NESTLE’s 1HFY22E earning came in broadly in-line with our forecast but exceeded consensus estimates. While we expect topline to be robust, courtesy of the economy being in the endemic phase, we remain cautious as input prices are likely to stay elevated, suppressing margins. Earnings estimates are unchanged but we lowered our TP to RM119.75 (DCF-derived based on a WACC of 4.9% and TG of 2%) to reflect a higher risk-free rate on a rising interest rate environment. Downgrade to UNDERPERFORM from MARKET PERFORM.

Met our forecast, beat the market. 1HFY22 PATAMI of RM375m met our expectation at 53% of our full-year forecast but beat market expectations at 62% of consensus full-year estimate. An interim DPS of 70.0 sen (implying a 44% payout) declared is broadly within expectation as NESTLE usually pays a bumper dividend in the 2H of the financial year.

1HFY22, topline grew 18% to RM3.3b as economies reopened. Domestic and export sales grew 14% and 36%, respectively, with domestic sales boosted by strong F&B and retail performances. F&B business grew 17% to RM2.8b, cementing its position as the largest topline contributor at 83%. GP margin saw a 2ppt erosion to 33% (vs. our assumptions of 34%) on account of the still elevated commodity prices and supply disruptions. However, EBITDA margin improved slightly by 1% on account of reduced Covid-19 related expenses. Nestle also introduced several new products that we believe had helped to improve margins. PATAMI ended 19% higher to RM375m as the impact of Cukai Makmur was milder than expected, at 29% vs. our estimate of 34%.

QoQ performance showed deterioration in both the topline and margins. 2QFY22 topline fell 3% sequentially to RM1.6b which we reckon was due to consumers tightening their belts as inflation ate into their disposable incomes. Likewise, 2QFY22 margins fell by 2-3ppt sequentially which we believe was due to NESTLE choosing to absorb part of the higher input costs.

Cautious outlook ahead. We are cautious on NESTLE’s outlook. We see downside risks to its topline growth and margins as consumers down trade, i.e. opting for cheaper brands or alternatives, while cost pressures remain with extended supply chain disruptions as well as a seemingly prolonged Russian-Ukraine war. Dairy prices, in particular, are expected to continue on an uptrend into 2023 as supply is only expected to catch up with demand by end-2023, according to expert opinion. Apart from concerns over the loss of market shares, we believe NESTLE has moral as well as ESG obligations not to excessively raise prices of its staple food products that make up the daily diet of the population.

Post results, we maintained our earnings estimates.

We revise down our valuation applying a DCF-derived TP of RM119.75 (RM136.50 previously) based on a WACC of 4.9% and TG of 2%. There is no adjustment to TP based on ESG of which it is given a 3-star rating as appraised by us. Downgrade to UNDERPERFORM.

Risks to our call include: (i) Normalization of food commodity prices, (ii) Stronger ringgit resulting in lower cost of imported raw materials.

Source: Kenanga Research - 29 Jul 2022