We attended NESTLE’s analysts’ briefing on 13-August and came away feeling more optimistic about its 2H14 earnings prospects. Despite weaker consumer confidence, we expect good domestic sales growth on aggressive marketing and pre-GST stocking-up activities. While operating cost was higher, margins should improve as: (i) commodity prices have generally declined after 1H14 and (ii) we expect lower advertising & promotional (A&P) spending in 2H14. We believe NESTLE will maintain its dividend payout ratio of between 95%-100% which implies RM2.55 dividend in FY14E and a 3.8% expected dividend yield, higher than peers’ average of 3.2% for Consumer F&B subsector. Reiterate OUTPERFORM call for NESTLE with Target Price of RM76.10 based on unchanged 26.1x Fwd. PER valuation.

Expecting better margins in 2H14 on buoyant domestic sales growth and lower commodities prices. Despite slowing consumer confidence, Nestle managed to improve domestic sales in 1H14 by 9.1% due to aggressive marketing efforts and introduction of new products such as MAGGI Royale – Penang Seafood Curry and NESCAFE Latte Caramel. Going forward, we expect to see a similar sales growth pattern in 3Q14 but higher growth in 4Q14-1Q15 as customers begin stocking up in the months prior to GST implementation come April 2015. We gather that NESTLE’s material cost was higher in 2Q14 as a result of higher commodity prices. However, things should improve in 2H14 as commodity prices have generally declined after 1H14. Note that NESTLE’s inputs are commodities such as coffee beans, skim milk powder, cocoa powder, crude palm oil (CPO), sugar and wheat.

A&P expenditure to be lower too in 2H14. During the briefing, we also gathered that NESTLE’s A&P expenditure was higher in 2Q14 against historical pattern. This is caused by its choice to spread such cost over the full-year instead of concentrating expenditure in 2H historically. Therefore, we expect to see lower A&P spending in 2H14, which should also improve margins going forward. We expect NESTLE’s operating margin to improve in 2H14 towards the 3-year average of 14.5%.

Maintain full-year dividend estimate of RM2.55. We expect Nestle to maintain its dividend payout ratio between 95% - 100%, in line with its 5-year historical dividend payout ratio of 97% - 100%. We believe the strong expected OCF of RM773m should cover almost all of the dividend payments estimated at RM603m or RM2.55 per share in FY14E. This translates into a decent 3.8% expected dividend yield, which is higher than peers’ average of 3.2% for Consumer F&B segment.

Reiterate OUTPERFORM with an unchanged TP of RM76.10. We maintain our FY14E and FY15E earnings forecasts of RM631.2m and RM683.6m, respectively. Our unchanged TP of RM76.10 is 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. We also maintain our OUTPERFORM call on NESTLE with an expected total return of 18.8% (15.0% upside, 3.8% dividend yield). With the YTD price performance of minus 0.4%, we believe Nestle is an attractive laggard play in the F&B subsector due to its defensive characteristics and consistent growth track record.

Source: Kenanga