Period  2Q14/1H14

Actual vs. Expectations 1H14 net profit (NP) of RM302.0m came in within expectations, making up 48% and 51% of our full-year forecast and consensus estimates, respectively.

Dividends  As expected, interim dividend per share (DPS) of 60 sen was declared, matching FY13’s interim dividend payment. We expect another final dividend of RM1.95 in FY14 giving a total DPS of RM2.55, which translates to a decent dividend yield of 3.8%.

Key Results Highlights

 QoQ, sales remained flattish at -0.2% QoQ while NP declined 35.4% to RM118.5m as EBIT margin declined from 19.1% to 12.6% on sharply higher input costs, particularly milk, coffee and palm oil.

 YTD-YoY, sales rose 4.1% as a result of earlier promotional activities in 1H14. However, NP declined 7.0% due to the aforementioned cost increase and higher marketing expenses compared to previous years.

 While the 15.5% NP decline in 2Q14 vs 2Q13 is more than expected, we are less concerned as we observed that the prices of several soft commodities (i.e. milk powder and palm oil) were either on a stable or declining trend in 2Q14, which could indicate more favourable costs pattern in 3Q14. For instance, we note that in 2Q14, milk prices have gone down 15-20% QoQ and 15-25% YoY. For Nestle, we estimate milk makes up 25-30% of operating cost.

Outlook  In response to higher input costs, Nestle raised prices for several products by 5-10% earlier this year. We believe that the higher cost environment is unlikely to persist into 2H14 as outlined above. Hence, we expect margins to improve in 2H14 towards the 3-year average operating margin of 14.5%.

 Furthermore, we foresee growth opportunities in the Ready-to-Drink segment on completion of the new Shah Alam manufacturing complex which is targeted to begin operations in late-2014.

 Towards year-end, we expect consumers spending to remain cautious due to potentially higher costs of living post-Budget 2015 and the GST implementation in April 2015. However, we believe the impending GST could provide a near-term sales boost in 4Q14-1Q15. Based on our study of previous consumption tax hikes, consumers tend to bulk-buy in the 6-9 months prior to the tax hike. While the bulk-buying/front-loading effect would benefit most consumer stocks, we believe the F&B sub-sector and Nestle will be more resilient to the post-GST slump in demand due to its strong branding and the non-discretionary nature of its products.

Change to Forecasts Maintain our NP forecasts for FY14E and FY15E of RM631.2m and RM683.6m, respectively. We may fine tune our forecasts pending further updates from management in the upcoming analysts’ briefing.

Rating Maintain OUTPERFORM

 We believe Nestle remains an attractive laggard play in the Consumer F&B subsector with YTD performance of negative 0.4% despite its stable growth history and decent dividend yield. We also note that Nestle’s FY14E expected earnings growth of 12.4% is the second highest among its peers, next to QL Resources.

Valuation  We maintain our TP of RM76.10 based on 26.1x Fwd. FY15E P/E which implies a +1.0SD premium over its 5-year historical Fwd. P/E. We believe the premium is justified due to Nestle’s ongoing expansion plans, aggressive marketing strategy and strong brand portfolio with entrenched market share.

Risks to Our Call  Further subsidies rationalization may hamper consumer spending.

 Higher-than-expected raw material costs (ie: coffee, cocoa, sugar).

Source: Kenanga