We came away from NESTLE’s 1Q18 results briefing feeling assured by their solid growth trajectory. Consistent product development and marketing should support top-line performance, while bottom-line is buoyed by better margins from lower raw material costs. However, rich valuations mean that the positives have already been largely factored in. Maintain UNDERPERFORM and TP of RM114.30

Time for numbers to step up. In the latest 1Q18 results, group sales expanded by 4% to RM1.43b on the back of growth in domestic and export markets. In the near term, Malaysian sales are poised to benefit from the recent political campaigning season as public spending is expected to be higher. Consumer sentiment appears to demonstrate a steady recovery and management aims to capitalise with more resources allocated towards marketing spend as compared to FY17.

New innovations to lead top-line growth. The group introduced 30 new products into the market in FY17. Towards FY18, management maintains that new innovations and offerings are the key growth drivers in stimulating consumer demand. We are optimistic with this approach as it ensures that the Nestle brand consistently remains relevant and sensitive towards any changes in consumer’s preference and taste while maintaining the competitive edge.

Lower costs expectations. 1Q18 gross profits only increased by 2% owing to higher cost exposure to key commodities. While gross margins registered lower YoY changes for four consecutive quarters, we believe better results could be seen in the near future, particularly led by the stronger domestic currency. To recap, 50% of cost of sales is imported and denominated in USD. Nonetheless, we believe that noticeable improvement should only be experienced in 2H18 accounting for laggards due to hedging policies and inventory clearing. Although export value is expected to be dampened by stronger MYR, we believe volume growth trajectory is still intact backed by a solid product portfolio.

Still growing. The group recently disclosed that it commanded 15.5% of the total F&B market share in Malaysia in 2017, from 15.2% in 2016. We believe the group is likely to maintain its leading position in the long term as they continue to be entrenched into the daily lives of its customers supported by the strong market confidence in Nestle brands.

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

Reiterate UNDERPERFORM and TP of RM114.30. Our valuation is based on an unchanged 32.0x FY19E PER, which is currently in line with its 5-year mean. As the stock currently trades at an implied c.39.0x PER, we believe most positives could have already been priced in following its stretched valuations post-inclusion into a key market index. In addition, its dividend yields are less attractive at current levels, generating 2.1%/2.5% for FY18/FY19.

Risks to our call include: (i) stronger-than-expected sales, (ii) better- than-expected recovery in commodity prices, and (iii) lower-than- expected operating costs.

Source: Kenanga Research - 26 Apr 2018