Nestlé’s high valuation ripe for correction

The share price performance has outshone its big-cap peers and on March 13 rising to a record high


Fast-moving consumer goods (FMCG) giant Nestlé Malaysia Bhd’s market capitalisation has doubled in the past 12 months to RM33.25 billion as it became the most expensive stock on the local exchange at RM150 a share last Friday.

The local unit of multinational Nestlé SA has become the 14th most valuable company on Bursa Malaysia on expectations it is set to benefit from higher consumer demand and lower operational costs from the stronger ringgit.

Analysts are, however, warning the stock valuations are now on the high side and suspect to a correction to more fundamentally reasonable levels.

Analysts and investors favour Nestlé for its solid brand name and defensive business prospects

Kenanga Investment Bank Bhd has a ‘Market Perform’ call on Nestlé with a target price of RM114.30 based on a revised price-earnings ratio (PER) of 32 times.

Kenanga analyst Clement Chua said going forward, it appears commodity prices will likely ease.

“The surge in Nestlé’s share prices is likely attributed by the inclusion of the stock into the benchmark Kuala Lumpur Composite Index (KLCI) component stocks in December 2017.

“While valuations appear to be more expensive resulting from this, we believe the short-term sentiment may keep the stock at present level due to its marketing leading position and resilient presence in the market,” he added.

According to Bloomberg, Nestlé now trades at 53.5 times its trailing 12-month earnings per share (EPS) and 48 times its estimates for the coming year.

That’s double the ratio of much of the previous five years; only late in 2017 did its valuation break above 30 times EPS.

Nestlé’s share price has returned 43% year-to-date and about 20% in the past month alone.

Nestlé kick-started 2018 with 37 gains in 44 trading days, for a 53% rise — easily the best in the country’s benchmark index.

The share price performance has outshone its big-cap peers and on March 13, 2018, it rose to a record high of RM157.40.

Analysts and investors favour Nestlé for its solid brand name and defensive business prospects.

Affin Hwang Capital Research expects Nestlé’s 2018 earnings to be stronger on a recovery in consumer spending, lower materials costs and the strengthening of the ringgit.

Nestlé’s share price is well above Affin Hwang’s target price of RM97.60, or 30 times its 2018 EPS forecast.

Affin Hwang expects Nestlé’s continuous effort to launch new products would help sustain growth in tandem with the 4% to 5% growth forecast for the food and beverage packaged food sales value in Malaysia.

It forecasts a 16% EPS growth on revenue and margin improvement.

To recall, Nestlé recorded its highest fourth-quarter net profit of RM133.54 million in 2017 due to sustained cost management and phasing of its marketing investments in 2017.

Its quarterly revenue rose 2.4% year-on-year (YoY) to RM1.28 billion from RM1.25 billion in 2016.

Full-year turnover was higher by 3.9% YoY at RM5.26 billion, as earnings rose 1.4% YoY to RM645.8 million.

CIMB Research analyst Kristine Wong has lifted Nestlé’s financial year of 2018 (FY18) to FY19 EPS by 0.8% to 0.9%.

CIMB also raised its 12-month discounted cashflow-based target price for Nestlé to RM97.40 as it reduced its beta assumption, given the lowered risks after the stock’s inclusion to the index last year.

“While we continue to like its defensive business model, strong brand name and huge consumer base, we think its valuations are stretched at FY18/FY19F to 41 times/38 times respectively, to the PE.”

“Its FY18 to FY20 dividend yields are also unappealing at an estimated 2.3% to 2.7%,” Wong added.

Any significant spike in cost of raw materials, such as milk powder, sugar and coffee beans are potential de-rating catalysts, while upside risks to CIMB’s call include better than expected export demand and a substantial recovery in domestic spending.

MIDF Amanah Investment Bhd analyst Nabil Zainoodin maintained a ‘Neutral’ rating with a revised target price of RM116.50.

He concurred its valuation is currently stretched with a forward PER of more than 40 times compared to the average three-year PE of 28 times before the inclusion in both the indexes (MSCI Malaysia Index and FTSE Bursa Malaysia KLCI) last year.

“We believe the improved earnings in the 4Q17 and expectation of better earnings in FY18 have been priced into the current valuation,” he added.

Nabil expects earnings to improve due to stable top line growth on better consumer sentiment and spending because of government measures to increase household disposable income, with the stronger ringgit helping to stabilise cost of input materials, and better efficiency.

The stronger ringgit, however, might taper export growth while the higher effective tax rate of 20% given the increasing deferred tax liabilities.

Hong Leong Investment Bhd analyst Gan Huan Wen expects Nestlé to benefit from a recovery in consumer spending in 2018 aided by the pre-election cash handouts.

Gan likes Nestlé for its defensive nature, diversified product portfolio and stellar management.

“Despite this, it must be noted at current price levels, dividend yield has slipped over the past five years,” he noted.