Nestlé Malaysia unfazed by equity ‘sugar rush’

This article first appeared in The Edge Malaysia Weekly, on April 9, 2018 - April 15, 2018.
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WITH its shares soaring to new record highs since April last year, Nestlé (M) Bhd is now the most expensive stock on Bursa Malaysia in terms of absolute value.

At Tuesday’s closing price of RM150, the stock was trading at a price-earnings ratio of 48.97 times 2018 forecast earnings — higher than the broader market. By comparison, the FBM KLCI was trading at 16.42 times 2018 estimates.

Led by the sharp rise in its share price, the Swiss food and beverage (F&B) giant’s market valuation has gained a whopping RM16.56 billion in just one year.

If an investor had bought 1,000 Nestlé Malaysia shares at RM79.40 each a year ago and held on to them, his investment of RM79,400 would have earned him a total return of 42.9% or RM70,600 as at last Tuesday, excluding dividends for the year of RM2.75 per share.

To take or to leave the profit is the question shareholders are asking themselves. Do the shares have further upside?

Four analysts tracked by Bloomberg are advising their clients to sell the stock while seven have a “hold” call on it. None recommend buying the stock.

CEO Alois Hofbauer points out that Nestlé Malaysia’s share price has almost tripled since he took the company’s helm on Feb 22, 2013, when the stock was trading at around RM57.

The 52-year-old Austrian opines that the company’s strong performance is reflected in the share price’s upward trend, which, in turn, reflects investors’ optimism about its growth prospects.

Nestlé Malaysia delivered another record net profit and revenue last year, mainly driven by volume growth and efficient cost controls.

For the year ended Dec 31, 2017, its net profit rose 1.4% year on year to RM645.8 million on revenue of RM5.26 billion, which was up 3.9%. This was Nestlé Malaysia’s third consecutive year of record profit.

The company also maintained its lead in the local F&B market, commanding 15.5% of it last year, up from 14.3% in 2014.

“The year 2017 was good for us amid a challenging environment, given the higher commodity prices and a weakened ringgit. We grew close to 4% (in revenue) even though the market was flat at about 1%. Also, our domestic sales, which account for 80% of our overall sales, grew faster than our exports,” Hofbauer tells The Edge.

He does not expect the operating environment to be any easier this year, but believes the company could continue to deliver earnings growth, given its track record. However, he stopped short of giving his guidance for Nestlé Malaysia’s performance this year as it is a public-listed company.

“What I can say with certainty is that the way we have improved ourselves over the years and put our strength in place, and also with our track record, we are [well equipped] to take advantage of an upswing, but even better, we can weather any storm.

“Already, we are delivering good growth in challenging times, which means when the times get a little bit easier, we can grow much faster.”

Improving consumer sentiment and new product offerings are two major factors that Hofbauer sees driving the company’s growth this year.

Like previously, the company is looking to launch 30 to 40 new products this year. However, Hofbauer notes that the number of new offerings really does not matter to him as he attaches more importance to the size of their contribution.

“I don’t measure our success by the number of products launched but by the contribution of these new products to our overall sales growth. For me, I want around 10% of our sales to come from new products and (launching) 30 to 40 products would more or less give us that percentage,” he says.

Last year, Nestlé Malaysia saw its gross margin decline by 2.7 percentage points to 36.7% mainly due to higher raw material prices. The company expects higher volume and efficiency in its operations to offset the decline in gross margin this year.

“Now that the prices of raw materials are falling and the ringgit is stronger, this should be good news for us,” Hofbauer says. Year to date, the local currency has recovered 3.8% to 3.865 against the greenback.

Still, Hofbauer has concerns about the ringgit and world economic volatility this year. “Even though the ringgit has recovered against the US dollar, it is still not at the level it was when I took over as CEO five years ago. At the time, the ringgit was trading at 3.20 versus the US dollar.”

Another of Hofbauer’s worries is global economic volatility, which has an impact on commodity prices. “We have three big buckets of commodities that we are watching very carefully. They are milk powder, wheat flour and cocoa.”

But he notes that the cost of goods is only part of the whole equation.

“Firstly, we not only buy our raw materials on a big scale but we also hedge on commodities and currencies. Our hedging positions could be anything from one month to one year as we see fit.

“Secondly, we continuously work on making our internal systems more efficient to deliver the savings needed as part of our three-pillar FIT strategy. This allows us to mitigate any fluctuation in commodity prices,” he adds.

This “fuel to grow” pillar enabled the company to save RM195 million last year, bringing the total savings since the inception of the FIT strategy in 2013 to RM843 million. The other two pillars are “innovate to grow” and “transform to grow”.

Hofbauer says the FIT strategy has worked well for the company, which has seen its profits grow year on year since the strategy was introduced, except in 2014 when it was affected by the weak performance of its exports to affiliated companies. The situation was compounded by the fact that the Philippines and Indonesia invested in local manufacturing facilities for products previously imported from Malaysia.

Hofbauer also notes that the company continues to invest strongly in marketing and promotional activities each year. “We have increased our overall marketing spend by more than 50% to RM1.2 billion, up from RM800 million five years ago.”

On parent Nestlé SA’s decision to set up a global procurement hub in Malaysia last year, Hofbauer says it has benefited Nestlé Malaysia as it enables the company to enjoy better prices and better quality raw and packaging materials on a consistent basis. Known as Nestrade SA, the hub is completely separate from the Nestlé Malaysia business.

On its part, Nestlé Malaysia is opening the group’s biggest state-of-the-art warehouse in Asia in Klang in the middle of this year. With a built-up area of 515,000 sq ft, it will be used by Nestlé Malaysia as a distribution centre.

“The warehouse is on a lease basis from Axis Real Estate Investment Trust and so, the capital expenses are minimal,” says Hofbauer.

Nestlé Malaysia invests roughly RM200 million per year in capital expenditure. According to Hofbauer, it will be about the same amount this year. “We plan to invest in our confectionery and culinary businesses to enhance our industry footprint, which will give us additional volume.”

On its plan to raise the prices of its products this year, Hofbauer estimates an increase of 2% to 3% on average across the board. “Obviously, that’s a last resort. We try to create efficiencies around our costs, but sometimes it [price increase] is unavoidable. If any, it will be very moderate.”

As one of the hottest stocks on the market as well as the priciest, Nestlé Malaysia is an easy target for those advocating more stock splits. However, Hofbauer says there are currently no plans to do so.

In January, the company had to deal with bad publicity after a video on the sugar content of the popular chocolate malt drink, Milo, went viral. However, Nestlé Malaysia successfully turned the crisis into an opportunity.

“The good news is that it gave us an opportunity to communicate facts, for example, that a cup of Milo contains only one teaspoon of sugar, with our consumers via social media. Milo sales, believe it or not, were very good in the first quarter of the year. Its market share has gone up,” says Hofbauer.

On e-commerce sales through online platforms such as Lazada, Shoppee and 11 Street, Hofbauer says they are growing at an accelerated rate. “Last year, [e-commerce] sales tripled and we expect sales to triple again this year. At some point, we expect this segment to become a RM500 million business for us, which is significant. And this is not going to take many years. I think this is going to happen much faster than we think.”

Today, e-commerce sales contribute 1% to the company’s total sales. Hofbauer believes a 10% contribution is “not far away, potentially in five years’ time”.

“We now have around 15% to 16% market share of online grocery sales. Our e-commerce sales make up about 30% of the online F&B market, which is double that of our physical market share,” he says.



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