Nestle: Upward Revision to 2018-2019F Estimates; SELL Rating Maintained

November 15, 2017/Cordros Research

Following Q3-17 result, we raise NESTLE’s 2017F EBITDA estimate by 10% but cut net profit by 9.7%, on net, equating to growth forecasts of 51% (previously 37%) and 290% (previously 331%) respectively. While we cut sales forecasts for 2018-2019F by 0.4% average, we raise EBITDA and net profit by 15% and 14% respectively on (1) better margin assumptions and (2) lower finance cost estimates. On our revised estimates, we value NESTLE at NGN843.54/share and reiterate SELL rating on the stock. We roll forward our model estimates and valuation by one year.

We raise gross margin estimates for 2017F by 141 bps to 41% and by 216 bps to 42% in 2018-2019F on better-than-expected formation over 9M-17 (+85 bps vs. 9M-16). Our 2018-2019F gross margin estimate, at 200 bps discount to the 44% achieved in Q3-17, factors in the key risk of potential pricing pressure from competition – as stronger dollar liquidity encourages more imports – and is therefore conservative. We reiterate the tailwinds for gross margin as being the (1) significantly reduced FX risk to production costs, (2) stable raw materials price outlook, and (3) possible stable selling prices in view of election spending boost to aggregate demand. Also, vis-a-vis the possible impact of pricing on margin going forward, is the brand premium – hence stable market share – that NESTLE enjoys across key products.

We raise our finance cost estimate for 2017F by 58% on higher-than-expected amount recognized in Q3-17 (+190% vs. our estimate) and overall, 9M-17 (+49% vs. our estimate). We are surprised that both net FX losses and interest charges on borrowings realized over 9M-17 were way ahead of our estimates which assumed (1) 20% NGN devaluation rate (on NGN366/USD vs. NGN305/USD) and (2) average borrowing cost of 7%. That said, we have cut finance cost estimates over 2018-2019F by 39% average, on the back of (1) NESTLE’s significantly deleveraged balance sheet (borrowings reduced by 42% over 9M-17) and importantly, (2) significantly reduced FX headwinds on stronger USD/NGN outlook, amidst the repayment of intercompany USD loans (NGN31.3 billion of the NGN38.3 billion due this year has been repaid YtD). Management is yet to provide guidance on the replacement of the repaid loans in 2018F, hence, we consider this a downside risk to our finance cost estimate.

From estimated 39% growth in 2017F, we forecast sales growth to moderate to 10% average over 2018-2019F, as the impact of price hikes wanes. Our 2018-2019F revenue growth forecast, 300 bps below NESTLE’s five-year historical average growth rate, is conservative. We note downside risks such as possible cut to selling prices (as competition intensifies) and less-than-expected impact of election spending on aggregate demand. Yet, we reiterate tailwinds such as (1) NESTLE’s brand premium, (2) products affordability via smaller package offerings, and (3) extensive distribution network.

On net, we forecast average EBITDA and net profit growth of 9% and 31% respectively in 2018-2019F. NESTLE’s share price has gained 2% QtD and 54% YtD, and we estimate the stock is trading on 2018F P/E of 21.1x, a material discount to five-year historical P/E of 43x, and but at premium to Bloomberg’s MEA 1-year forward peer average of 17.7x.

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