INVESTMENT HIGHLIGHTS

• 1QFY17 performance driven by the FIT strategy which generated savings of RM197m

• Savings from improved efficiency to drive growth through strengthening of brand portfolio

• Company to continue to invest in CAPEX of approximately RM200m in FY17 despite the subdued consumer sentiment

• Reaffirm NEUTRAL with a revised TP of RM82.76

1Q17 performance driven by FIT strategy. Nestle’s good 1QFY17 performance is very much attributed to the FIT (Fuel, Innovation and Transform) strategy it introduced two years ago. The initiatives implement under the strategy ensured that the internal systems such as the procurement process are more efficient to deliver cost savings. In FY16, the savings generated from the such initiatives was RM197m. Due to the improved efficiency, the group manage to reduce the cost of sales which resulted in a higher gross profit (GP) margin of 39.9%, an increase of +0.2ppts yoy. This was achieved despite the adverse business environment of higher commodities prices and depreciating Ringgit. Going forward, the FIT approach will remain a core focus for the group especially in FY17.

Savings from improved efficiency to drive growth. The savings realised from the improved efficiency is reinvested into strengthening Neste’s brand portfolio to fuel its growth. For instance, in its confectionary business segment, the KitKat brand has a 20.2% market share in the Malaysian chocolate market in FY16 through new product innovation. In FY16, the contribution from new product innovation to revenue was quite sizeable at 10%. Hence, Nestle will continue to invest in CAPEX of approximately RM200m in FY17 despite the subdued consumer sentiment. Nevertheless, management admitted that some products have experienced increasing production cost and hence, prices for these products were increased to cope with the increasing cost. The percentage of price increase is expected to be at low single digit level.

Impact to earnings. We maintain our FY17 earnings estimates as the 1QFY17 result was very well within our expectation and we believe that the profitability margins will continue remain stable benefiting from the operating effiency level set in place.

Reaffirm NEUTRAL with a revised TP of RM82.76. We are maintaining our NEUTRAL call on Nestlé with a revised target price of RM82.76 per share (previously RM81.56 per share) as we roll forward our valuation base year to FY18. Our target price is based on dividend discount model premised on a required return on equity of 5.70% and sustainable dividend growth rate of 2.11%.

Source: MIDF Research - 27 April 2017