We attended Nestle’s 1Q18 results briefing which yielded no major surprises. Rebounding consumer sentiment is expected to spur top line growth while cheaper commodities and stronger ringgit should result in margin improvement in FY18. Despite this, we maintain our SELL call on the back of unchanged DDM based TP of RM112.30 as we opine that its valuation is too rich. Nestle currently trades at 44.6x FY18 P/E compared to its parent-co (Switzerland) at 19.7x and sister-co (Nigeria) at 29.3x.

Market Share. Management shared that their overall market share in Malaysia’s F&B segment has grown to approximately 16%.

Expiry of the Group’s Halal Certification Tax Incentive. The recent expiry of the group’s favourable halal tax incentive should see the group’s effective tax rate to average higher in FY18. We expect the group’s effective tax rate to be around 22-23% going forward (FY17: 20.6%)

Coffee Conundrum. Nestle shared that their coffee mix segment is currently facing stiff competition as competitors are slashing prices in attempt to claim market share. Nestle guided that consumers of this segment are very receptive to cheap prices (i.e. high price elasticity), indicating poor brand loyalty. Nestle’s competitors in this segment include Ah Huat, Oldtown, Super and Alicafe.

Price Increases An Act of Last Resort. Nestle continued to emphasise that they see increasing prices as an act of last resort, preferring to drive profitability via volume increase or garnering better internal or external efficiencies.

Better Top Line Expected. We expect the group’s top line to grow by 7.5% in FY18 supported by improved consumer sentiment and higher disposable income spurred by government cash injections and stronger Ringgit. Additionally, the group shared that they expect to increase A&P spending in FY18 in order to drive volume growth after a prudent year in FY17 which was plagued by sluggish consumer spending.

Outlook: Rebounding consumer spending in FY18 should benefit Nestle’s top line. Additionally, stronger ringgit and cheaper key commodity prices should result in lower input costs going forward (Figure #1). Note that approximately 50% of the group’s raw materials are imported. Despite this, we only expect to see improved margins in 2H18 due to lag effect from existing hedging contracts. We forecast gross profit margins to increase from 36.7% in FY17 to 40.3% in FY18.

Forecast. As the briefing yielded no major surprises, we retain our earnings forecast.

Maintain SELL. Despite favourable domestic consumption indicators, we maintain SELL call as we feel that valuations are unjustifiably rich. At current price, Nestle is trading at 44.6x FY18 P/E and yielding an unattractive 2.2% in dividend. In comparison, its holding-co in Switzerland trades at 19.7x FY18 P/E while its sister-co in Nigeria trades at 29.3x 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 - 26 Apr 2018