Following Nestlé’s post-results briefing, we remain positive on its long-term outlook, despite some short-term headwinds arising from commodity price fluctuations and a softer external environment, which is affecting its export sales. Domestic demand remains robust, while the group continues to record good traction for its new product launches. Post-earnings revision, we maintain our HOLD call, albeit with a slightly lower DCF-derived TP of RM137.

2Q19 Impacted by Higher Raw Material Costs

To recap, Nestlé’s 6M19 earnings (-3.4% yoy) missed expectations despite a sturdy 1.8% top-line growth yoy (+3.5% yoy, pre-divestment of chilled dairy business), as EBIT margin dipped 0.5ppts due to an uptick in key commodity prices and the weaker Ringgit in 2Q19, in addition to oneoff warehousing expenses incurred ahead of its Chembong factory expansion. Robust domestic sales growth of 4.1% yoy (+6.1% predivestment), supported by strong reception garnered for its new product launches, partially made up for the weakness in export sales (-7.2% yoy) due to softer demand from these markets.

Headwinds From High Raw Material Costs Expected to Ease

We foresee headwinds, particularly with margin pressure from raw material costs to persist only over the near term. Nestlé has locked-in most of its raw material and forex requirements for the year at fairly favourable levels. We expect the Ringgit to gradually strengthen, as we have also observed a broad-based price retracement in key commodities such as milk, cocoa and wheat. Coupled with the group’s domestic sales momentum and operating efficiency improvements, we expect earnings to expand at a growth rate 6.5% yoy in FY20E and 9.2% yoy in FY21E. Export market, which accounts for 18% of Nestle’s 6M19’s group turnover, may not have such a detrimental impact on the company in the event sales are hit negatively.

Maintain HOLD; Price Target Revised to RM137.00

We however trim our 2019-21E EPS by 1-4% to account for slightly softer export sales and margins over the near term. Subsequently, we lower our DCF-derived TP to RM137.00 (from RM138.20), but maintain our HOLD recommendation on the stock. Upside/downside risks: (i) surge/dip in local consumer spending; (ii) decline/increase in input costs; and (iii) higher/lower demand for new products.

Source: Affin Hwang Research - 29 Aug 2019