We came away from NESTLE’s 2Q17 results’ briefing feeling reassured that the recent cost pressures are likely to be temporary as commodity outlook improves. Going forward, management intends to extend effort on products which have high traction with consumers. Prevailing soft sentiment and constant-changing market landscape would remain as key challenges for the group. Maintain MARKET PERFORM and TP of RM83.90.

Rising costs a short-term concern. In the recent 1H17 results, the group registered a 4% YoY growth in sales to RM2.7b on solid export and domestic demand growth. However, gross margins dipped by 3% which later led to 1H17 net profits to record at RM503.3m. Our view of higher forex and commodity prices base against 1H16 as the culprit concurs with the management’s comment as we were reminded that 1H16 commodity levels had lingered at lower-than-average bases, while forex rates during that period were also more favourable. In spite of this, we believe that the recent easing in global price trends should also translate to looser production costs for the group in the near future, granted exchange rates do not weaken significantly with it.

Product portfolios identified for focus. Commenting on a small but meaningful rise in market share, the group intends to invest further into product portfolios, which could appeal to an expanding audience. Such products with established names but could still have untapped potential range from ready-to-drink coffee products, ice creams and instant noodles. We conform with the management’s approach as we believe consumer demand tends to evolve over time and brand acceptance may divert towards the competition if the group is unable to cater to the consumers’ needs.

Price increase still a last resort. While the group had recently exercised a small degree of price increase for selected products, it did not express an intention to raise prices on a large scale. To ensure the sustainability of operations, the group would seek other avenues such as to continue improving on supply-chain management, procurement management and marketing rationalisation.

Likely to continue standing firm. We are confident of the group’s position as a leading FMCG player backed by their strong branding and consumer confidence in their products. Nonetheless, steadfast initiatives have to be persistently explored on marketing and product development for the group to remain relevant and visible to the consumers. In addition, while commodity trends could appear favourable in the near future, mechanisms have to be set for the group to withstand any shortcomings.

Post briefing, we maintain our FY17E/FY18E earnings estimates.

Reiterate MARKET PERFORM with an unchanged TP of RM83.90. Our valuation is based on an unchanged PER of 28.0x on FY18E EPS in line with the +0.5 SD over its 5-year mean PER. While the group’s growth potential could be suppressed by the prevailing softness in consumer sentiment, which has lingered below “optimistic” levels since Sep 2014, we do not discount the possibility for a re-rating from a sooner-than-expected recovery in statistical readings.

Source: Kenanga Research - 25 Aug 2017