Saturday, May 25

Analysts: Material costs shrink Nestle’s margins, despite price increase

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RISING COSTS: Photo shows a worker inspecting packets of Milo at a Nestle’s production and packing plant. The group’s profit margins are shrinking on costlier raw materials, despite price increase on selected products. — Bloomberg photo

KUCHING: Nestle (Malaysia) Bhd’s (Nestle) strong nine month financial year 2011 (9MFY11) financial results are within market expectations, but the margins are being diminished by stubbornly high materials costs.

Nestle registered strong 9MFY11 earnings of RM369.2 million, showing a year-on-year (y-o-y) robust sales growth of 14.7 per cent was driven by both domestic and export sales.

Domestic sales were driven by the year’s newly launched products, which included ‘Nestle Crunchy Bite wafer’, ‘Nescafe Menu Kopi O’ and others while export sales were boosted by the high demand for soluble coffees, coffee creamers and ‘Milo’ powders.

Year-to-date, Nestle recorded net profit of RM369.2 million, or a five per cent increase whilst revenue jumped by 15 per cent to RM3.51 billion.

However, the third quarter’s (3QFY11) net profit however fell slightly by 2.8 per cent y-o-y as the effective tax rate increased from about 15 per cent in 3Q10 to about 20 per cent in 3Q11.

The 9MFY11 net profit y-o-y growth of 4.9 per cent was lower than 9M10’s y-o-y growth of 32.6 per cent due to the higher input cost of key raw materials.

Gross profit, earnings before interest and tax (EBIT) and net profit margins for 9MFY11 eased by 0.7 per cent points (ppt), 0.9 ppt and one ppt y-o-y respectively against the backdrop of the high costs as well as other factors.

OSK Research Sdn Bhd (OSK Research) analyst Eing Kar Mei elaborated, “The 9MFY11 margins shrank on costlier raw materials despite price increase on selected products, as well as due to higher nine month operating expenses and a higher effective tax rate.

“We expect Nestle’s bottom-line growth in the following quarter to remain weak due to the still high raw material prices and as the group’s plans to continue to pump up its marketing investment.”

Despite the higher revenue, gross profit dipped 3.7 per cent due to high raw material prices, although this was offset by lower third quarter operating expenses, resulting in a net profit growth of 3.2 per cent.

TA Securities Holdings Bhd (TA Securities) analyst Farhana Hamzah report concurred with the bottom line mitigating factor by adding, “Margins are under pressure from the rising raw material costs.

“Quarter-on-quarter (q-o-q), net profit rose slimly by three per cent and revenue to one per cent to RM1.17 billion. Lower operating expenses helped cushion the impact of rising raw material costs.”

“We believe Nestle is able to tackle any downturn as it did back in 2009 with its PPP (popularly positioned products), which are placed for lower income groups or for down‐trading purposes.

“We remain optimistic on the F&B sector outlook as we believe the sector to remain stable and resilient,” Farhana added.

The analyst also pointed out that the Malaysia Institute of Economic Research (MIER) released weak third quarter sentiment index as inflationary pressures continued.

Farhana made no changes in TA Securities’ earnings estimates for Nestle and maintained the target price of RM50.60 per share, based on a dividend discount model.

Given that the results were in line with OSK Research’s expectations, Eing maintained the stock’s fair value pegging at RM47.43 per share, based on a discounted cash flow analysis.