NESTLE’s 9MFY22 earnings missed our forecast on cost pressures but came in broadly in-line with consensus estimate. While we expect topline to be robust, courtesy of the reopened economy, we remain cautious as input prices are looking to stay elevated, suppressing margins with consumers likely to switch to cheaper alternatives if inflation persists. We cut our FY23F net profit by 10% and TP by 3% to RM115.65 (from RM119.75). Maintain UNDERPERFORM.

Below our, met market’s, expectation. 9MFY22 PATAMI came in below our expectation at only 69% of our full-year forecast but met market’s at 75% of full-year consensus estimate. The variance against our forecast came largely from higher-than-expected input costs in 3QFY22. A DPS of 70.0 sen was declared for the period, cumulating to a DPS of 140 sen (implying a 67% payout), broadly within expectations as NESTLE usually pays a bumper dividend in the 2H of the financial year.

9MFY22 turnover grew 18% YoY as economies reopened. Its domestic and export sales grew 14% and 34%, respectively, with domestic sales boosted by strong F&B and retail performances. Its F&B business grew 16%, cementing its position as the largest topline contributor at 83%. However, its EBITDA only grew 11% on account of the still elevated commodities prices, supply disruptions and a weaker ringgit, partially mitigated by reduced Covid-19 related expenses and improved operational efficiency, and the introduction of several high-margin new products like MAGGI Nutri-licious, KITKAT Bar Dark and HARVEST GOURMET Plant-Based Nuggets.

QoQ, 3QFY22 topline returned to the growth path with a 3% increase sequentially – a strong testimony that it had not priced its products out of reach of consumers. The flip side to this is its EBITDA plunging 29% as it chose to significantly absorb 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. Nestle is expected to raise its ASPs of certain products to cope with elevated input costs which could dampen demand. Meanwhile, commodities prices have eased in recent weeks which should alleviate margin pressures in FY23 but unlikely to retrace to their pre-Covid levels. On the other hand, dairy prices are expected to sustain its 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 cut our FY22F earnings by 10% but raise our FY23F earnings by 8% assuming commodities prices to ease while the ringgit strengthens. Correspondingly, we tweak our DCF-derived TP down by 3% to RM115.65 (from RM119.75) based on an unchanged WACC of 4.9% and TG of 2%. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 4). UNDERPERFORM reiterated.

Risks to our call include: (i) significant fall in commodities prices, (ii) a stronger ringgit resulting in lower cost of imported raw materials, and (iii) consumers switching to food products of higher quality as their spending power rises on easing inflation.

Source: Kenanga Research - 27 Oct 2022