Nestlé S.A. - expanding its operating efficiencies
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Nestlé S.A. - expanding its operating efficiencies
Company deep dive on Nestlé S.A. and explore how the company is trading at undervalued valuations while expanding its operating efficiencies.
A bit of housekeeping, I have recently updated my logo from the green fonts and globe to the current simple white and blue colours. Hope you like it! Thank you for reading my articles and supporting my newsletter. Here is a company deep dive into Nestlé for this week’s insights into international investments.
Introduction
Nestlé SA (NESN) is a food and beverage company with a history dating back to 1866. Henri Nestlé, the founder developed a breakthrough baby food in 1867 and then merged with Anglo-Swiss to form Nestlé Group in 1905.
Today, Nestlé is mainly traded on the SIX Swiss Exchange with a total market capitalisation of CHF283.5bn (USD317.8bn). The stock can also be traded across various global stock exchanges like the BATS Europe, US OTC markets, London, Mexico and Frankfurt.
Company information
Throughout the century, Nestlé has been riding out the storm through harsh global events till it became one of the biggest food and beverages manufacturers and traders today. The group today is headquartered in Vevey, Switzerland.
NESN is a nutrition, health, and wellness company, which engages in the manufacture, supply, and production of prepared dishes and cooking aids, milk-based products, pharmaceuticals and ophthalmic goods, baby foods, and cereals. It operates through the following geographical segments: Zone North America (NA), Zone Europe (EUR), Zone AOA, Zone LATAM, Zone GC, Nespresso, and Nestlé Health Science.
Historical share price movements
Over the years, NESN has generally been outperforming the S&P 500 up till 2020. Since then, the share price has underperformed the index by around 100%-pts due to an after-effect of the recent pandemic i.e. 1) record-level commodities prices, 2) a decline in consumer sentiment and 3) ongoing supply chain disruptions.
Even then, I believe it is a good time to accumulate while the valuation seems to be attractive. Especially if I aim to invest and hold for the long term.
NESN share price performance vs. S&P 500 since inception
Ownership information
The ownership of NESN is divided into 35.3% of various institutional funds, 0.1% of individual insiders and 64.6% of the general public thus providing healthy liquidity to buy and sell the stock.
Note that the biggest shareholders belong to BlackRock Inc holding at 5.2%, The Vanguard Group Inc. at 3.8% followed by Norges Bank Investment Management at 2.9%.
NESN ownership breakdown
Revenue Analysis
A holistic product portfolio within the consumer staples
The company products portfolio includes baby food, water, cereals, chocolate and confectionery, coffee, culinary, chilled, and frozen food, dairy, drinks, food service, healthcare nutrition, ice cream, and pet care.
NESN biggest revenue contributor as of 2022 is the powdered and liquid beverages segment accounting for 26.7%, followed by PetCare at 19.2%, Nutrition and Health Science at 16.6%, prepared dishes and cooking aid at 13.2%, milk items and ice cream at 12.0%, confectionary at 8.6%, and finally water at 3.7%.
Steady growth across product segments in general
Over the past five years, we can see that NESN has been delivering steady sales growth across all of its product segments with the exception of the water segment. The segment declined by 12.5% YoY in 2022 while the other segments improved between 3.3-18.9% YoY within the same period.
Geographical revenue breakdown
The biggest chunk of revenue comes from the North America region holding 35.0% of the total group revenue, followed by Europe (23.6%), Asia, Oceania, and Africa (22.2%), Latin America (13%) and Greater China (6.1%).
Given the wide variety of geographical revenue contributions, I find that NESN is also sensitive to volatility in currency movements. Note that in the 1HFY23 financial results, NESN reported a total sales growth of 1.6% YoY. This is despite a 9.8% increase in product pricing and 8.7% in organic growth which were mostly offset by factors like a lower foreign exchange impact of -6.7%, net M&A impact of -0.4% and Real Internal Growth (RIG) decline of -0.8%.
Great momentum from eCommerce sales
The eCommerce sales have a CAGR of 16.4% between 2018-2022 on the back of growing organic growth creating sales momentum, especially within the North America, Europe and Greater China region. By 2025, NESN is committed to capturing 25% of total sales from online to become a “data-powered, fully digitised experience-brands company” by 2025. Looking at the company’s progress, I find them to be on track to meet their online sales target.
Other Financial Analysis
Net gearing surpasses the 110% mark in 2022
NESN net gearing which is also the net debt to equity ratio increased to 111.3% (+50.7%-pts YoY) in 2022. The sudden increase in net gearing was caused by a lower cash and cash equivalents level due to a higher dividend payout ratio in 2022 of 83.2% vs. 45.4% in 2021 and undertaking a share buyback exercise of CHF10.5bn in 2022.
