British American Tobacco (M) Bhd (BAT) is currently — and has been for some time — the most expensive stock, in terms of absolute share price, among all listed companies on the local bourse. But Nestle (M) is rapidly gaining ground, with its relatively stronger performance over the past few years. At this pace, might the food & beverage giant soon overtake BAT as the highest priced stock?
The similarities ...
The two companies have long, established track records and good corporate governance. They are leaders in their respective industries with enduring brand names. BAT is estimated to have some 60% share of the domestic cigarette market, driven by the Dunhill and Pall Mall brands. Similarly, Nestle leads the market with its household brand names such as Milo, Nescafe, Maggi, Kit Kat and Nespray.
Both companies are, traditionally, viewed to have relatively low-risk businesses that generate steady cash flow. Indeed, they appeal primarily to yield-seeking investors with their higher-than-market average dividend payout. These characteristics still apply to BAT but investor expectations of Nestle appear to have changed somewhat.
And differences ...
Whilst BAT remains very much focused on the domestic market, Nestle’s strategy to expand its exports sales, in particular for the made-in- Malaysia halal products, appears to have rejuvenated its growth prospects — and investor interest in the company. Indeed, investors appear willing to pay a premium for the stock judging by its prevailing valuations.
The company is currently the largest halal producer within the Nestle world with a range of some 300 products exported to more than 40 countries worldwide. Its biggest markets are in the Middle East and Asean regions although it is also working to raise visibility in the European markets.
Between 2007 and 2009, Nestle invested some RM500 million in technical skills for halal manufacturing and production capacity to cater to the large — and growing — export market. Capital expenditure this year is estimated at RM140 million.
The investments are starting to bear fruits. In the first six months of this year, exports registered double-digit growth and accounted for roughly 24% of total sales. In 2006, exports contributed just over 16% to the company’s sales.
Competitive environment and earnings
Operating conditions are challenging for both industries. Nestle has to contend with volatile raw material prices and competition from generic and hypermarket house brands. Meanwhile, BAT continues to struggle within the increasingly tightly regulated tobacco industry, rising government taxes and illicit trade.
By comparison, however, Nestle has fared much better, especially in extracting greater profitability from sales. Its sales grew at a compounded annual rate of 4.6% whilst net profit expanded by over 10% per annum from 2007-2009. Over the same period, BAT’s net profit grew a pedestrian 1.24% per annum on the back of annual 2.8% growth in sales.
We estimate BAT’s net profit to decline by roughly 5.8% to RM703.5 million this year — in 1H10, net profit dropped 7.2% year-on-year (y-o-y) — and to fall further in 2011. The just announced three sen per stick hike in excise duty and resultant 70 sen price increase for a 20-pack of cigarettes are expected to send volume sales reeling. A 20-pack of premium and value brand cigarettes now cost a hefty RM10 and RM8.50 per pack, respectively. On the other hand, net profit for Nestle expanded 29% y-o-y to RM239 million in 1H10. We estimate net profit will total RM418 million for 2010, up 19%.
The disparity in the shares’ price performances underlines investor expectations for their earnings prospects. Nestle’s share price rose from RM24.40 at end-2006 to the current RM42, or up 72%. BAT shares are now hovering around RM48, up just 12% from RM42.75 at end-2006.
Even though Nestle’s yields are expected to be lower than BAT’s, its shares are trading at richer valuations. That suggests that investors remain relatively more upbeat on the company’s growth prospects going forward, even after taking into account gains over the last few years
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