INVESTMENT HIGHLIGHTS

• Gross profit is expected to improve in coming quarters as benefit from lower commodities price kicks-in

• Nevertheless, earnings growth will be partially mitigated by higher A&P expenses and higher effective tax rate

• Better earnings prospect in FY18 have been priced into the current valuation

• Maintain NEUTRAL stance with a revised TP of RM132.32

Gross profit is expected to improve in coming quarters. To recall Nestlé recorded a marginal earnings growth of +0.2%yoy to RM231.2m for 1QFY18. This is within management’s expectation as the group is yet to benefit from a lower cost of sales as agricultural commodity prices have been stabilising and Ringgit has strengthen against the USD. In the coming quarters, gross profit is expected to improve as higher value inventories had been cleared off.

Earnings will be impacted by higher A&P expenses and taxes. While we expect future earnings to improve, its growth is expected to be partially mitigated by: (i) higher projected advertising and promotional (A&P) expenses in FY18 compared to FY17 to take advantage of the improving consumer sentiment and; (ii) higher effective tax rate of 22-23% as the Halal tax incentives had been fully claimed.

Impact to earnings. We are maintaining our earnings forecast postanalyst briefing.

Maintain NEUTRAL stance with a revised TP of RM132.32. Nestlé’s valuation is currently stretched with a forward PER of 47x in comparison to the average three-year PER of 28x before the inclusion to both KLCI and MSCI Malaysia indices. We believe that the expectation of better earnings prospect in FY18 have been priced into the current valuation. We are maintaining our NEUTRAL call on Nestlé with a revised target price of RM132.32 per share (previously RM116.50 per share) as we roll forward our valuation base year to FY19. Our target price is based on dividend discount model with the assumption that required return on equity is of 5.00% and sustainable dividend growth rate of 2.4%.

Source: MIDF Research - 26 Apr 2018