INVESTMENT HIGHLIGHTS

• Disposal of chilled dairy business to Lactalis group for a cash consideration of RM155.3m

• We are supportive of the disposal as the chilled dairy business outlook is expected to be challenging

• Proceeds from the disposal to be invested to further expand the MILO business and pare down debts

• Maintain NEUTRAL stance with a revised target price of RM133.60

Disposal of chilled dairy business. Nestlé (Malaysia) Bhd (Nestlé) is disposing of its chilled dairy business to French dairy giant, the Lactalis group for a cash consideration of RM155.3m. The disposal comprised of the agreement to sell: (i) the business of manufacturing chilled dairy products and cold sauces; (ii) the packing of milk powder; (iii) manufacturing fixed assets used in these businesses and; (iv) its Petaling Jaya factory. Nestlé will record a one-off gain of approximately RM27.0m which is expected to be recognised across FY18 and FY19 as the disposal is expected to be fully completed by 1st of July 2019.

Challenging outlook for chilled dairy business. Historically, the chilled dairy business contributed about 2.0% of the group’s total revenue. The business comprises of drinkable and spoonable yogurt products mainly led by BLISS, BLISS PLUS, Nestlé Natural Yogurt and Nestlé Fat Free Yogurt (refer to Figure 1). For FY17, the business recorded a decline in revenue by -8.6%yoy to RM106.1m. We expect the outlook for the segment to remain challenging in view of the intense competition and rising raw material costs.

Reinvestment in MILO plant in Chembong. RM100.0m of the total proceeds will be utilised to: (i) further upgrade production facilities; (ii) improve operational efficiencies and; (iii) scale up capacity of MILO plant in Chembong in 2HFY19. These improvements will result in the plant becoming the biggest MILO Manufacturing Centre in the world which will help Nestlé to meet growing local and export demand. At present, the plant supplies MILO to the local market as well as exports to over 20 countries.

Remainder of the proceeds to be invested in paring down debts. The remainder of the proceeds of about RM50.0 will be used to reduce the bank borrowings and intercompany debts. Currently, Nestlé has total borrowings of RM607.2m. We estimate finance costs to be reduce by between RM5.0m to RM5.5m as a result of the reduction in borrowings.

Marginal FY19 downward earnings adjustment. As the acquisition is due to be completed by 1st of July 2019, we are making no changes to our FY18F earnings at this juncture. As for FY19F, we have adjusted our FY19 earnings downwards by –0.9% after taking into consideration the loss of earnings contribution from the chilled dairy business and lower finance costs. While we expect earnings to be slightly impacted in FY19 from the loss of earnings contribution from the chilled dairy business, we expect that it will be mitigated by positive earnings accretion contributed by improvement in: (i) operating efficiencies and; (ii) capacity of MILO production in Chembong. Premised on the latter, we expect future contribution from MILO to pace up the earnings growth of Nestlé from FY20 onwards.

Maintain NEUTRAL stance with a revised TP of RM133.60. All in, we are supportive of the group’s decision to exit the chilled dairy business as the segment outlook is expected to remain challenging. The move also allows Nestlé to focus on growing its key brands such as MILO. In the near term, we anticipate subdued 4QFY18 sales growth due to the temporary transition in spending after the end of tax-holiday period. Nevertheless, over a longer term horizon, we believe that the earnings growth to remain stable as : i) prices of its products will not be significantly different under the new SST; ii) continuous improvement in its market share and; iii) stabilizing prices of agricultural commodities such as sugar, cocoa and coffee beans. All in, we maintain NEUTRAL stance with a revised target price of RM133.60 (previously RM132.32). 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 - 10 Oct 2018