This article first appeared in The Edge Financial Daily on March 6, 2018
Nestle (M) Bhd
(March 5, RM127.90)
Maintain sell with a higher target price (TP) of RM97.60: During a recent briefing, Nestle (M) Bhd guided that financial year 2017’s (FY17) revenue growth of 4% year-on-year (y-o-y) was mainly driven by volume growth. We believe that Nestle should see higher revenue growth in FY18 supported by improvement in consumer sentiment and higher disposable income spurred by the strengthening of the ringgit and a favourable Budget 2018. Nestle’s continuous effort to launch new products should also help sustain its growth in tandem with the 4% to 5% growth in food and beverages (F&B) packaged food sales value in Malaysia. We are forecasting 16% earnings per share (EPS) growth on revenue and margin improvement.
The gross margin in 2017 declined by 2.7 percentage points (ppts) to 36.7% (versus 39.4% in 2016), mainly due to the higher raw material price hedged in the first half of 2017 (1H17) when raw material prices were still at elevated levels. Nevertheless, we saw quarter-on-quarter (q-o-q) recovery in gross margin in the fourth quarter of 2017 (4Q17). In light of the decline in the prices of key raw materials in 2H17, we expect sequential improvement in gross margin as Nestle’s raw material cost usually lags four to six months, due to hedging contracts. We forecast 2018 gross margin to improve to 39%. Recent strength in the ringgit against the US dollar is also positive for Nestle given that about 50% of its raw materials are imported.
We leave our FY18 estimate (FY18E) to FY20E earnings per share (EPS) unchanged, but change our valuation methodology from the dividend discount model (DDM) to discounted cash flow (DCF) to better reflect its earnings prospects in the medium term. As a result, we revise up our TP to RM97.60, which implies a price-earnings ratio of 30 times FY18E EPS. We maintain our “sell” rating on Nestle because we think that the current valuation of 39 times FY18E EPS (historical high) is overly stretched. While we still like Nestle for its solid brand name and the defensiveness of its business, we deem the 5% to 6% average earnings growth and dividend yield of 2% to 3% as unattractive for such valuation. — Affin Hwang Capital Research, March 5