We came away from NESTLE’s 4Q17 results’ briefing feeling optimistic on its short to medium term outlook. Recovering sentiment could spell healthier demand while favourable forex and commodity trends should benefit margins. Production cost savings could allow for more aggressive promotional activities. However, rich valuations may suggest that the positives have already been factored in. Maintain MARKET PERFORM and TP of RM114.30.

Production costs showing a positive shift. Recall that in the recent 12M17 results, group revenue increased by 4% to RM5.3b thanks to growth in both domestic and export sales. However, higher production costs sliced gross profits by 3%. This is likely due to the highly unfavourable hedging positions on key commodities during the first half of the year. However, the YoY decline has narrowed from a -5% range thanks to favourable cost prices seen in 4Q17, in line with the expected easing in average commodity cost exposure. Going forward, management expects a continuing positive reflection from this in FY18, further supported by the recovery of our local currency.

Stronger Ringgit a boon for the group. The group’s exports account for c.20% of total sales. However, given that c.50% of raw materials are imported, the group would be a beneficiary from the recovery of the Ringgit. Although this could spell lower export revenue for the group, management believes the emphasis on new product development could continue to result in growth for this segment.

Leaner operating spending? While management expects better gross profits from stronger sales backed by the recovering consumer sentiment coupled with easing production costs, management will continue to invest in operational streamlining initiatives for longer term sustainability. Recall that the group had also invested in the construction of a new distribution facility which should improve the national supply chain. Furthermore, management intends to ensure its marketing presence remains aggressive. The added allowance from better margins could potentially expand the use of promotional rates for trade.

Going strong. The brand equity for the Nestle product portfolio continues to be the largest asset for the group. This is demonstrated by the group’s ability to register sales growth despite bleak consumer sentiment indicators. With the turnaround potentially insight, we believe NESTLE would be well positioned to enjoy a head start in growth trajectory ahead of their competitors, especially as a market leader in F&B products.

Post briefing, we made no changes to our FY18E/FY19E net earnings estimates.

Reiterate MARKET PERFORM and TP of RM114.30. Our valuation is based on a 32.0x FY19E PER which is in line with the stock’s 5-year mean at +0.5SD. We believe that investors may have already bought into the stock in anticipation of the better outlook ahead. However, with the surge in buying interest in the stock, dividend yields are currently less attractive at 2.4%/2.9% for FY18/FY19 (from +c.3% previously). Hence, we believe the positive have already been priced-in.

Risks to our call include: (i) lower-than-expected sales, (ii) higherthan-expected commodity prices, (iii) higher-than-expected operating expenses.

Source: Kenanga Research - 23 Feb 2018