This article first appeared in The Edge Financial Daily on August 30, 2019

Nestle (Malaysia) Bhd
(Aug 29, RM147)
Maintain sell with an unchanged target price (TP) of RM111: We attended Nestle (Malaysia) Bhd’s second quarter of financial year 2019 (2QFY19) results briefing and came away feeling neutral on the group’s prospects going forward.

Nestle will continue to introduce new product offerings to refresh its portfolio, which we expect to make up over 10% of total sales. In 2QFY19, new products by Nestle included the relaunch of Nescafe Gold Jar, Maggi Pedas Giler 2X Ayam Bakar, Maggi Pedas Giler Seafood, La Cremia Summer Berries Yogurt Ice Cream and Kit Kat (Popcorn Flavour). We are particularly positive on the new products launched recently, such as Milo Protein Up and Starbucks-branded coffee products, which have been well received by consumers so far.

Nestle plans to leverage its global alliance with Starbucks by selling the latter’s branded in-home coffee products, which include ground coffee beans and coffee pods. Note that Malaysia is the first country in Southeast Asia in which Nestle has introduced Starbucks-branded coffee. We are positive on the introduction of premium offerings as we understand that they command better margins than core products.

Nestle has guided that while it has locked in commodity costs for the remainder of FY19, it expects to incur slightly higher raw material prices this year. Lower coffee and palm oil prices are expected to be more than offset by the rising prices of other key commodities, such as barley and wheat. Nestle has shared that the reason for the higher barley and wheat prices were due to a drought in Australia, which had reduced availability of these commodities.

Export sales declined 7.2% for the first half (1H) of FY19 (versus 1HFY18), which then prevailed into July and August. Note that in total, Nestle exports to approximately 50 countries given its reputation as a producer of halal-certified products and Malaysia’s proximity to other Asean neighbours. Historically, export sales make up approximately 20% of the group’s total sales.

We expect the introduction of innovative product offerings like Milo Protein Up and Starbucks coffee to ignite consumer interest. Despite this, larger macro factors, such as steeper raw material costs and tepid export sales, are expected to be a boon to the group. Despite the higher commodity costs, Nestle continues to view price increases as an act of last resort. Instead, we expect the group to grow profitability by finding operational cost synergies in production and logistics.

As the meeting yielded no surprises, we maintain our forecasts.

We maintain our “sell” call, with an unchanged TP of RM111, based on the dividend discount model valuation methodology. While we are confident that Nestle will continue to strengthen its portfolio of products, external headwinds mentioned above do not augur well for the group. Furthermore, we reckon that its share price has risen beyond justifiable levels. At the current price, Nestle is trading at 46.3 times FY19 price-earnings ratio (PER) and yielding an unattractive 2.2%. In comparison, its holding company in Switzerland trades at a cheaper 24.7 times FY19 PER, while its sister company in Nigeria trades at 19.1 times FY19 PER. — Hong Leong Investment Bank Research, Aug 29