We came away from NESTLE’s 1Q19 results briefing feeling assured of its near-term prospect. While its export numbers saw pressures from the phasing out of certain products, domestic numbers remain supported by a solid brand portfolio. Production costs should be kept in check from hedging contracts while operating costs could be leaner from improving efficiencies. Maintain Market Perform and TP of RM137.00.

Revenue supported by domestic demand. 1Q19 sales only saw a YoY growth of 2%. However, this was on the back of a 4% growth in domestic sales against a 7% drop in export demand. Their contribution makes up 82% and 18% of the sales mix. Management indicated that the fall in exports was due to the phasing out of certain products. On the other hand, local demand remains strong, fed by constant product innovations to keep consumer interest strong.

Running costs in check. As compared to 1Q18, gross profit margin and operating margin registered better performance, at 39.2% (+0.1ppt) and 22.2% (+1.0ppt). Stable production cost was sustained by timely hedging policies while operating expenses eased from leaner distribution expenses from the group’s new National Distribution Centre (NDC) and with marketing costs seeing more effective execution. In the near term, we believe that there could be further improvements in margins as downward commodity trends could spell lower input costs, on top of the recent NDC which was only recently commissioned in 2H18 to further drive cost savings.

Heavier investments for the year. Management guided an earmarked capex allocation of RM220.0m for FY19. A large proportion of this is for the consolidation of the Milo production facilities in Chembong, funded by the disposal of the group’s Chilled Dairy business. While the plan premised on the expansion of the group’s Milo production capabilities and to improve its economies of scale, we believe the initiative could only result in meaningful earnings contribution in the medium term given the time needed to optimise operation.

Post-briefing, we leave our FY19E/FY20E earnings unchanged.

Maintain MARKET PERFORM and maintain TP of RM137.00. Our call is based on an unchanged 42.0x FY20E PER, closely in line with the stock’s +1.0SD over its 3-year mean. While the overall outlook for the stock appears positive on upbeat revenue drivers, effective cost management and solid brand equity amongst consumers, the stock persistently commands very steep valuations. This is possibly attributed by the defensiveness of its business model and positioning as one of the very few large cap F&B stocks, as well as being a FBMKLCI index member, warranting above-mean valuations for now. However, the low dividend yield of 2.2% may be unappealing to certain investors. Additionally, NESTLE being already the market leader in a highly saturated industry, its earnings growth may not be as exciting as compared to other stocks,

Risks to our call include: (i) stronger/weaker-than-expected sales, (ii) more/less favourable commodity prices, and (iii) lower/higher-thanexpected operating costs.

Source: Kenanga Research - 25 Apr 2019