9M17 net profit of RM512.3m (-10%) was below estimates due to higher production costs on unfavourable commodity rates. A 70.0 sen interim dividend was declared, which is deemed within estimates. While we are confident with NESTLE’s top-line growth potential, earnings will still be pressurised by high commodity prices. Post-results, we cut our FY17E/FY18E NP by 11.4%/3.2%. Maintain MARKET PERFORM with a lower TP of RM81.10 (from RM83.90).

9M17 net profit fell below expectations. Although 9M17 net profit of RM512.3m made up of 76% of both our and consensus estimates, we deem the results to be below estimates as the 4Q period is seasonally weaker due to the highest marketing spend on year-end and CNY festivities. The negative deviation was due to higher-than-expected production costs, likely due to unfavourable hedging positions. An interim dividend of 70.0 sen was declared, which is within expectations. Typically, the group announces a larger dividend portion with its 4Q results release.

YoY, 9M17 sales of RM4.0b continued to expand by 4% due to better domestic and export market demand, thanks to effective marketing and promotional activities. However, gross profits fell by 5% at lower gross margins of 36.9% (-3.5pts), which we believe is due to the group being exposed to more unfavourable hedging positions despite the recent easing of commodity prices. Key commodities for the group are sugar, coffee and milk powder. This translated to a lower PBT of RM648.4m (- 5%). With higher effective taxes seen during 9M17 at 21% (+4.2pts), net profits came to RM512.3m (-10%).

QoQ, 3Q17 revenue of RM1.3b was stronger by 3%, which could be on normalising in demand as 2Q17’s sales were underpinned by the fasting season. Gross profit was lower by 4% as margin was thinner at 34.1% (-2.5pts) likely from the same reason mentioned above. PBT showed an even steeper decline by 32% from the phasing of marketing investments during the quarter. 3Q17 net profit registered at RM119.7m (-26%) with lower effective taxes of 17.5% (-6.2pts).

Commodities still a stingy pinch. Against poor consumer sentiment, NESTLE’s market leading position has persistently generated growth by tapping on its strong product development capabilities and marketing know-how. Despite this, the group is still vulnerable to fluctuations in commodities prices, which have been affecting players industry-wide. Although current trends are demonstrating easing prices, implementing the right hedging strategies also pose a great challenge as a sharp downturn may leave the group in a more unfavourable condition than before. NESTLE’s hedging practices vary between a few weeks to a year.

Post-results, we cut our FY17E/FY18E earnings by 11.4%/3.3% to account for a wider exposure to commodity prices and a slower-thanexpected price correction based on current trends. We reserve further adjustments to our earnings, pending further clarification from the management during an upcoming analyst briefing next week.

Maintain MARKET PERFORM with a lower TP of RM81.10 (from RM83.90, previously). Our valuation is based on an unchanged PER of 28.0x on FY18E EPS in line with its 5-year mean PER. We had previously used a +0.5SD on its 5-year mean PER but decide to tone this down due to the prevailing production cost pressures.

Source: Kenanga Research - 8 Nov 2017