In-line. Reported 1Q18 core PAT of RM231.2m accounted for 31.6% and 32.1% of ours and consensus forecasted PAT respectively. Note that 1Q is seasonally stronger, usually accounting for 29% to 35% of full year earnings, as explained below.

Dividend. None declared.

QoQ. Core PAT accelerated to RM231.2m (+73.1%) from RM133.5m due to (i) phasing of marketing spend as Nestle incurs disproportionately larger amount of marketing cost in 4Q and (ii) seasonally higher sales from Chinese New Year in 1Q.

YoY. Better top line (+4.2%) that was driven by increased domestic (+4.4%) and export (+3.4%) sales did not translate to higher core PAT (+0.2%) due to higher commodity prices and marketing spend. (PAT 1Q18: RM 231.2m vs 1Q17: RM230.7m)

Outlook: Rebounding consumer spending in FY18 should benefit Nestle’s top line. Additionally, stronger ringgit and cheaper key commodity prices from the majority of Nestle’s key commodities should result in lower input costs going forward (figure 2). Note that approximately 50% of the group’s raw materials are imported. Despite this, we only expect to see improved margins in 2H17 due to lag from hedging contracts. We forecast gross profit margins to increase from 36.7% in FY17 to 40.3% in FY18.

Forecast. Unchanged.

Downgrade to SELL on Lofty Valuations. Despite favourable domestic consumption indicators, we downgrade our rating from Hold to SELL as we feel that valuations are unjustifiably rich. At current price, Nestle is trading at 47.3x FY18 P/E and yielding an unattractive 2.1%. In comparison, its holding-co in Switzerland trades at 19.8x FY18 P/E while its sister-co in Nigeria trades at 27.1x P/E. We opine that Nestle’s entry into the MSCI and KLCI index in late-2017 may have forcefully inflated its share price due to accumulation from index tracking funds. We maintain our TP of RM112.30 based on DDM valuation methodology (r: 6.8%, TG: 3.5%).

Source: Hong Leong Investment Bank Research - 25 Apr 2018