Nestle’s 2017 core net profit increased by 8.7% yoy to RM658.4m. This was within our and consensus expectations. Although we like Nestle for its strong brand name and solid execution, we downgrade the stock to SELL from Hold due to its stretched valuation (trading at 38x 2018E EPS). The stock has rallied by c.40% since its inclusion in the MSCI Global Index, and in our view, the share price has run too far ahead of fundamentals, with the stock now trading at a sharp premium to the market and its peers.

Results Within Expectations

Nestle recorded a 3.9% yoy increase in FY17 revenue to RM5.3bn, supported by 4.1% yoy growth in domestic sales (accounts for c.78% of FY17 total sales) and 3.0% yoy growth in export sales. The growth was supported by steady demand of FMCG, coupled with Nestlé’s effective marketing and successful new product launches, such as MAT KOOL Fruity Bugz, NESCAFE Black Ice, MILO Nutri-up and MANGO TANGO. FY17 GPM declined 2.7 ppts to 36.7% due to higher raw-material costs. However, effective cost management and marketing-trade investments reduced operating expenses by 10% yoy, resulting in 6.2% yoy growth in PBT. 2017 core net profit increased by 8.7% yoy to RM658m, which was within our and consensus expectations. A final DPS of 135 sen was declared, bringing FY17 DPS to 275 sen (vs FY16: 270 sen).

Improvement in 4Q17 EBIT Margin

The gross margin improved from 34.1% in 3Q17 to 36.1% in 4Q17. The improvement was in tandem with the decline in raw commodity prices in 2H17. Also, the 4Q17 EBIT margin was higher at 13.6% compared to 7.2% in 4Q16. Operating expenses declined by 22% during the quarter due to cost management and also timing differences of marketing expenses. We expect improvement in margins to be extended into 1H18, underpinned by lower raw-material prices and a stronger RM.

Downgrade to SELL With Target Price of RM85.60

We adjusted FY18-19E EPS marginally by 2% to account for actual FY17 numbers, increasing our DDM-derived TP to RM85.60. Post its inclusion in the MSCI Global Standard Index in November 2017, Nestlé’s share price has rallied by c.40%. Trading at 38x 2018E EPS (Fig 2) and at a sharp premium to its regional peers (Fig 3), we think that valuation has run ahead of fundamentals. Hence, we downgrade Nestle to SELL (from Hold). Upside risks: less competitive environment from other F&B players.

Source: Affin Hwang Research - 21 Feb 2018