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Company Report

Nestle (M) Berhad

Date: 18 July 2012

Pricey consumer giant

NESZ continues to grow revenue admirably and protect margins despite a very volatile macro conditions in the last five years. This is attributed to NESZ strong cost controls and pricing power of its various consumer brands. However, we believe NESZ price is currently very stretched. At current price, NESZ would have to grow revenue very aggressively in order to deliver a decent yield to investors. Based on DDM, we derived a fair value of RM40.00 for NESZ. We have also assigned an Average conviction rating to NESZ. Overall, we have a SELL on NESZ.

Sell
Fair value Previous FV Share price Yield Capital gain Total return Conviction Stock code Market cap RM40.00 N/A RM59.00 +3% -32% -29% Average NESZ MK RM13,840m

Robin HU
robin@nonameresearch.com

nonameresearch.com | 18 July 2012

Solid Consumer Giant

Well-established consumer brand names
Market leader in various segments. NESZ has a portfolio of well-known consumer products in various segments such as cereals, creamers, beverages, culinary products, dairy, ice cream and confectionary. Some of its brands are Cereals Koko Krunch, Stars, Corn flakes, Cookie Crisp, Honey Stars, Cheerios, Nestum, Nesvita Creamers Coffeemate Beverage Milo, Milo 3-in-1, Milo Sejuk, Nestea Coffee Nescafe Classic, Nescafe 3-in-1 mixes Culinary products Maggi instant noodle, sauces, flavourings Chilled dairy Nestle yogurt Ice Cream Mat Kool, Drumstick, Trophy Confectionary Kit Kat, Crunch, Milkybar Milk - Nespray

Nescafe Classic has a market share of circa 80% in Malaysia coffee segment. Its nearest competitor, Indocafe, holds circa 10%. Nescafe coffee mixes has a market share of 40%. Its nearest competitors Super and Natural Bio hold 10% each.
Figure 1: Selection of consumer brands under Nestle

Source: NESZ

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Pricing power
History of successful price hikes. As a testament to NESZ strong branding, NESZ has successfully raised the price of its products on many occasions in the past. For example, the price of Milo products has been raised four times between 1Q10 and 1Q12.
Table 1: Recent price hikes Product line 1Q12 2Q11 All Milo products Milo powder Milo Fuze Nescafe Milo powder Milo Fuze Nescafe 3-in-1 mixes Milo powder Milo 3-in-1 mixes % increase 5%-6% 4% 4% 6% 5%-6% 5%-6% 4% 9% 9%

1Q11

1Q10

Similarly, the selling price of Maggi was also raised by 8% in Mar 2008, the third price increase since May 2007. The ability to raise price is not restricted to NESZ as Maggi competitor brand, IndoMie raised price five times during the same period. However, there are also instances of price reduction. For example, the price of Milo products was cut by 6%-9% in 1Q09.

Serving regional needs

Ramping up capex to expand production capacity. Since 2007, NESZ has spent almost RM1bn in capex to expand its production facilities. NESZ invested RM240m to expand the production lines for Nescafe and Coffee-mate. The increase in sales from Nescafe exports has help increase beverage division revenue Nestle SA, NESZ parent company has spent RM100m on a cereal plant in Chembong, Negeri Sembilan. The plant is the third breakfast production centre in Asia after Lipa in the Philippines and Tianjin in China. The plant is situated next to NESZ own confectionary and ice-cream facility and will be producing fiver bestselling breakfast cereals namely Koko Crunch, Honey Stars, Cookie Crisp, Koko Krunch Duo and Milo Breakfast Cereals for Malaysia, Singapore, Indonesia and Thailand. Previously, cereals sold in Malaysia were imported from the Philippines In the future, NESZ plans to continue to invest in a new plant next to its existing factory Batu Tiga, Shah Alam as its manufacturing facilities are currently at 90% utilization

NESZ also took over Australia Maggi noodle production in 2008. Maggi products are now exported from Malaysia to Australia and New Zealand. NESZ Shah Alam factory is currently the regional production hub for infant cereals, Nescafe and Coffee-mate.

