KEY INVESTMENT HIGHLIGHTS

• 9MFY24 results came in below expectations
• Weaker domestic sales impacted performance
• Challenging environment expected to persist in the near term
• Cut FY24-26F core earnings
• Maintain NEUTRAL with a lower TP of RM109.90 (from RM126.00)

9MFY24 results below expectations. Nestle Malaysia chalked in 3QFY24 revenue of RM1,446.2m (-5.1%qoq; -18.4%yoy) and core PATANCI of RM98.3m (+3.6%qoq, -46.2%yoy) which brought 9MFY24's sum to RM374.5m (-28%yoy). This missed ours and consensus forecast, at 53% and 66% of full year expectations respectively. The variance against our forecast was largely due to lower domestic sales. The Group declared an interim dividend of 35 sen, half of last year's 70 sen.

YoY, its 9MFY24 top line decreased by -11.4% driven primarily by weaker domestic demand exacerbated by inflation, which has eroded purchasing power. We believe the decline is also partly linked to the changing customer preference stemming from the Israel-Gaza conflict. Gross profit contracted by -11.8%yoy, largely due to higher input costs, particularly for key commodities like cocoa and coffee. Consequently, net profit fell sharply by -28%yoy, as the Group continues to face ongoing cost pressures and impairment losses on certain assets.

QoQ, revenue dipped by -5.1%, reflecting a slowdown in consumer demand due to abovementioned reasons. Net profit declined by - 8.7%qoq, driven by lower sales and increased cost pressures, although core PATACI managed a modest increase of +3.6% after adjusting for one-off items. This marks the second consecutive quarter in which Nestle's net profit has fallen below the RM100m threshold.

Revising earnings estimate down. Factoring in the weak set of results, our FY24-26F core earnings estimates are lowered by -26%/- 14%/-13% respectively. This was after factoring in (1) weaker consumer sentiment due consumer shifting toward local brands, as well as (2) slightly higher transportation and warehouse costs amidst cost pass- through from service providers.

Outlook. Taking into account the challenging conditions, Nestle expects market challenges to persist for the remainder of FY24, driven by weak consumer sentiment and inflationary pressures. Domestic sales are anticipated to remain soft as consumers exercise caution in their spending, prioritizing essential items. Additionally, we assume the ongoing Israel-Gaza conflict to still persists, further influencing consumer preferences and dampening Nestle's sales performance.

On a more positive note, we foresee that the normalization of major input ingredient prices-such as sugar, milk, and wheat-will help offset the continuously rising costs of cocoa, Arabica, and Robusta. This normalization could provide some relief to Nestle's margins moving forward. The company's strong market presence, anchored by core brands like Milo, Nescafe, and Maggi, is expected to offer resilience amidst these challenges as these products are still preferred by some consumer segment. Coupled with ongoing cost management efforts and a focus on innovation, we believe Nestle will be able to effectively navigate near-term headwinds. While FY24 is expected to remain challenging, we are optimistic that Nestle's sequential earnings in FY25 may benefit from increased spending momentum, spurred by recent cash handouts announced in Budget 2025, EPF Acc 3, civil servant salary hikes, and improved margins from a stronger ringgit. Consequently, we maintain a cautious stance while recognizing Nestle's resilience and long-term growth potential.

Maintain NEUTRAL with a lower TP of RM109.90 (from RM126.00). Our revised TP is based on DDM valuation with a consistent 3.2% growth and an unchanged WACC of 6.7%.

Valuation. Nestle is currently trading at an FY25F P/E ratio of 33.5x, which is below its two-year average P/E ratio of 46.3x.

Additionally, it offers a 2.3% dividend yield in FY24F. Downside risks include (i) a sudden increase in commodity prices, notably cocoa, coffee and dairy; (ii) surging energy costs which would disrupt the value chain; (iii) stronger USD against MYR exchange rates; and (iv) weaker-than-expected consumer demand due to macro-economic headwinds and consumer sentiments in line with geopolitical tensions, regulatory changes and inflationary pressures.

Source: MIDF Research - 25 Oct 2024