast to take into account margin expansion on the back of better efficiency across operations and organic sales volume growth as Nestle leads the charge in the recovery in consumer sentiments. Our FY16/17 EPS forecasts are revised upwards by 5%/6%.

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

Maintain HOLD. Our TP increases to RM80.12 from RM77.80. (WACC: 7.5%; TG: 3%)

Source: Hong Leong Investment Bank Research - 30 Aug 2016