This article first appeared in The Edge Financial Daily on April 10, 2018

Nestle (Malaysia) Bhd
(April 9, RM149.60)
Maintain sell with a target price (TP) of RM129.90: We believe Nestle (Malaysia) Bhd shares are fully valued at this level and therefore downgrade our call from “hold” to “sell” with an unchanged TP of RM129.90 per share based on dividend discount model (DDM) valuation. The bases of the downgrade in the stock call include: Nestle Malaysia shares are trading over 50 times price-earnings ratio (PER) and the dividend yield for financial year 2018 (FY18) is projected to be below 2.5%. We made no change to our earnings forecasts.

Taking into account the defensive quality of the stock, which would offer a safe haven in a volatile market before the 14th general election, and also the strength of ringgit movement and the downward trend in the skimmed milk powder price (-9.5% year-on-year to US$1,849 or RM 7,156 per tonne), we selected Nestle Malaysia as one of our stock picks for 2018 on Dec 8, 2017, when the share price was RM102.40.

Last Friday, Nestle Malaysia’s share price closed at RM149 after hitting its all-time high of RM163 in mid-March. It has advanced about 44.4% year-to-date (YTD) and is currently trading at 46.2 times FY18 earnings. We find that this is a huge premium to Nestle Malaysia’s three-year historical PER of an average of 28.9 times. Furthermore, Nestle Malaysia is relatively expensive if we compare it with its sister companies listed on other stock exchanges, suggesting that foreign investors may likely take profit on Nestle Malaysia and switch to other cheaper Nestle stocks in other countries.

Apart from the PER level, a peer comparison indicates that Nestle Malaysia’s earnings per share (EPS) growth is 4.7 percentage points (ppts) higher than other Nestle companies’ average of 12.3% for FY18, while in terms of return on equity (ROE), Nestle Malaysia’s value is more than double the average ROE of all Nestle companies (52.7% for FY18). Recognised as a stable dividend stock, the Nestle group of companies has an average projected dividend yield of 3% for FY18. However, at the current share price, Nestle Malaysia’s FY18 dividend yield is projected to be only 2%, which is 1ppt lower than its sister companies.

Nestle Malaysia is projected to pay dividends of RM3 per share for FY18, representing a yield of 1.9% based on its closing price in March 2018, 2ppts lower than 10-year Malaysian Government Securities’ yield of 3.95% as at end-March 2018.

The compressing level of dividend yields caused by share price increases is reducing the stock’s attractiveness as a safe haven. Local investors should opt for other stable and low-risk investments in Malaysia, such as fixed deposits, bonds or even other undervalued dividend stocks. All in, we believe the relatively high PER and compressed dividend yield of Nestle Malaysia suggest that investors are overpaying for safety. As such, we downgrade Nestle Malaysia from “hold” to “sell” with an unchanged TP of RM129.90 per share based on DDM valuation. — TA Securities, April 9