This article first appeared in The Edge Financial Daily on November 2, 2018
Nestle (Malaysia) Bhd
(Nov 1, RM143.50)
Maintain neutral with a lower target price (TP) of RM131.70: One-off events boosted third quarter of financial year 2018 (3QFY18) earnings. To recall, Nestle (Malaysia) Bhd’s 3QFY18 revenue rose by +8.3% year-on-year (y-o-y) while earnings rose by +15.7% y-o-y. The management attributed the strong quarterly earnings to one-off effects from the move to the new distribution centre in Sijangkang, Selangor, which resulted in the one-month delay in sales of RM25 million from June 2018 (2Q) to July 2018 (3Q); and improved consumer spending resulting from the tax holiday. In addition, earnings grew as a result of successful innovation, particularly for the Maggi Noodles range where strong growth was recorded following the introduction of the “Pedas Giler” variety and external factor of lower raw material price.
Continuous focus on enhancing operating efficiency is seen. In the immediate term, we believe that 4QFY18 earnings will moderate due to: i) the temporary transition in spending after the end of the tax holiday period; ii) expected recovery of raw material prices specifically corn, grains and milk powder; iii) loss of revenue contribution from chilled dairy business; and iv) higher effective tax rate as a result of full utilisation of the halal tax incentive. Nonetheless, we believe that Nestle’s recent disposal of its chilled dairy business and channelling the proceeds to upgrading its Milo plant in Chembong, Negri Sembilan, will further improve its operating efficiency. Given that Milo is Nestle’s biggest product category, upgrading the Chembong plant’s production facilities and capacity will help it achieve economies of scale.
Post analysts’ briefing, we are revising our FY18 forecast (FY18F) and FY19F marginally downwards by -2.9%.and -2% respectively. This is mainly premised on higher raw material prices such as corn, grains and milk powder.
We revised our TP to RM131.70 per share (previously RM133.60). Our TP is based on the dividend discount model with the assumption of required return on equity of 5% and sustainable dividend growth rate of 2.4%.
In the near term, we anticipate subdued 4QFY18 sales growth due to the temporary transition in spending after the end of the tax holiday period. Nevertheless, over a longer-term horizon, we believe that earnings growth would remain stable given: a) prices of its products will not be significantly different under the sales and service tax; b) continuous effort to expand its market share; and c) economies of scale achieved from focusing on core brands, namely Milo, Maggi and Nescafe. As such, we are maintaining our “neutral” call on Nestle. — MIDF Research, Nov 1