We came away from NESTLE’s 9M18 results briefing feeling assured by their near-term prospects. Sales growth should be led by recovery in the domestic market while operational improvements could boost margins. We upgrade to MP with a TP of RM146.50 (from RM129.00) as we raise our valuations to 42.0x FY19E PER (from 37.0x) at a +1.5SD 3- year mean base.

Spreading the topline. In the latest 9M18 results, group revenue increased by 5% YoY, which management attributes primarily to better domestic performance. Underlying drivers could consist of: (i) wider product portfolio of flagship brands, and (ii) turnaround in consumer spending appetite and sentiment, namely from 2Q18 onwards. Going forward, while new innovations will be consistently introduced to inject vibrancy into consumer spending options and demand, the group also intends to improve upon the production and outreach of key brands.

This is seen in the disposal of the group’s chilled dairy segment (which contributed less than 3% of group sales) to consolidate resources in expanding the Milo plant in Chembong. With the expectation of better capacity, economies of scale and efficiency, management aspires for these gains to spill over to boost exports, particularly for Milo products. Exports account for c.20% of group sales. As the exercise is earmarked to be completed by 2H19, we anticipate any meaningful improvement to only be seen in FY20.

Keeping an eye out for costs. Recall that 9M18 gross margins registered at 38.6% (+1.3ppt YoY), backed by easing commodity costs and better product mix led by the progressively introduced premium product offerings (i.e. Maggi Bowls, specialised coffee RTDs). While further boons could still be enjoyed in the near-term, the normalisation of commodity prices as well as higher forex could undermine longer- term profitability. As such, management aims to minimise volatility in production costs through the continuous hedging of its raw materials, which could extend to positions of up to one year for certain items. It is anticipated that c.50% of the group’s raw materials are imported. In the meantime, we believe savings from operational streamlining exercises (most recently the commissioning of the new National Distribution Centre) could provide some buffer for any cost pressures to come.

Post-briefing, we made no changes to our FY18E-19E net earnings estimates.

However, upgrade call to MARKET PERFORM with a higher TP of RM146.50 (from UP and TP of RM129.00, previously). Our call is based on a higher ascribed valuation of 42.0x FY19E PER (from 37.0x, previously) which is closely in line with the stock’s +1.5SD over its 3- year mean (+1.0SD, previously) which we think is very generous in light of very thin dividend yields of 2.0-2.4% for a consumer counter and very steep FY18-19E PERs of 41.2-46.9x corresponding EPS growth rate of 11.4-13.7%. The persistency in steep valuations is largely attributed to the defensiveness of its business model and positioning as one of the very few large cap F&B stock, which is also an FBMKLCI index member, warranting above mean valuations for now.

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

Source: Kenanga Research - 01 Nov 2018