We came away from NESTLE 1Q16 result briefing feeling reassured on its earnings growth. Management dissected 1Q16 results but is of the view that the low commodity prices are overly low and therefore unsustainable. As continuous improvement in efficiency still able to protect profit margins, products prices increase are unlikely at least in FY16. Postmeeting, we made no changes to our earnings forecast. We reiterate our OUTPERFORM view on NESTLE with unchanged Target Price of RM82.10.

Double-pronged top line growth. To recap, NESTLE recorded 2.8% growth YoY in 1Q16 revenue to RM1.3b. Management revealed that the domestic market has grown 1% YoY while the export market expanded by >10%. Although the domestic growth appeared uninspiring, it was achieved on the back of a higher base in 1Q15, which was boosted by pre-GST buying. Meanwhile, export sales continued to recover on the back of stronger demand momentum from the Philippines and Indonesia. We think the growth in both markets was encouraging with the former being achieved despite weak consumer sentiment while the latter benefited from the efficiency and innovation advantage of Nestle Malaysia.

Lower marketing expenses recognized in 1Q16. Looking at the bottom line, 1Q16 net profit surged 17.5% to RM220.7m. The impressive growth was driven by favourable raw material prices, higher efficiency and recognition timing of marketing expenses. 1Q16 operating expenses were lower at 18.0% of revenue as compared to 19.6% in 1Q15 due to the earlier timing of Chinese New Year, which led to higher marketing expenses being recorded in 4Q15. Thus, we believe the marketing expenses will be more evenly spread in FY16 vis-à-vis FY15.

Efficiency to shield profit margin. On commodity prices, management was positively surprised as it had initially anticipated prices to rebound from low base. However, the management still believes that the prices are too low to be sustained but ruled out raising prices to protect margins as the continuous improvement in operating efficiency can offset the impact from the uptick in raw material prices. To ensure that, Capex of RM130m (FY15: RM191m) has been earmarked to upgrade automation with no big-scale expansion being planned. We are positive on the approach as the growth would not be solely dependent on the commodity price movements, which is beyond the Group’s control.

Reiterate OUTPERFORM with unchanged Target Price of RM82.10. Post briefing, we made no changes to our earnings forecast. We maintain our TP at RM82.10, which is based on 27.1x FY17E EPS, in line with +0.5SD 5-year mean. Our positive rating is premised on the sustainable earnings growth driven by production efficiency, sound investment in brand building and product innovation to stimulate sales volume. The valuation can be justified by its established brand name and proven track record.

Source: Kenanga Research - 3 May 2016