We attended Nestle’s 3Q18 results briefing and came away feeling neutral on the group’s prospects going forward. Forecasts remain unchanged. We maintain our SELL call with an unchanged TP of RM109.10, based on an unchanged DDM valuation methodology (r: 6.8%, TG: 3.5%). We feel that valuation is unjustifiably rich.

We attended Nestle’s 3Q18 results briefing and came away feeling neutral on the group’s prospects going forward. Despite this, we reiterate that valuations remains stretched at current levels.

Disposal of Petaling Jaya production facility to Lactalis. Currently, Nestle’s Petaling Jaya production facility produces Milo powder, culinary sauces, milk powder (under brand names Nespray and Everyday) and chilled dairy products (under brand names Bliss and Nestle Milk). Effective 1 July 2019, Nestle’s culinary sauces and milk powder repackaging operations will be run by Lactalis for Nestle Malaysia. Furthermore, as Nestle recently disposed their chilled dairy product line, Lactalis will own the Bliss yoghurt drink brand but will be required to change the name of the Nestle Milk brand after a grace period of one year. Note that Lactalis is one of the largest global dairy product groups and already manufacture dairy products for Nestle in other countries.

Consolidating Milo production. Nestle have shared their reasoning for consolidating Milo production in their Chembong production facility. They expect to spend RM100m upgrading the current facility which should result in increased capacity and better cost efficiencies. We expect the increased capacity to spearhead export growth.

SST regime not expected to increase shelf prices significantly. We do not expect Nestle’s product prices to be significantly different post-SST introduction as a number of product lines being taxed at the raw material level as opposed to the finished product should result in minimal price change. For example, milk based products (such as Milo) are tax exempt at the finished product level. Therefore, only the raw materials used for the production of milk based products will be subject to SST, resulting in a lesser amount of tax paid than if it were taxed as a finished good. In order to maintain margins, Nestle will raise selling prices for these products. However, under SST tax regime, retailers will no longer be mandated to pay the 6% (which they paid under GST regime) on this transaction, resulting in a marginal change in price change.

Outlook. Streamlining the production of Milo should result in increased efficiency and capacity, which should drive profitability in the long term. The disposal of chilled dairy products (which accounted for RM106.1m or 5.5% of FY17 sales) should allow Nestle to focus on key brands such as Milo and Maggi noodles. We are expecting 4Q18 earnings to be comparatively weaker as Nestle usually books a disproportionate amount of marketing spend in 4Q in preparation for the festive season in 1Q of the following year.

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 43.9x FY18 P/E and yielding an unattractive 2.1%. In comparison, its holding-co in Switzerland trades at 20.2x FY18 P/E while its sister-co in Nigeria trades at 22.0x FY19 P/E. We maintain our SELL call with an unchanged TP of RM109.10, based on An Unchanged DDM Valuation Methodology (r: 6.8%, TG: 3.5%).

Source: Hong Leong Investment Bank Research - 1 Nov 2018