• 3QFY18 earnings (+15.7%yoy) was primarily lifted by relocation of its distribution centre and tax holiday spending

• Subdued 4QFY18 earnings expected post tax holiday season

• Continuous focus on product innovation and enhancing operating efficiency to support future earnings growth

• Maintain NEUTRAL stance with a revised target price of RM131.70

One-off events boosted 3QFY18 earnings. To recall, Nestlé (Malaysia) Berhad’s (Nestlé) 3QFY18 revenue rose by +8.3%yoy while earnings rose by +15.7%yoy. The management attributed the strong quarterly earnings to one-off effects from the move to the new distribution centre in Sijangkang resulted in one month delay in sales of RM25.0m from June 2018 (Q2) to July 2018 (Q3); and improved consumer spending resulting from tax holiday. In addition, earnings grew as a result of successful innovation particularly for the Maggi Noodles range where strong growth was recorded following the introduction of ‘Pedas Giler’ variety and external factor of the lower raw materials price.

Continuous focus on enhancing operating efficiency. In the immediate term, we believe that 4QFY18 earnings will moderate due to: (i) the temporary transition in spending after the end of tax-holiday period; (ii) expected recovery of raw material prices specifically corns, grains and milk powder; (iii) loss of revenue contribution from chilled dairy business; and (iv) higher effective tax rate as a result of full utilisation of Halal tax incentive. Nonetheless, we believe that Nestlé’s recent disposal of its chilled dairy business and channelling the proceeds on upgrading its Milo plant in Chembong will further improve its operating efficiency. Given that Milo is Nestlé’s biggest product category, upgrading Chembong plant’s production facilities and capacity will help it achieve economies of scale.

Impact to earnings. Post analysts’ briefing, we are revising our FY18F and FY19F marginally downwards by -2.9%.and -2.0% respectively. This is mainly premised on higher raw material prices such as corns, grains and milk powder.

Target price. We revised our target price to RM131.70 per share (previously RM133.60). 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%.

Maintain NEUTRAL stance. 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 SST; ii) continuous effort to expand its market share and; iii) economies of scale achieved from focusing on core brands namely Milo, Maggi and Nescafe. As such, we are maintaining our NEUTRAL call on Nestlé.

Source: MIDF Research - 1 Nov 2018

Nestlé (Malaysia) Berhad - 4QFY18 Earnings Growth to Trend Lower