OPINION: Nestlé - Quality at fair value
JOHANNESBURG- Nestlé is a nutrition, health and wellness company. It is the world’s largest food company by revenue and operates in over 190 countries. The Swiss company was founded in 1905 after the Anglo-Swiss Condensed Milk Company merged with Henri Nestlé’s infant food company.
The group’s product categories include powdered and liquid beverages, milk products and ice cream, nutrition and health science, prepared dishes and cooking aids, confectionery, water and pet care products.
Nestlé owns more than 2,000 brands, of which more than 20 brands each generate annual sales in excess of one billion Swiss francs (R14 billion). Some of its most well-known brands include Nescafé, Nespresso, Milo, Maggi, San Pellegrino, KitKat and Friskies.
The group recently reported commendable annual results. It displayed the defensive properties that make it such an attractive stock for more conservative investors. Key financial performance metrics improved significantly. Organic sales grew three percent to 91.4 billion Swiss francs (R1.3 trillion), even after accounting for substantial currency headwinds. The company managed to increase free cash flow by fifteen percent. During 2018 Nestlé returned 13.9 billion Swiss francs (R195 billion) to shareholders through share buybacks and dividends. Management reaffirmed their 2020 earnings targets on the back of revived growth in the company’s two largest markets, the United States and China.
Nestlé offers investors optionality through its 23 percent shareholding in L’Oréal. The shareholding represents twelve percent of Nestlé’s market capitalisation. In 1974 Nestlé became one of the primary shareholders of the cosmetics giant. If Nestlé were to sell its holding worth €29 billion (R460 billion) it could potentially lead to share buybacks, special distributions to shareholders or acquisitions in higher growth/margin categories such as coffee, pet care, infant nutrition and premium waters. Alternatively, Nestlé could remain invested in L’Oréal, considering the opportunity cost of selling shares that have doubled in value over the past 5 years. Either way, this optionality creates a value proposition that is unique to Nestlé.
According to United Nations estimates the global population stands at 7.7 billion. This number is set to grow at approximately 83 million people per year. That is 1.5 times the current South African population. In addition, the number of elderly people globally is projected to increase dramatically in the years ahead. Yet even though an increasing number of people around the world have to eat, Nestlé has faced a number of challenges. The need to strike the right balance between leveraging global scale and being responsive to local consumers and competitors has become crucial. The emergence of niche brands which can easily distribute via e-commerce and a shift in consumer demand to healthy, organic, locally produced food could result in market share losses for Nestlé.
However, Nestlé’s strong balance sheet, robust cash flow generation and L’Oréal stake optionality support innovation and allow leverage in above average growth opportunities. Its purchase of exclusive rights to sell Starbucks packaged coffees and teas around the world attests to the group’s commitment to implement a strategy of regularly introducing new products in the market, driving synergies and leveraging its distribution network.
The defensive nature of Nestlé’s well-diversified, high quality product portfolio and its consistent earnings growth offer investors a low risk profile. Given this safety premium and dependable dividend growth its shares are rarely undervalued. Nestlé shares are trading in line with peers and their own history and offer conservative investors fair value at current values.
Frants Preis, CFA is a portfolio manager at VEGA Asset Management based in Pretoria. Nestlé shares are owned on behalf of clients.