NESTLE's 9MFY24 results disappointed due to sluggish domestic sales and input cost inflation since end-CY23. Its 9MFY24 net profit plunged 27% YoY, as the company appears unable to effectively pass through the rising raw material costs, particularly with cocoa and coffee prices soaring. We cut our FY24–25F net profit forecasts by 20–8%, and trim our DCF-derived TP by 3% to RM111.65 (from RM114.90). We do not rule out a knee-jerk reaction to the weak quarterly print, but considering the silver lining that the company is already stating gradual improvement in consumer spending seen in end-3QFY24, we reiterate OUTPERFORM.

NESTLE's 9MFY24 net profit of RM375m missed expectations, coming in at only 63% and 60% of our full-year forecast and the full-year consensus estimate, respectively. The variance against our forecast came largely from weak domestic sales and increased raw material costs (e.g. cocoa and coffee).

It declared an interim dividend of 35 sen in 3QFY24, bringing 9MFY24 dividend to 105 sen (9MFY23: 140 sen), which appears unlikely to meet our full-year forecast. Hence, we cut our FY24–25F DPS to 195 sen (from 250 sen) and 250 sen (from 275 sen), respectively.

YoY, its 9MFY24 turnover dropped by 11% attributed to the decline in domestic sales as consumers curbed spending amidst inflationary pressures, though signs of gradual improvement emerged later in the quarter. Not helping either, was the lingering boycott of certain Western products due to the Middle East tensions. Its net profit dived by a steeper 27%, which we believe, due to its inability to fully pass on higher input costs, particularly from elevated commodity prices such as cocoa and coffee.

QoQ, its 3QFY24 top line declined by 5%, likely due to lower sales volume, we estimate, as customers shifted to more affordable alternatives following a 5% to 6% price hike on its best-selling products (i.e. Milo, Nescafe and Maggi tomato ketchup) starting from 1 Jul 2024.

Its bottom line fell by a sharper 9% due to eroded economies of scale resulting from lower sales volume. The company is holding a briefing on 25 Oct where we will have more colour on the revenue slippage.

Outlook. NESTLE expects gradual improvement in the near term, aiming for a return to growth by 1HCY25. Notably, its parent company NESTLE S.A. has revised its full-year sales growth target to 2.0% and adjusted its own EPS growth outlook to "broadly flat", while maintaining its plans to slow down on price hikes as consumers become more cost-conscious. Additionally, we opine profit margins are likely to remain under pressure due to high commodity prices, particularly for cocoa and coffee, driven by supply concerns. Nonetheless, NESTLE's extensive range of staple food products should help to mitigate some impact.

Forecasts. While 3QFY24 was weak, it was not unexpected due to normalised freight cost and lingering boycott effects. We trim our FY24F net profit forecast by 20% and a less harsh 8% to our FY25F earnings as NESTLE has stated that it has seen signs of gradual improvement in later part of 3QFY24.

Valuations. We also reduce our DCF-derived TP by 3% to RM111.65 (from RM114.90), based on an unchanged WACC of 5.2% 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).

Investment case. We like NESTLE for its strong brand and diversified product range, and the inelasticity in the demand for staple food products. However, recent experience has shown that it is vulnerable to downtrading by consumers amidst sustained elevated inflation. While it is a weak quarter, and knee-jerk reaction is likely, a dip in its share price may present an accumulating opportunity as we foresee earnings likely to improve from here. Reiterate OUTPERFORM.

Risks to our call include: (i) a significant rise in commodities prices, (ii) a weaker MYR leading to higher cost of imported raw materials, and (iii) consumers opting for more affordable alternatives as purchasing power declines or inflation worsens.

Source: Kenanga Research - 25 Oct 2024