nonameresearch.com | 18 July 2012

Financial Review
Solid growth of 7% CAGR. NESZ resilience is apparent from its financial performance. Revenue has consistently been growing at an average rate of 7% per annum to RM4.7bn in 2011. Even the global recession in 2009 was unable to slow NESZ growth as revenue only declined 3% during that period. Net income growth is even more resilient, growing at 11% per annum between 2004 to 2011 to RM456m. This is particularly commendable considering the last five years were marked by highly volatile commodity prices.
Figure 2: NESZ revenue and net income 2003-2011

Source: NESZ

Pricing power and cost control protect margin. NESZ pricing power and cost control are clearly reflected by its consistent GP margin. GP margin consistently hovered around the 33% mark even across period of highly volatile commodity price of the last five years.
Figure 3: NESZ GP and NI margin 2004-2011

Source: NESZ

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Steady increase in dividends. NESZ dividends have been growing steadily. Between 2004 to 2011, NESZ dividend grew 12% annually to RM399m in 2011. Except for 2005 and 2008, dividend payout was between 80% to 90%.
Figure 4: NESZ dividend and payout ratio 2004-2011

Source: NESZ

nonameresearch.com | 18 July 2012

Valuation and Conclusion

Valuation method and key assumption
Based on DDM, we derived a fair value of RM40.00 for NESZ. At current price of RM59.00, this represents a potential total return of -29% comprising 3% dividend yield and 32% capital loss. We expect revenue to continue growing at least high single digit in the short term DPS for 2012 to be close to RM1.80 NESZ will continue to maintain its margin i.e no margin compression from higher input cost

At last year DPS of RM1.70, NESZ yields only 2.9% at current price of RM59.00. NESZ should be able to generate EPS of at least RM1.80 each year but with continued growth, EPS could reach RM2.40 in the short term. However, even assuming RM2.40 EPS and 100% payout, NESZ will still yield only 4% at current price. It appears that very high expectations have been imputed into NESZ price. It is hard to justify RM59.00 for NESZ even if net income continues growing at 10% per year in the short term and hence our negative sentiment.

Key risks
Yield expansion. Our key concern is not with NESZ operations but rather that the stock is currently trading at a very compressed yield of 3%. NESZ dividend will have to grow very rapidly in order to generate reasonable return for investor at current lofty price. Regional growth. NESZ has invested heavily to expand its production facilities in the last few years. Furthermore, NESZ continues to guide higher than normal capex for 2012. If export sales continues to grow at high double digit, EPS will grow faster than our projection and will provide an upside surprise to our fair value.

Conclusion
NESZ continues to grow revenue admirably and protect margins despite a very volatile macro conditions in the last five years. This is attributed to NESZ strong cost controls and pricing power of its various consumer brands. However, we believe NESZ price is currently very stretched. At current price, NESZ would have to grow revenue very aggressively in order to deliver a decent yield to investors. Based on DDM, we derived a fair value of RM40.00 for NESZ. We have also assigned an Average conviction rating to NESZ. Overall, we have a SELL on NESZ.

nonameresearch.com | 18 July 2012

Historical Statistics
Revenue and Net Income (FYE-Dec) Payout Ratio (FYE-Dec)

Net Income Margin (FYE-Dec)

EPS and DPS (FYE-Dec)

Revenue and Net Income Growth (FYE-Dec)

Exports to total sales (FYE-Dec)

nonameresearch.com | 18 July 2012 Rating structure The rating structure consists of two main elements; fair value and conviction rating. The fair value reflects the security intrinsic value and is derived based on fundamental analysis. The conviction rating reflects uncertainty associated with the security fair value and is derived based on broad factors such as underlying business risks, contingent events and other variables. Both the fair value and conviction rating are then used to form a view of the security potential total return. A Buy call implies a potential total return of 10% or more, a Sell call implies a potential total loss of 10% or more while all other circumstances result in a Neutral call.

Disclaimer This report is for information purposes only and is prepared from data and sources believed to be correct and reliable at the time of issue. The data and sources have not been independently verified and as such, no representation, express or implied, is made with respect to the accuracy, completeness or reliability of the information or opinions in this report. The information and opinions in this report are not and should not be construed as an offer, recommendation or solicitation to buy or sell any securities referred to herein. Investors are advised to make their own independent evaluation of the information contained in this research report, consider their own individual investment objectives, financial situation and particular needs and consult their own professional and financial advisers as to the legal, business, financial, tax and other aspects before participating in any transaction.