After attending Nestlé’s briefing recently, we feel neutral about it’s near term earnings outlook. We concur with management that 2018’s earnings are expected to be stronger driven by a recovery in consumer spending, lower raw material costs, and strengthening of RM. Nevertheless, these are already well anticipated by the market and we believe this leaves limited earnings upside. We change our valuation method from DDM method to DCF method to better capture its future earnings growth, increasing TP to RM97.60. Maintain SELL as we believe share price has run too far ahead of fundamentals.

Better Earnings Growth in 2018

During the briefing, Nestlé guided that 2017’s revenue growth of 4% yoy was mainly driven by volume growth. We believe that Nestle should see higher revenue growth in 2018 supported by improvement in consumer sentiment and higher disposable income spurred by the strengthening of the RM and a favourable Budget 2018. Nestlé’s continuous effort to launch new products should also help to sustain its growth in tandem with the 4- 5% growth in F&B packaged food sales value in Malaysia. We are forecasting 16% EPS growth on revenue and margin improvement.

Gross Margin Improvement in Sight

The gross margin in 2017 declined by 2.7 ppts to 36.7% vs. (39.4% in 2016) mainly due to higher raw material price hedged in 1H17 when raw material prices were still at elevated levels. Nevertheless, we saw qoq recovery in gross margin in 4Q17. In light of the decline in key raw materials’ prices in 2H17, we expect sequential improvement in gross margin as Nestlé’s raw material costs usually lags 4-6 months, due to hedging contracts. We forecast 2018 gross margin to improve to 39%. Recent strength in RM against US$ is also positive to Nestle given that c.50% of its raw materials are imported.

Maintain SELL With Higher TP of RM97.60

We leave our 2018-20E EPS unchanged, but change our valuation methodology from DDM to DCF to better reflect its earnings prospects in the medium term. As a result, we revise up TP to RM97.60 which implies a PE of 30x 2018E EPS. We maintain our SELL rating on NESTLE because we think that current valuation of 39x 2018E EPS (historical high) is overly stretched. While we still like Nestle for its solid brand name and defensiveness of its business, we deem the 5-6% average earnings growth and dividend yield of 2-3% as unattractive for such valuation.

Source: Affin Hwang Research - 5 Mar 2018