1QFY19 core PAT of RM238.9m was in line with ours and consensus expectations accounting for 33.7% and 32.8% respectively. While we are confident Nestle will continue to strengthen its group’s portfolio of products, we expect the group to face some headwinds in FY19 from rising raw material and wage costs. We maintain our SELL call and TP of RM111.00 based on an unchanged DDM valuation methodology (r: 6.8%, TG: 3.5%).

In line. 1QFY19 core PAT of RM238.9m (QoQ: +98.8%, YoY: +6.6%) was in line with ours and consensus expectations accounting for 33.7% and 32.8%, respectively. We deem this in line as 1Q is seasonally stronger, usually accounting for between 29% and 35% of full year earnings.

Dividend. None Declared. (1Q18: None)

QoQ. Core PAT nearly doubled (+98.8%) mainly due to significantly lower marketing expenses in 1Q19 as well as higher sales (+7.8%), which was partially due to Chinese New Year festive period. Note that Nestle incurs a disproportionately higher amount of marketing spend in 4Q in preparation for festive season sales in 1Q of the following year.

YoY. Marginally higher top line (+1.6%) was predominantly driven by strong domestic sales (+4.9%). Excluding the Chilled Dairy business (which was disposed in FY18), sales grew 3.2%. In addition to better sales, increased supply chain efficiencies resulted in core PAT growth of 6.6%.

Outlook. Nestle will continue to invest in enhancing their brand portfolio and look to increase cost efficiencies. However, we expect Nestle to face headwinds in FY19 from higher commodity prices and more volatile demand in their export markets. Additionally, we expect Nestle’s tax rate to remain at current levels (circa 23.0%) as their tax incentive (linked to halal food production) expired in FY18. Note that between FY15 to17, Nestle had posted an average effective tax rate of 19%.

Forecast. After bookkeeping adjustments, our FY19/20 forecasts rise by 0.9%/0.4%.

Maintain SELL. While we are confident that Nestle will continue to strengthen its group’s portfolio of products, we expect the group to face some headwinds in FY19 from rising raw material and wage costs. We maintain our SELL call and TP of RM111.00 based on an unchanged DDM valuation methodology (r: 6.8%, TG: 3.5%). At current price, Nestle is trading at 47.8x FY19 P/E and yielding an unattractive 2.1%. In comparison, its holding-co in Switzerland trades at a cheaper 22.2x FY19 P/E while its sister-co in Nigeria trades at 24.4x FY19 P/E.

Source: Hong Leong Investment Bank Research - 24 Apr 2019