OSK Research re-initiated its coverage on Nestlé (M) Bhd with a neutral recommendation on the stock at RM29.75, despite the company’s strong performance over the last year as its relatively small free float would limit investment opportunities.

“Given that Nestlé SA owns 72.5% of Nestlé Malaysia, its available free float is rather limited at 48 million shares. As such, there are constraints on investment opportunities,” OSK said in a recent note.

“Furthermore, as Nestlé has strongly outperformed the KLCI by 30% over the last one year, we do not see much potential upside to the stock.”

The research house pegged Nestlé’s target at RM29.80 based on a discounted cash flow (DCF) valuation method, implying a price of 18 times its earnings for FY09.

OSK noted that the outlook for the food and beverage (F&B) industry was generally resilient as food was one of the last expenses that consumers would cut down on. Nestlé had the added advantage of being the market leader in Malaysia, it said.

“Being a market leader in the F&B manufacturing sector, Nestlé has relatively greater flexibility compared to other players in raising prices to protect margins and to counter rising commodity input price pressure,” OSK said.

“Products will be differentiated when determining price adjustments. Best selling products such as Milo, which is estimated to have a market share of about 90%, commands more pricing power in efforts to counter narrowing margins in other competitive products.”

Nestlé’s transformation into a halal food manufacturer was also a strong avenue of growth for the company, the research outfit noted, as the global halal food sector was estimated at RM570 billion.

“Nestlé SA transformed Nestlé Malaysia into a halal hub in mid-2006 as it believes that the Malaysian operation will be able to achieve economies of scale and better resource utilisation via lower cost of capital... We believe this is a strong and sustainable source of revenue and earnings growth in the long term,” OSK said.

So far as Nestlé’s financials were concerned, OSK said that the company’s earnings growth has been consistently resilient and “largely unaffected by the economic slowdown” as evidenced in 1998, 2001 and 2003.

“Going forward, we believe its margins would continue to improve as the company implements Nestlé’s Continuing Excellence programme, which emphasises on cost-cutting and minimal wastage,” it said.

For Nestlé’s 1Q09 results, OSK said the F&B manufacturer has managed to increase its sales volume and maintained its earnings margin despite volatility in input costs.

Nestlé’s generous dividend payout of more than 80% also makes the company attractive, although there continues to be risks to the company, particularly the volatility of raw material costs.

“Raw materials alone make up 60% of the its manufacturing operations’ costs and rising input cost exert pressure on its profitability. Raw material prices had soared to their highest before crashing to their lows in late 2008,” OSK said.

“As such, we do not foresee any further downside in the prices of the raw materials given that most of them are at their lowest with the exception of cocoa price which is still at its high level.”

It added that Nestlé has been able to pass on the cost to consumers, as evidenced by the price increase in many of Nestlé’s products of between 5% and 15%.