3Q19 core PAT of RM150.7m (QoQ: +5.9%, YoY: +10.2%) brought the 9M19 sum to RM532.0m (YoY: +0.7%). This made up 71.5% and 75.5% of ours and consensus full year expectations respectively, which was below expectations as 4Q is typically seasonally weak. The shortfall in earnings was mainly attributed to poorer-than-expected export sales and higher-than-expected raw material cost. We lower FY20/21/22 earnings forecasts by 6.0%/5.7%/2.8% to account for lower export sales and high raw material cost. After factoring in our new forecasts, our TP falls from RM111.00 to RM102.00 pegged to an unchanged DDM valuation methodology (r: 6.8%, TG: 3.5%).

Below expectations. 3Q19 core PAT of RM150.7m (QoQ: +5.9%, YoY: +10.2%) brought the 9M19 sum to RM532.0m (YoY: +0.7%). This made up 71.5% and 75.5% of ours and consensus full year expectations respectively. We deem this below expectations as 4Q is typically seasonally weak, making up approximately 15-20% of full year earnings as Nestle incurs a disproportionate amount of marketing spend in 4Q. The shortfall in earnings was mainly attributed to poorer-than-expected export sales and higher-than-expected raw material cost.

Dividend. DPS of 70 sen (3Q18: 70 sen) was declared, going ex on 28 Nov. 9M19 DPS amounted 140 sen vs 9M18’s 140 sen.

QoQ. Sales growth of 4.9% to RM1,400.8m was attributed to stronger domestic sales. This translated to bottom line growth of 5.9%.

YoY. Despite weaker sales (-2.2%), core PAT rose to RM150.7m (+10.2%). Lower sales in 3Q19 were attributed to high base effect as 3Q18 included two months of ‘tax holiday’ period. In spite of unfavourable exchange rates and higher commodity prices (gross profit margin shrunk from 38.8% to 36.8%), Nestle guided that better profitability was due to on-going improving internal efficiencies.

YTD. Flattish sales growth of 0.4% (+2.1% after adjusting for divestment of the chilled dairy business) was driven by domestic sales growth of 2.6% (+4.6% net of the chilled dairy divestment). Note that Nestle had disposed of its chilled dairy business at the start of FY19. Better domestic sales were attributed to effective marketing support over festive periods and introduction of new product offerings, which included the Starbucks at Home range, Milo Protein Up, new varieties of Nescafe RTD, Nescafe Blend & Brew White Coffee, Maggi Pedas Giler 2x Ayam Bakar amongst others. Core PAT rose marginally by 0.7% in tandem with sales growth.

Outlook. Nestle will continue to drive sales growth with the introduction of innovative new products, which we estimate to make up approximately 10% of total sales. Despite higher commodity costs and tepid export sales, we do not expect Nestle to raise shelf prices, particularly given the current rising cost of living.

Forecast. We lower our FY19/20/21 earnings forecasts by 6.0%/5.7%/2.8% to account for lower export sales and high commodity cost.

Maintain SELL. After factoring in our new forecasts, our TP falls from RM111.00 to RM102.00 pegged to an unchanged DDM valuation methodology (r: 6.8%, TG: 3.5%). At current price, Nestle is trading at 48.7x FY19 P/E and yielding an unattractive 2.1%. In comparison, its holding-co in Switzerland trades at a cheaper 23.7x FY19 P/E while its sister-co in Nigeria trades at 17.5x FY19 P/E.

Source: Hong Leong Investment Bank Research - 19 Nov 2019