We walked away from Nestle’s analyst briefing, feeling slight positive on the group’s outlook given i) sustained growth in domestic product demands, ii) launch of new products specifically “Starbuck At Home”, and iii) establishment of MILO Centre of Excellence in existing Chembong Plant. These factors are expected to cushion the impact of i) rising soft commodities prices and ii) volatile exchange rate. However, we believe the valuation is rich at the moment. Hence, maintain Hold.

Fortifying Brand Equity in the Heart of Consumer

The group places great amount of focus on building brand equity, which is critical for sustainable growth. This is done by embracing various cultures, empowering people and exciting the consumers through innovating new products. For instance, MILO Breakfast Day is one the key event that Nestle has successfully organised to engage and build relationship with Malaysian consumers. As for products innovations, the group has an amazing R&D team to innovate new products. In 2QFY19, the group’s new product launches include NESCAFÉ GOLD, MAGGI Pedas Giler Seafood, MAGGI Pedas Giler 2X Ayam Bakar, LA CREMERIA Summer Berries Yogurt, etc. While these products are meant to cater towards a wider range of consumers, we note that it is also an initiative, which the group strategically takes to ride on the trend of premiumisation. We find these measures effective as reflected by 1HFY19 domestic growth of 4.1%.

Nestle-Starbuck Coffee being the New Thing

Recall that global coffee alliance between Nestle and Starbuck was formed in August-2018. We are excited that after one-year period since the formation of alliance, products of the alliance are finally arriving Malaysia and Singapore. Nescafe and Nespresso have been one of the most iconic coffee brands consumed in Malaysia and Singapore (estimated to be c.15-20% of group’s revenue). 11 new products under “Starbucks At Home” range was introduced which include signature Starbuck blends and single-origin coffee, as well as selection of classic beverages such as Caramel Macchiato and Cappuccino. With this line of Starbuck’s inspired coffee, we believe Nestle could help customers “replicate” their Starbuck experience at home; hence will further grow the in-home coffee markets. We gathered that the new line of Starbuck coffee products has garnered strong demand in other recently launched Asian market (Japan, South Korea, Hong Kong and Taiwan), thus also expect positive performance in Malaysia. Note that, Nestle has the perpetual rights to market Starbucks’ products (excluding ready-to-drink products) outside of Starbucks location.

Completed Divestment of Chilled Dairy, Now What?

Nestle has successfully completed its divestment of chilled dairy business to Lactalis Group in which the one-off gain of RM29.1mn has been captured (RM19.7mn in 2QFY19; and RM9.4mn in 4QFY18). While the gain may be oneoff, the balance payment of RM140.9mn, which has been received by Nestle on 1 July 2019 is expected to be put into good use. We believe this proceed would be used to support the expansion of Chembong Plant alongside reduce debts. This is in line with the group’s long-term sustainable growth plan as MILO is an integral segment in the business with strong domestic presence and export contributions. Recall that Nestle is allocating RM220mn as capex for FY19, where expansion in Chembong Plant is expected to utilise c.RM90mn of the full-year capex. Note that, c.RM60mn has been spent in 1HFY19 to facilitate various expansions and upgrades.

Higher Cost of Commodity and Exchange Rate Volatility

The group needs a wide basket of raw materials to support its extensive product range in which management noted that some commodities, specifically barley, wheat and milk powder are exerting upward price pressure to the basket of raw materials. In addition, volatility in exchange rate is also affecting cost of procurements.

Taking the indication from management alongside the slight weakness in 1HFY19 GP margin (-0.8%pts to 37.7%), we suppose near term GP margin may be narrower though would not be expecting huge negative surprises given that the group strategically hedge its commodity and foreign exchange position.

Impact

We make no change to our earnings forecasts.

Valuation

We believe the valuation for Nestle is rich at the moment, thus maintain Hold with unchanged target price of RM159.60/share based on DDM valuation (k: 6.0%, g: 3.0%).

Source: TA Research - 29 Aug 2019