With minimal revisions to our estimates, we maintain our target price at LKR1,300/share, and revise our rating to Hold from Sell. Including a dividend of LKR 39.00/share, we derive a total return of +3.0%. NEST reported a Q2 CY 19 recurring net profit of LKR376mn (-48.9% yoy) below our estimates. While revenues came in better than expected, down 6.5% yoy, an increase in raw material cost from to FX depreciation, resulted in EBIT margins declining by 4.4ppts. Higher interest costs also added to the profit decline. With consumers slowly moving back to regular purchasing patterns and schools back in operation, NEST noted that demand has seen a recovery from the lows in May, albeit at a slow pace. On a positive note, NEST expects the FX impact on raw material imports to be minimal in Q4, which could lead to some margin improvement.
Demand recovering slowly; pressure on top line growth
The 6.5% reduction in sales came mainly from a slowdown in out-of-home sales, low milk powder sales (partially driven by the fresh milk shortage), and a significant export sales price drop in Maggi Coconut Milk Powder. At out-of-home, volumes declined across key brands Nestomalt, Maggi, Milo and Nescafe. May saw the worst demand conditions as consumers avoided dining out/public places and schools remained closed. Demand for coconut milk powder also remained low with consumers switching to fresh coconuts due to lower prices. With consumers slowly moving back to regular purchasing patterns and schools back in operation, NEST noted a recovery in demand from the lows in May, albeit at a slow pace. Our channel checks indicate that while modern retail is seeing faster movement, the general trade, particularly in rural markets are still showing slow progress. However, we note that competition has also picked up significantly across NEST’s product categories. While we expect a spending recovery to come through, this will only be towards late CY 19e (see page 2). Hence, we expect top line to remain pressured in CY 20e.
FX and raw material costs hurt EBIT; interest expenses to remain high
While there was a benefit from lower fresh coconut prices, the impact of higher raw material prices including packaging material and FX depreciation resulted in the c4.0ppts gross margin contraction. Hence, despite lower marketing expenses, EBIT margins contracted by 4.1ppts to 9.7%. On borrowings, in addition to the LKR1.8bn taken from the Nestlé Treasury Centre in CY 18 for capex, there were additional borrowings in Q2 for working capital, resulting in higher interest expenses. We expect this trend to continue in CY 19e as NEST noted that the internal debt needs to only be repaid in three years. On a positive note, however, NEST expects the FX impact on raw material imports to be minimal by Q4, which could lead to some margin improvement.
We maintain our TP at LKR 1,300/share and revise our rating to Hold
The stock reached our target price of LKR 1,300/share and is down c24.0% YTD and down c29.0% yoy. It is currently trading at 26.9x our CY 19e earnings. However, with minimal changes to our estimates, we maintain our target price at LKR1,300/share. With a dividend of LKR 39.00/share, we derive a total return of +3.0%, and revise our rating from to a Hold.