We came away from NESTLE’s 1H18 results briefing feeling assured by their near-term prospects. Revenue looks to be supported by new product pipelines and recovering consumer sentiment. Near-term cost factors should ease thanks to better hedging positions while a new distribution centre should add to operating efficiency. However, rich valuations mean that the positives have already been largely factored in. Maintain UP and TP of RM132.55.

Steady sales. In the latest 1H18 results, group sales grew by 3% YoY following growth in both local and export markets. Domestic sales, which accounts for c.80% of NESTLE’s top-line, looks set to continue expanding with: (i) turnaround in consumer spending, and (ii) new launches of convenience Ready-to-Drink products. The group may also be poised to benefit from higher spending in 3Q18 from the “taxholiday” during the period. However, management is confident that the Nestle brands could achieve sustainable organic growth, regardless. Additionally, management attributed c.90% of 1H18’s sales expansion to volume growth.

Minimal need to increase prices with SST. Management does not expect major increase in prices following the implementation of the coming SST. This is led by the group’s primary focus to enhance operating efficiencies and savings, which would make up for any significant losses on margins, which may occur from the reintroduced tax.

Input costs environment to be stable in the near-term. Recall that in 2H17, gross profit margin recorded at 35.1%, a decline from 38.9% in 1H17. This was led by poorer raw material purchasing during that period, affected by high forex exposures and untimely hedges. Management foresees a more positive landscape for the rest of the year as they have secured more favourable positions. This should sustain the group from any short-term spikes in commodity prices. Recall that c.50% of the group’s raw materials are imported.

New National Distribution Centre up and running. In the recent quarter results release, the group explained that it had incurred a onetime relocation expense to operate the new facility. Expected to cost up to RM10.0m, this marks the beginning of the group to achieve better economies of scale in their distribution and logistics management. Further savings may be reaped in the medium-term as a fully optimised operation will enable the group to manage its entire domestic supply chain via in-house resources.

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

Maintain UNDERPERFORM with an unchanged TP of RM132.55.

Our valuation is based on a 37.0x FY19E PER (at +1.0SD over 3-year mean PER, applied across large cap F&B stocks). We believe most positives have already been priced in following its stretched valuations post-inclusion into the key benchmark index. In addition, its dividend yields are less attractive at present price levels, generating 2.0%/2.4% for FY18/FY19.

Risks to our call include: (i) weaker-than-expected sales, (ii) unfavourable commodity prices, and (iii) higher-than-expected operating costs.

Source: Kenanga Research - 16 Aug 2018