This article first appeared in The Edge Financial Daily on August 16, 2018

Nestle (Malaysia) Bhd
(Aug 15, RM146.10)
Maintain reduce with an unchanged discounted cash flow-based target price (TP) of RM97.40. Nestle recorded a core net profit of RM182 million in the second quarter of its financial year ended June 30, 2018 (2QFY18), bringing its first half financial year ended June 30, 2018 (1HFY18)’s core net profit to RM398.2 million, after stripping out forex gain, derivatives and write-off of receivables amounting to RM0.8 million, which was up 6% year-on-year (y-o-y).

This is in line with our and consensus expectations, making up 58% and 55% of the respective full-year forecasts. We deem this in line as the group’s 1HFY18 usually makes up an average of around 58% of its full-year numbers. Nestle also declared an interim dividend per share of 70 sen, in line with expectations.

The group’s 2QFY18 revenue increased 2% y-o-y to RM1.3 billion while core net profit expanded 15.9% y-o-y to RM182 million. The former was mainly supported by new product launches and effective consumer and trade promotions in addition to the Raya festivities.

Taken together with improved cost controls and efficient marketing trade investments, the group managed to chalk up a core net profit growth for the quarter under review. Accordingly, 2QFY18 earnings before interest, taxes, depreciation and amortisation margin also grew 1.4 percentage points y-o-y to 20.8%.

Demand for products remains healthy as Nestle’s 1HFY18’s topline rose 3.1% y-o-y to RM2.7 billion while core net profit expanded 6% y-o-y. The y-o-y revenue growth was attributed to better domestic and export demand, mainly driven by local festivities as well as continued marketing and trade support.

Despite an increase in operating costs due to the one-off expense incurred from the relocation to Nestle’s new distribution centre, the group managed to eke out a higher net profit on the back of lower production costs (that is lower raw material prices) and improved internal operating efficiencies.

We retain our earnings forecasts pending the company’s 1HFY18 analyst briefing due yesterday. Nestle is currently trading at 50 times and 47 times to its forecasted earnings for FY18 and FY19 respectively, which are five standard deviation higher than its historical five-year average price-earnings ratio. Even though we continue to like its defensive business model and strong brand name, we think the current valuations are unjustifiable. FY18-FY20F estimated dividend yields have also compressed to 1.9%-2.2% (from average of 3%-3.3% previously).

Any substantial spike in raw material costs (that is costs of milk powder, sugar and coffee beans) are potential de-rating catalysts. Upside risks to our call include stronger-than-expected export demand and a significant recovery in domestic spending. — CIMBCGS Research, Aug 14