When I just started value investing in the Malaysia stock market, it was my dream to eventually own shares of Nestle (Malaysia) Berhad (KLSE: NESTLE).
With its wide product range, catering to both the young and the old, and its reputation as a household brand associated with quality, it seemed like a no-brainer stock to hold for the rest of your life.
It was also easy to humble-brag about owning just 1 lot of Nestlé Malaysia shares. With 100 shares per lot, owning one lot of Nestlé Malaysia meant a minimum capital outlay is at least RM 10k, a figure that not many are willing to fork upfront to invest, let alone on a single company.
I have always deemed the shares of Nestlé Malaysia to be expensive whenever they traded above RM 100 back then. But as I slowly broaden my investment horizons, I realised that there were, for various reasons, better companies out there to invest in.
Over the past 5 years, Nestlé Malaysia share prices have retreated from its height of RM150 to RM100 – almost a 50% drop.
Did Malaysians really drink less MILO to cause such a drop in share prices?
Why are share prices of Nestlé Malaysia down?
Due to the massive capital outlay to become a shareholder, Nestlé Malaysia shares are mostly traded by the institutions rather than retail investors.
And being a well-known bluechip stock, share prices tend to move more due to fundamental reasons rather than speculation and volatility. Looking at just the 5-year toppling financials, we start to see the potential root causes.
Even though revenue is still growing, gross margins have shrunk by 594 basis points, from 37.58% to 31.64%!
It is not that Malaysians or Singaporeans are drinking less Milo, but Nestle isn’t passing on the cost of its cost of production fast enough, thus exhibiting a gross margin compression.
So why are gross margins deteriorating?
Higher commodity and input prices
A food manufacturing business converts raw ingredients into finished goods or products that are either ready-to-eat or drink, or require minimal preparation for customer consumption.
These ingredients are mostly commodities that see their prices gyrate due to various reasons. But overall, prices of commodities are on a long-term upward trend.
Robusta and Arabica coffee, which goes into every jar of Nescafe instant coffee, have seen prices rally by 130% and 86% respectively. Robusta coffee, which is majorly planted and harvested in South East Asia countries such as Indonesia and Vietnam, have seen harsher weathers that impact yield, as well as a shift by farmers to higher paying crops like durian and dragon fruits.
Sugar, which also goes into most of Nestle’s products, has also risen by 37% over the last 5 years. Sugar prices have climbed in producing countries like Brazil and Thailand to support farmers. On top of that, the revolving ESG theme has also seen sugar being channeled to ethanol production for fuel. With fuel prices now on the higher side, more sugar would be channeled to ethanol production, leaving lesser supply for human consumption.
And lastly, cocoa powder is on a rampage, especially over the last 2 years. Major cocoa producing countries like Ivory Coast and Ghana are seeing lesser yields due to drought. You might have noticed the price hikes on MILO and KitKat, but looking at Nestle Malaysia’s margins, it’s scary to think that customers are just beginning to feel the impact of the commodity price spikes.
Weakening domestic sales
Although Nestlé Malaysia does have some business operations in Singapore and ASEAN, it’s main revenue is still predominantly derived from the domestic market.
In its latest quarterly results, it reported a sharp dip in its revenue, where it was down by more than -18%.
Nestle has been one of the corporation erroneously targeted by mass boycotts by the Islamic world when war erupted between Israel and Palestine. The boycott has definitely affected Nestlé Malaysia as it is uncommon to see revenue dip by so much without any signs of economic downturn.
What present day JP felt different
Back then, I felt that even though Nestlé Malaysia was a solid business, it was trading at a rich valuation. With a dividend yield of less than 3%, I was better off investing in capital-guaranteed fixed deposits with a 4% yield.
And there were definitely better investments that paid a higher dividend yield yet have more visibility in terms of growth and expansion over a “Jaguh Kampung” (Village Champion), albeit a very commendable one.
Today, Nestlé Malaysia faces dual challenges: on one hand the company is trying its best to contain the effects of higher input costs, on the other end it is trying to reassure its large Muslim consumer base that it is in fact not a company owned by the Jews.
The moat that I thought it has, wasn’t really a strong one, as we see this once strong company’s top line and margin getting whipsawed.
My verdict
While I couldn’t have foreseen the sudden rise in commodity prices nor another racial and religious boycott, I recognize that Nestlé Malaysia’s business scope limits its growth potential, creating an invisible ceiling.
I’m thankful to have allocated capital elsewhere to the US markets, where growth is on an international and global level.
I rest my case here. Good is never good enough. I want only the best businesses in my portfolio.
Nestlé Malaysia might find itself entrenched in a sticky situation that does not promise an escape back to its glory days, looking at the current doldrums it is in.
Perhaps this is the end of Malaysia’s used to be best-listed company in terms of pedigree and investment returns?
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