INVESTMENT HIGHLIGHTS

• Commendable FY17 financial performance

• Optimisation initiatives cushioned the impact of higher costs

• Earnings to improve further in FY18, driven by a more aggressive marketing campaign

• Maintain NEUTRAL stance with unchanged TP of RM116.50

Commendable performance despite challenging environment. To recall, Nestlé Malaysia Holdings Bhd’s (Nestlé) 4QFY17 reported close to a +100%yoy growth in earnings to RM133.5m. Nevertheless, full year FY17 earnings rose at a modest pace of +1.4%yoy to RM645.8m Despite a resilient revenue growth of +4.0%yoy, earnings for FY17 were mainly impacted by high cost of sales contributed by the: (i) uptrend of commodity costs and; (ii) the weakening of Ringgit.

Optimisation initiatives resulted in costs saving. Nestlé has undergone aggressive operating efficiency initiatives implementation over the past two years. The company has implemented a quicker ordering process, more efficient logistic handling and a global procurement hub to leverage on its economies of scale. These ensure that the internal systems are more efficient to deliver cost savings. For instance, the simplification of its ordering process where the use of latest technology helped to increase automation and make the process twice as fast. This resulted in faster payment from customer. Such initiatives contributed to the decline in operating expenses of -9.7%yoy which partially buffered the +8.6%yoy increase in cost of sales.

FY18 earnings to grow at a steady pace. We expect a higher revenue growth for FY18 driven by a more aggressive advertising and promotional (A&P) expenses. Due to the recent stabilising commodity prices and strengthening Ringgit, more spending is expected to be channelled to A&P activities to boost customer purchase. We expect that the A&P expenses for FY18 will be significantly higher than FY17. In addition, effective tax rate is expected to be sustained at 21% going forward as most tax incentives such as the Halal tax incentives had been fully claimed. All in, we expect that earnings will remain at a steady state of growth in FY18.

Impact to earnings. No change to our earnings assumption at this juncture.

Maintain NEUTRAL stance with an unchanged TP of RM116.50. Nestlé’s price has risen approximately +21% since the public announcement of its inclusion into MSCI Malaysia and FBM KLCI Index in November 2017. Nevertheless, valuation is currently stretched with a forward PER of more than 40x in comparison to the average three-year PE of 28x prior to the inclusion. We believe that the improved earnings in the 4QFY17 and expectation of better earnings prospect in FY18 have been priced into the current valuation. We are maintaining our NEUTRAL call on Nestlé with an unchanged target price of RM116.50 per share. Our target price is based on dividend discount model with the assumption that required return on equity is of 5.0% and sustainable dividend growth rate of 2.4%.

Source: MIDF Research - 23 Feb 2018