We attended NESTLE 2Q16 result briefing and came away feeling cautious on its prospect due to the diminishing advantage from cheaper raw material prices. Management indicated that the general sentiment is still fragile while the higher raw material cost is expected to be offset by higher production efficiency and thus we made no changes to our earnings forecasts. We reiterate our MARKET PERFORM view on NESTLE with unchanged Target Price of RM82.10.

Healthy sales growth despite weak sentiment. To recap, NESTLE recorded 5.4% growth in 1H16 revenue to RM2.6b. The top line growth was driven by 14.9% jump in export sales and 3.2% growth in domestic sales. Moving forward, the export sale growth should normalize as export sales had recovered since 2H15 and thus creating a higher base effect, whereas domestic sales growth, which was driven solely by volume growth should continue to grow healthily. Management indicated that the general sentiment was still weak but gradually recovering, and the domestic sales growth was derived from market share gain due to its innovative product launches and effective brand-building exercises.

Efficiency driving margin expansion. NESTLE registered impressive 1H16 operating profit growth of 23.5% YoY to RM515.6m as operating margin expanded by 2.9ppt to 20.2%. Management attributed the encouraging margin expansion to lower raw material costs due to softness in commodities prices, better operating efficiency and lower A&P spending in comparison as the Group had invested heavier than usual in 1Q15 marketing expenses in anticipation of GST implementation. However, the Group expects the A&P expenses to skew more towards to 2H16 and thus lower profitability as compared to 1H16, which is in line with our earnings forecasts.

Unperturbed by commodity uptrend. Having earlier anticipating the normalization of commodity prices, management is not overly concerned by the uptrend in price movement of key commodities, including milk powder, coffee, and sugar. The Group once again reiterated its approach of not raising selling prices, at least in FY16 as it expects the continuous improvement in operating efficiency to offset the impact of the normalization in raw material prices. As such, we are not making changes to our earnings forecasts.

Reiterate MARKET PERFORM with unchanged Target Price of RM82.10. Post briefing, we maintain our TP at RM82.10, which is based on 27.1x FY17E EPS, in line with +0.5SD 5-year mean. Although we like the company for its strong brand names and ability to continuously improving its operating efficiency, the earnings growth moving forward might slow as the advantage of cheaper raw material prices diminish, thus we retain our neutral view on the company.

Source: Kenanga Research - 30 Aug 2016