We came away feeling cautiously optimistic on NESTLE’s outlook after attending its 1H15 analysts’ briefing, which was attended by more than 40 analysts and fund managers. Management shared their formula in maintaining solid performance amid a challenging operating environment through production efficiency initiative while soft commodities’ prices have helped further in cost savings. The Group was well prepared for the GST implementation with innovative launchings and marketing investments while sales volume has normalized in 3Q15 post-GST. New ready-to-drink (RTD) plant has started operations, although not officially opened while new products have received positive responses. All in, we maintain our neutral view on NESTLE as valuation is at the higher end. Reiterate MARKET PERFORM with unchanged Target Price of RM76.20.

Challenging but solid 1H15. NESTLE was able to record net profit growth of 3.2% despite 4.8% decline in sales revenue. Management indicated that the resilient numbers were achieved thanks to the higher operation efficiency while further aided by the favourable raw material costs. Net profit growth could have been greater, but the Group reinvested the savings into marketing spending in order to ensure a smoother and faster transition period for consumers to adapt to new costing environment post-GST. We think that the performance was steady considering the persistently weak consumer sentiment throughout the year and also the implementation of GST starting 2Q15.

Nestle Continuous Excellence (NCE) paying dividends. The Group has leveraged on its NCE program, a continuous improvement initiative based on LEAN and Total Productive Maintenance (TPM) principles that allowed NESTLE to accelerate efficiency drive across the value chain. As a result, 1H15 gross margin expanded by 3.7ppt to 39.0% which grew gross profit by 5.2% to RM944.1m. Management also attributed the impressive margin expansion to the favourable commodities prices, particularly the milk powder prices which has tumbled by c.40% YTD due to the slowing China demand and strong supply.

Well strategized against soft sentiment and GST. Domestic revenue declined merely by 2% despite the challenging operating environment. Product innovation has played a vital role in attracting consumers with interesting new product launches, including Milo Nutri G, green tea flavoured Kit Kat, Nescafe Creamy Roast, to name a few. Besides, successful and aggressive marketing campaigns have also bore fruit with core products Milo, Maggi, liquid drinks and milk powder all gaining market shares while consolidating its position in the competitive 3-in-1 coffee market. We are positive by the Group’s approach in dealing with the soft consumer sentiments and we expect further commitments in marketing investments.

New plant provides a timely boost. NESTLE’s latest plant, Sri Muda plant located in Shah Alam commenced operation in mid 3Q15. The plant, which specialized in RTD has rolled out its first product, Milo Nutri G, a new blend of Milo served inpet resin bottle. Management revealed that the product has received an overwhelming response but is confident that there will be no cannibalization on the existing product as the targeted customers are different. Moving forward, the Group expects the RTD plant to drive domestic and export sales with more innovative RTD products in the pipeline. We made no changes to our forecast as we have factored in the contribution from new plant.

Reiterate MARKET PERFORM with unchanged Target Price of RM76.20. Our TP is based on 27x FY2016E EPS, which is in line with +0.5SD5-year mean. We maintain our neutral stance on the company as we like its strong brand name and innovative marketing, which are essential in sustaining growth in view of the subdued local consumer sentiment. However, we think that its valuation is on the higher end while dividend yields of 3.5%-3.8% are less attractive. 

Source: Kenanga Research - 17 Aug 2015