KUALA LUMPUR: Nestle (M) Bhd sees a challenging year for the group amid a weak ringgit and softening consumer sentiment on the back of the implementation of the goods and services tax (GST), which will also see the prices of its products increase by between 3% and 6% next month.

However, the company is “cautiously optimistic” that it will be resilient and meet its target in the financial year ending December (FY15) by introducing more new products and upping its marketing activities.

Nestle (fundamental:1.35; valuation: 0.9) managing director Alois Hofbauer said the GST will lead an increase of between 3% and 6%  on the prices of its products and not a standard 6% across the board.

“The GST is going to have an impact on consumers. We have looked at what happened in Japan, Australia and Singapore, what we are going to see is the second quarter of this year will be adjusted.

“People will see prices go up. In all the markets which we looked into, it will take three to six months until it readjusts,” Hofbauer told The Edge Financial Daily in an interview.

He said that Nestle, which makes popular household brands such as Nescafe, Milo and Maggi, has a broad range of products subject to sales tax ranging up to 10%. With the implementation of the GST at 6%, some of the savings from lower tax compared to 10% sales tax previously will be passed back to consumers. 

As the domestic market accounts for more than 75% of Nestle’s total revenue, the weakening ringgit and expected slower consumer sentiment post-GST will make FY15 a challenging year for the company as well as the food and beverage manufacturing industry, said Hofbauer.

He said the group’s earnings consist of two components, the domestic market and exports to affiliated companies. In FY15, the group registered a turnover of RM4.81 billion, 0.4% higher than RM4.78 billion in FY13, mainly due to “nice growth of 4% in the domestic market”.

However, this increase was moderated by a decline of 11% to 12% in exports to affiliated companies.

“There are two reasons — first, as in many of the markets, the overall business environment was not conducive. Their orders had gone down. The second reason is that some of the markets, such as Indonesia, Vietnam and the Philippines, have opened their own factories and they are producing on their ground, so they are not getting from us,” he said.

Despite the loss in the export business, he said, Nestle managed to maintain profitability. “Which is very good,” Hofbauer quipped. 

After Nestle announced its financial results for the fourth quarter (4Q) of FY14 on Feb 23, which were considered below expectations, research houses have mostly maintained a “hold” call or downgraded the stock to “sell”.  Affinhwang Capital has downgraded Nestle to a “hold” due to uncertainties arising from the impact of GST.

Speaking to The Edge Financial Daily, the Affinhwang Capital analyst said that slower consumer spending post GST will have an impact on Nestle’s earnings in FY15 as the domestic markets contribute to about 80% of its earnings.

“We expect the group’s earnings to go down in 2015 before gradually picking up again in 2016/17 on the back of improved consumer spending,” she said, adding that Nestle’s export segment is set to stabilise as it has bottomed out.

The research house said although 4QFY14 earnings of RM98.3 million were 34.5% lower than 3Q’s, a careful study of the performance of the export segment showed a slight improvement sequentially, signifying that a bottom has been reached.  “It [export segment] will go up ... although not significantly,” the analyst said. 

For FY14, net profit slipped 2% to RM550.4 million from RM561.7 million in FY13.  The company paid a total RM2.35 dividend per share for FY14, the same as FY13, translating to a yield of 3.17% based on Nestle’s closing price of RM74 last Friday. Hofbauer also pointed to a few factors that have impacted the group’s operating costs, including the weaker ringgit, which has declined by 15.6% against US dollar since September last year. “We have favourable commodity prices but an unfavourable exchange rate, that makes it not easy for us,” said Hofbauer noting that a lot of raw materials used by Nestle are from overseas.

To remain competitive in this trying year Hofbauer shared Nestle’s strategies, which will involve the launching of new products and stronger marketing and promotional activities while continuing to invest in manufacturing capacity to support its growth. Nestle launched at least 10 new products last year, including the Royale Penang Seafood curry noodle and fried ice cream. New products so far this year include the premium Kit Kat and Nescafe Brent & Brew coffee.

Hofbauer said the new products have contributed growth to the company in 2014. Tapping into the convenient “on-the-go” food and beverage consumption trend, Nestle has invested in a new factory in Sri Muda, Shah Alam, to produce liquefied “on-the-go” products for the Malaysian and Asian markets. 

It has also begun the “More Value, More Goodness” promotion campaign, which offers consumers lower prices on a range of Nestle products, for the benefit of the middle and lower income group who make up a large component of its consumer base.

Nestle closed unchanged at RM74 last Friday, giving it a market capitalisation of RM17.35 billion.

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This article first appeared in The Edge Financial Daily, on March 23, 2015.