• Management remains committed to maintain product prices

• FY17’s revenue will continue to grow, albeit at a slower pace than that of FY16

• Profit margin to remain stable

• Drop in 4QFY16’s earnings due to higher operating expenses

• Low effective tax rate to continue at least until 1QFY18

• Continue growing its e-Commerce channel

• Reaffirm NEUTRAL with a revised TP of RM81.56

Management remains committed to maintain product prices. Nestlé remains committed to maintain product prices. In fact, for some of its product, prices post-GST was lower than pre-GST implementation. Moreover, as the Malaysian’s F&B market has been sombre since the last two years, growing market share is the only way to increase business for manufacturer as well as retailers. In such environment, increasing prices might lead to Nestlé losing its 15.2% market share. Hence, Nestlé will continue to focus on increasing volume to spur revenue growth.

FY17’s revenue will continue to grow albeit at a slower pace than that of FY16. Management is expecting that revenue will continue to grow in FY17 as consumer confidence has started to normalise. To recall, revenue growth for FY16 of +4.7% was driven by the domestic sales and export growth of +3.3% and +9.6% respectively. As of FY16, revenue for domestic and export sales accounted for 80% and 20% of total revenue respectively. The high export growth in FY16 was mainly due to the new product launches in its ready-to-drink segment which gave Nestlé a broader product mix to sell to more countries. Going forward, management guided that the export growth will remain solid but not as high as FY16 level. Taking this into account, we expect that FY17’s revenue will grow at 4.1%.

Profit margin to remain stable. The gross profit (GP) margin for 4QFY16 contracted marginally by -1.8ppts to 36.6%. The decline was driven by the high commodity prices mainly coffee bean and milk powder which was partially mitigated by Nestlé’s hedging in foreign exchange exposure. In addition, operating expenses for FY17 is expected rise due to the increase in e-commerce marketing expenses as well increase in overall cost of doing business. However, these increases are expected to be compensated by the ongoing operational efficiency initiatives.

Low effective tax rate to continue to at least until 1QFY18. Nestlé has been benefiting from a lower effective tax rate. In FY16, the effective tax rate decreased by -1.9ppts to 16.9% as the group was able to capitalize on accelerated capital allowance for investment in some of its production facilities until 1QFY18. As of current, the group is still in discussions with the government for further tax initiatives beyond 1QFY18.

Capex between RM103m-RM180m. Management guided that the capex for the next 3-4 years will be between RM130m to RM180m. As there will be one specific investment in FY17 which focuses on distribution segment, we expect that FY17’s capex will fall at the higher end of the range given.

Continue growing its e-Commerce channel. Revenue from e-Commerce grew from RM3.5m in FY15 to RM10.8m in FY16 (+309%). The tremendous growth was as a result of the tie up with key eRetailers such as Lazada from October 2016. The group aim to deliver RM30m revenue from e-Commerce channel in FY17 through brand building and acquisition programme via retailer’s digital platform. However, at this juncture, the contribution from e-Commerce channel is still less than 1% of total revenue.

Impact to earnings. We are revising upwards Nestlé’s earnings in FY17 by +3.6% premised on: (i) the expectation of stable margin despite the expectation of higher commodity prices as we believe that Nestlé has adequate measures in place to offset the increase and; (ii) the lower tax rate assumption of 18%at least until FY18.

Reaffirm NEUTRAL with a revised TP of RM81.56. We are maintaining our NEUTRAL call on Nestlé with a revised target price of RM81.56 per share (previously RM82.68 per share). Our target price is based on dividend discount model using the assumption that required return on equity of 5.70% and sustainable dividend growth rate of 2.11%.

Source: MIDF Research - 2 Mar 2017