NESTLE has reaffirmed in its post-results briefing that it anticipates a gradual improvement in domestic demand by 1HCY25, despite recent declines driven by sustained inflation that has reduced consumer purchasing power. We expect this recovery to be aided by government initiatives aimed at rising disposable income, including civil servant salary hike (effective Dec 2024), and an increase in the minimum wage (effective Feb 2025). We also draw comfort from the briefing that boycott impact is dissipating. While cost challenges remain, we believe these should be mitigated by topline recovery as demand improves steadily, albeit gradually. We maintain our forecasts, TP of RM111.65 and OUTPERFORM call.

We came away from NESTLE's post-results briefing feeling mildly positive on its prospects. The key takeaways are as follows:

1. Domestic demand to gradually improve by 1HCY25. NESTLE has revealed that the recent decline in demand is attributed to sustained inflation which is eroding consumer purchasing power. Despite these challenges, NESTLE anticipates a gradual recovery towards the end of this year, with a return to growth in 1HCY25. This recovery is expected to be supported by an improving economic environment, which we believe could be enhanced by government initiatives to increase disposable income; these include civil servant salary hike (effective Dec 2024), and the rise in minimum wage to RM1.7k (up from RM1.5k, effective Feb 2025). Additionally, the company is seeing a reduction in consumer hesitancy toward international brands.
2. Minimal labour cost impact from minimum wage hike. NESTLE has indicated that it sees no significant impact from the recent announcement on minimum wage hike (effective Feb 2025) as it is already paying well above the minimum wage rate.
3. Limited impact from sugar tax hike. As expected, NESTLE guided that the increase in excise duty on sugar-sweetened beverages to 90 sen per litre (up from 50 sen), starting Jan 2025 to have minimal impact. This is mainly due to: (i) all its powder products falling below the 33.3g/100g sugar threshold, and (ii) 97% of ready-to-drink products are under the 5g or 7g sugar limit.

Outlook. We expect consumer spending to remain soft until year-end but share similar view with management that FY25 should show sequential improvement. However, we opine that profit margins are likely to remain under pressure due to high commodity costs, particularly for cocoa and coffee, driven by supply concerns. Still, NESTLE's extensive range of staple food products and the recently strengthening ringgit should help to ease cost pressures.

Forecasts. Maintained. Based on our preliminary estimates (using data from latest annual report), if the ringgit strengthens by 10%, it may result in forex gain of about 1─2%.

Valuations. We also keep our DCF-derived TP of RM111.65, based on an unchanged WACC of 5.2% and TG of 2%. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 4).

Investment case. We like NESTLE for its strong brand and diversified product range, and the inelasticity in the demand for staple food products. However, recent experience has shown that it is vulnerable to downtrading by consumers amidst sustained elevated inflation. While the recent 3QFY24 was a weak quarter, and knee-jerk reaction is likely, a dip in its share price may present an accumulating opportunity as we foresee earnings likely to improve from here. Reiterate OUTPERFORM.

Risks to our call include: (i) a significant rise in commodities prices, (ii) a weaker MYR leading to higher cost of imported raw materials, and (iii) consumers opting for more affordable alternatives as purchasing power declines or inflation worsens.

Source: Kenanga Research - 28 Oct 2024