Nestle (M) Bhd
(Oct 29, RM67.70)
Maintain “outperform” with a target price (TP) of RM76.10: We came away from the analysts’ briefing hosted by Nestle’s management feeling more assured of its prospect with easing raw material prices acting as a near-term catalyst while the completion of its Sri Muda “ready-to-drink” (RTD) plant providing longer-term earnings impetus for both domestic and overseas markets.

During the briefing we were introduced to Nestle’s new finance director Martin Kruegel, who professionally interpreted the latest set of earnings results as well as expressed his optimistic view on the long-term prospect of Nestle Malaysia, which was in line with our “outperform” call on the stock.

We maintain our positive stance on Nestle with its TP unchanged at RM76.10, implying forecasted 26.1 times financial year 2015 (FY15) price-to-earnings ratio (PER), +1 standard deviation (SD) above its five-year mean.

The nine-month period in 2014 (9M14) results were diagnosed as positive by the management.

To recap, Nestle wrote RM452.1 million of net profit on the back of sales revenue amounting to RM3.7 billion for 9MFY14, which reflected a slight net profit decline of 2% despite a marginal 3.9% top line growth.

Despite the subdued local consumer sentiment on the back of a higher living cost environment, 9MFY14 domestic sales grew steadily by 5.8% year-on-year, in line with the group’s target of 5% to 6% of sustainable organic growth. Nestle attributed the commendable growth to a healthy mix of both volume and pricing increases, thanks to its aggressive marketing and promotional activities, which ramped up the operating costs by 3.9%.

The management revealed that export sales continued its downtrend with year-to-date decline of 13.1%, with contribution from export to total shrinking to 20.2% from 23.6% a year ago, as a result of weaker global economic outlook as well as the setting up of new plant in the Philippines and Indonesia; both more effective in terms of labour costs.

Moving forward, the management indicated that the focus would be on the local market as it provides better predictability as well as profitability as compared to the export market with the export price being fixed by the Nestle group based on its strict transfer pricing policy.

As for the higher labour costs as opposed to the neighbouring counterpart, the management highlighted the importance of productivity and efficiency enhancement in order to bridge the gap.

The management prudently highlighted the possibility of capital expenditure (capex) exceeding the RM320 million sum it guided initially due to the costs overrun in the Sri Muda RTD plant.

Besides, the group has also earmarked about RM10 million in order to mitigate the impact of water shortage by sourcing its own water supply.

We maintain our capex forecast of RM320 million in FY14 as we think that the excess could be phased out to FY15 which is within our FY15 forecast of RM130 million.

Meanwhile, dividend per share forecast of 255 sen (95% dividend payout ratio, 3.7% dividend yield) in FY14 is achievable as the heavy capex is funded by its borrowings with net gearing still manageable at 0.5 times, supported by its strong operating cash flow.

Reiterate “outperform” with unchanged TP of RM76.10. The TP is unchanged and pegged against 26.1 times to forecast FY15 earnings per share, representing +1SD five-year mean.

We continue to like Nestle for its: i) product portfolio with strong branding and non-discretionary in nature, which is more resilient against slow consumer spending; ii) state-of-the-art Sri Muda RTD plant, which will double the current capacity and drive the earnings growth moving forward; and iii) aggressive marketing strategy in order to counter the weak consumer sentiment. — Kenanga Investment Bank Research, Oct 29

This article first appeared in The Edge Financial Daily, on October 30, 2014.