Investment Highlights

• We maintain our UNDERWEIGHT recommendation on Nestle (Malaysia) with an unchanged FV of RM122.74 based on DCF valuation (5.3% WACC, 2.0% terminal growth rate). At RM122.74/share, the implied PE for FY19F is 39.6x.

• Recall that Nestle’s topline grew 1.6% YoY in 1QFY19 with an EBITDA margin of 25.2% (vs. 23.6% in 1QFY18). This was on the back of good commodity control and a far better performance of its national distribution centre (NDC), especially during the Chinese New Year festive period. We believe Nestle aims to re-emulate this for future festive seasons such as Hari Raya.

• Positively, Nestle has gained clarity from the authorities regarding the details of sugar tax. The impacted stock keeping units (SKUs) are much smaller than initially anticipated and has minimal impact on Nestle as canned beverages are a minor contributor to the group’s topline.

• The group has allocated circa RM90mil of capex in FY19 for its Chembong factory in Negri Sembilan to establish the factory as the world’s biggest Milo Manufacturing Centre of Excellence which allows Nestle to better allocate its resources to its more established brands and achieve economies of scales, further improving its margins. The group has spent circa RM20mil on the Chembong factory in 1QFY19.

• Nestle has launched a “Super Brand Day” on ecommerce website Shopee in 1QFY19. The joint marketing effort between Nestle and Shopee aims to strengthen the group’s online presence in Malaysia. Nestle has introduced the Nescafe cold brew sticks exclusively on Shopee. The company is prioritizing ecommerce in the long run as it slowly builds its presence and drive exposure as it is key to long-term relevance and sustainability of a company.

• As shown in Exhibits 1– 5, changes in raw material prices have been mixed. Comparing YTD with FY18, sugar and skimmed milk powder prices have increased 3.4% and 27.2% respectively. On the flip side, robusta coffee, arabica coffee and cocoa prices have declined by 10.7%, 13.8% and 1.1% respectively. Nestle is confident in its ability to manage its raw material procurement.

• We believe that the outlook for Nestle’s net profit in FY19F is upbeat. Although raw material prices may rise, this would be compensated by operational savings from the streamlining of the group’s supply chain. The impact of rising raw materials will be dampened by Nestle S.A. Group’s procurement hub in Malaysia. We anticipate FY19F and FY20F EBITDA margins to be 19.5% and 20.1% respectively.

• We like Nestle for its established presence, position as the market leader in the FMCG space and efforts to streamline its operations, which should translate into improved operating profit margins. However, as the company is trading at 51.4x PE which is close to 1.5SDs of Nestle’s 1-year forward PE of 46.2x, we believe that the stock is fully valued.

Source: AmInvest Research - 25 Apr 2019