Nestle’s 1H18 core PAT of RM397.4m (+1.3% YoY) was within ours and consensus expectations. Better sales from launching of new products more than offset higher operating expenses from relocation to a new National Distribution Centre. Going forward, cheaper commodity prices should reduce Nestle’s input costs. Despite this, we reckon the stock is trading at overly rich valuation of 47.3x FY18 P/E. Hence, we maintain our SELL call and unchanged TP of RM112.30 based on DDM (r: 6.8%, g: 3.5%).

In line. Reported 6M18 core PAT of RM397.4m accounted for 54.4% and 55.1% of ours and consensus forecasted PAT, respectively. We deem this in line as 2H is usually weaker than 1H.

Dividend. Declared dividend per share of 70 sen was within our expectation (2Q17: 70 sen) going ex on 30/8/18.

QoQ. Core PAT declined to RM166.2m (-28.1%) from RM231.2m in tandem with lower revenue of -8.4%. This was due to seasonality as 1Q usually has higher sales associated with CNY as well as timing of marketing spend (Nestle usually expenses marketing costs for 1Q in 4Q of the year before).

YoY. Both revenue (+2.0%) and core PAT (+2.9%) were higher. Slightly higher operating expenses (from one-off expenses incurred from relocation costs associated with Nestle’s new National Distribution Centre) was more than offset by better sales due to Raya period in June and the launch of new products.

YTD. Profitability was driven by higher sales at RM2,738.7m (+3.1%) from the launch of new products (Maggi Pedas Giler, Nestum Kurma & Prun) as well as the opening of the new Nespresso Boutique in the Gardens Mall. This resulted in core PAT growth of +1.3% (1H18: RM397.4m vs 1H17: RM392.1m).

Outlook: Rebounding consumer spending in FY18 (which hit a record high of 132.9 in 2Q18) should benefit Nestle’s top line. Additionally, lower commodity prices of Nestle’s major raw materials should result in lower input costs going forward (Figure #2). Despite this, we only expect to see improved margins in 2H18 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.

Maintain SELL. Despite favourable domestic consumption indicators, we maintain our SELL call 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 21.1x FY18 P/E while its sister-co in Nigeria trades at 29.2x P/E. We maintain our TP of RM112.30 based on DDM valuation methodology (r: 6.8%, TG: 3.5%).

Source: Hong Leong Investment Bank Research - 15 Aug 2018