We left Nestle’s analyst briefing yesterday feeling neutral about FY17 prospects on the back of i) normalizing level of CAPEX, ii) positive sales momentum and iii) continuous improvement in cashflow. Despite promising outlook for FY17, we have lowered our earnings forecast by 15.1% and 11.3% for FY17 and FY18 respectively taking into consideration the continuous increase in costs of sales and marketing expenses, which we expect to be offset by positive topline growth. Reiterate our BUY call with a lower TP of RM83.86/share based on DCF valuation.

CAPEX Level Normalizing

As we can see in figure 1, CAPEX level has been decreasing YoY from FY14 to FY16 by 47.1% and 35.6% YoY. Moving forward, management guided that the CAPEX level will be normalizing in between RM150mn – RM180mn for FY17 and FY18. CAPEX will be used for specific investments to improve on Nestle’s operational efficiencies i.e. centralised distribution centre for Nestle’s manufactured products. We believe that this is in line with Nestle’s FIT strategy to fuel, innovate and transform to grow the business. We are positive on this as it will benefit the operational efficiencies in the long run.

Sustainable Growth of Sales Domestically and Abroad

Nestle’s FY16 revenue improved by 4.7% YoY to RM5.1bn on account for increase in domestic sales and export sales by 3.3% and 9.6% respectively. This was also due to the launch of new products (coffee and Ready-To-Drink (RTD) based). Export sales improved following Nestle’s efforts in expanding its export markets to more than 50 countries now. We expect Nestle’s FY17 and FY18 total revenue to grow by 2.5% and 3.0% respectively on the back of 1) resilient demand, 2) launch of new products.

Moreover, according to the Department of Statistic Malaysia, the Consumer Price Index (CPI) for Food and Non-Alcoholic Beverages has increased to 127.2 (+4% YoY) in Jan-2-17. Note that sub-categories, which are applicable to Nestle’s products only experienced a CPI increase of less than 1%. Hence, it could further support Nestle’s sustainable turnover growth plan. Looking at the export sales, we believe weakening of Ringgit will create better margin of sales for exports.

Healthy Level of Cash Flow in The Past

Other than that, Nestle’s cash flow after investment improved YoY over the last three years (+8.4%, +12.4%, 43.5%/FY14, FY15, FY16). Management guided that this was due to remarkable improvement in trading capital due to extension of payment terms with the suppliers and this is without increasing the cost of capital of the suppliers. On the receivables end, given the current economic condition which caused tightening of cash level, Nestle is working closely with banks to mitigate this. We believe that Nestle will be able to negotiate for a lower financing rate for FY17 and FY18, therefore contributing to better expected PBT margin in FY17 and FY18 (est. 15.8% and 16.8% respectively). Note that current PBT margin stood at a solid 15.1% for FY16.

Outlook

We are positive that Nestle will be able to continue operating efficiently to be in line with the group FIT strategy for sustainable growth. Note that, Nestle is also exploring additional sales channel through eCommerce where sales target is set at RM30.0mn for FY17, which will account for less than 1% of total expected group revenue. Currently, this is only at its market testing phase so Nestle will be able to determine in the future on the best route-to-market for Malaysia. This goes to show that Nestle is leading the industry by fuelling, innovating and transforming the way consumers purchase their food and beverages.

While our short-term view that weakening consumer sentiment has an inelastic effect to the pricing of Nestle products. Therefore, we forecast that sales will be able to continue to grow on attributable to intense marketing and new product launches.

Valuation

Overall, given that FY16 results came in below ours and consensus expectations due to higher than expected marketing costs, we have lowered our earnings forecasts for FY17 and FY18 by 15.1% and 11.3%. But we maintain our BUY call with a lower target price of RM83.86/share (previously RM88.16/share) based on DCF valuation. Determinant factors to our call are i) attractive dividends trend, ii) positive upside and iii) highest market share for Nestle’s core products to sustain turnover.

Source: TA Research - 2 Mar 2017