2Q20 core PAT of RM98.9m (QoQ: -48.1%, YoY: -30.5%) brought 1H20 sum to RM289.4m (YoY: -24.1%), which is below ours and consensus expectations. We lower our FY20/21/22 earnings forecasts by 4.7%/3.9%/2.8%. Despite earnings cut, TP is adjusted marginally higher to RM103.45 (from RM100.55) to reflect persistently lower risk free rate. Maintain SELL.

Below expectations. 2Q20 core PAT of RM98.9m (QoQ: -48.1%, YoY: -30.5%) brought 1H20 sum to RM289.4m (YoY: -24.1%). This is below ours and consensus expectations, making up 43.2% and 44.6% of full year expectations, respectively. The shortfall in earnings was due to weaker-than-expected sales and higher-than expected operating expenses from the implementation of safety measures in food production processes to combat the spread of Covid-19. 1H20 core PAT was arrived at after adjusting for RM2.4m forex gain.

Dividend. Declared DPS of 70 sen/share goes ex on 14 Sep 2020 (2Q19: 70 sen/share). 1H20: 70 sen (1H19: 70 sen).

QoQ. Sales decline of -15.0% was mainly due MCO restrictions on HORECA (hotels, restaurants, cafes) sales channel during 2Q20. We note that the impact on HORECA channels in 2Q20 were for a longer period compared to just 2 weeks in 1Q20. Core PAT declined (-48.1%) by a larger quantum than sales decline due to fixed cost component.

YoY. Sales declined -8.7%. Despite off-trade (supermarkets, hypermarkets) channels performing admirably from consumer stocking up on staples, this was not sufficient to make up for weaker sales to hotels, restaurants, cafes, R&R stops and offices due to MCO restrictions. Overall, we note that off-trade channels were boosted by the launch of new products which included Starbucks range, Nescafe Gold Origins, and more. Core PAT declined by -30.5% due to weaker sales coupled with increased expenses to ensure a safe working environment during the Covid-19 outbreak.

YTD. Sales decline of -4.8% and subsequent core PAT decline of -24.1% was due to impact of MCO to HORECA operators, as mentioned above.

Outlook. We expect sales to shift back to HORECA channels from off-trade in 2H20 (vs. 1H20) as consumers feel lesser need to stock up on staples (Maggi Mee, Milo Powder etc.) and return to dining out. Despite encouraging Covid-19 case numbers, we expect Nestle to continue with safety measures in order to ensure the safe production of food products, which should continue to result in higher operating expenses. Nestle shared that additional safety procedures put in place during 2H20 have amounted to ~RM50m in additional operational expenses thus far.

Forecast. We lower our FY20/21/22 earnings forecasts by 4.7%/3.9%/2.8% to account for weaker expected sales and increased operational expenses from safety measures mentioned above.

Maintain SELL. Despite relaxation of MCO rules signalling a return to normalcy, we note that Nestle will not benefit from “panic buying” in 2H20, whilst continuing to incur on-going expenses from safety measures put in place. Furthermore, we continue to believe Nestle trades at an unreasonably high valuation level of 51.6x FY20 PE and yielding an unattractive 1.9%. By comparison, its holding-co in Switzerland trades at a cheaper 26.2x FY20 P/E while its sister-co in Nigeria trades at 22.0 P/E. Despite the earnings cut, we adjust our TP marginally higher to RM103.45 (from RM100.55) as we lower our cost of equity assumption (6.8% to 6.6%; TG: 3.5% to reflect the lower risk free rate (i.e. 10 year MGS).

Source: Hong Leong Investment Bank Research - 26 Aug 2020