FCF yield declined to 2.0% in 2022
Moreover, the pandemic after-effect has also affected the free cash flow (FCF) yield which declined to 2.0% (-3.5%-pts YoY) in 2022. The free cash flow was affected by a temporary increase in inventories to manage global raw material shortages and supply chain disruptions. With time, I believe the FCF yield will normalise as conditions start to improve as we enter a new normal post-pandemic. We are already seeing improvements in the FCF and inventory levels in the 1HFY23 results.
Financial Outlook
Revenue is projected to CAGR at +2.9% for 2022-25E
According to consensus, NESN's total revenue is projected to grow at a CAGR of 2.9% between 2022-2025E. Note that the management is projecting NESN to deliver 6-7% in organic growth for 2023E and mid-single-digit organic sales growth in 2025E.
The growth in revenue growth is expected to come from organic population demand growth to be partially offset by inflation and volatile foreign exchanges.
Net profit is projected to CAGR at +13.1% for 2022-25E
On the other hand, the net profit is projected to CAGR at 13.1% for 2022-25E on the back of 1) steady sales growth, 2) improvement in gross margins as management continues to operate at the right costs through better costs management and 3) continuous investments in improving operation efficiencies.
Improving operating margins
According to NESN's recent quarterly results briefing presentation, management expects to sustain its underlying trading operating margins around the 17.5% level for 2023E and plans to maintain the level till 2025E at around 17.5-18.5%. This is despite declining gross margins from high raw material prices resulting in increasing costs of sales.
With the right cost management, expert hedging in soft commodities as well and continuous investments in operational efficiencies, NESN is on track to deliver healthy operating margins. Note that its 1HFY23 trading operating profit margins stood at 17.1%.
Key Drivers
Continued growth from emerging markets
The emerging markets which exclude North America, Europe, Australia and Japan have been delivering better than the group’s 10-year average growth across its organic, pricing and Real Internal Growth (RIG) aspects. The growth is supported by NESN’s 5 Research and Development (R&D) locations, 188 factories and 165,000 employees worldwide.
This is further supported by the group’s strong and deeply rooted presence in the emerging markets. Some countries like Greater China, Brazil, Philippines and India consuming NESN’s products for over a century.
NESN's longest emerging markets presence
General growth in the consumer business
According to NESN’s various resources, the Consumer market is expected to grow in mid-single digits in 2023-2025. This is driven by 1) increasing population and purchasing power, 2) leveraging on digitalisation, and 3) capturing premium and affordable opportunities.
Consumer market to grow in mid-single digits in 2023-2025
Unlock growth by evolving the sales channels
On top of selling NESN’s products through traditional, modern trade and e-commerce channels, the group is evolving to the out-of-home category to unlock further sales growth. By leveraging new business models, the group is able to capture more sales from more sales channels.
Evolving sales channels
Key Risks
Despite the rosy outlook, I am cautious of the following risks which may limit earnings delivery by NESN;
Geopolitical tensions may affect trade routes and deliveries to customers as well as supply chain disruptions,
Volatile commodity prices which may affect costs of sales thus the gross margins performance,
Increasing inflation may dampen consumer sentiment thus reducing their propensity to spend, and
Financial results coming in below consensus estimates and management earnings guidance.
Company Valuations
Historical PE Peers comparison
According to Simply Wall Street, NESN is currently trading at 29.3x historical PE which is on the pricier end of its peers’ average PE of 24.2x. Even then, I believe the current PE seems to be justified considering its market leadership position in the global food and beverages industry.
NESN’s higher PE vs. peers is justified
Short-term valuation
The share price has declined by 2.7% YTD. It is currently trading below its five-year historical forward mean PE of 23.7x. At current levels, the share prices seem to be slightly undervalued on a one-year forward earnings basis.
Mid-term valuation
On a mid-term basis, considering the robust earnings outlook, I do find the stock to be attractive. At the time of writing, NESN's share price was trading at CHF105.22/share.
Below are my target price projections assuming that the stock may be trading between 25-35x forward PEs based on consensus earnings forecasts between 2023E to 2025E.
Target Prices (CHF) to various PEs based on consensus forecasts
Upside potentials based on consensus earnings forecasts to various PEs
At current levels, or even if there is a correction below the CHF100.00/share mark, the stocks seem to be attractive. The risk here is when earnings forecasts come below the consensus estimates thus lowering the projected target prices assuming the same forward PEs.
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Disclaimer: Please note that by signing up on any of Simply Wall St’s paid plans through my affiliate link, I get some commission to support my substack at no additional cost to you. I am currently considering but have not yet invested in the stock at the time of writing. All contents on this website are only my personal opinions and thoughts. Please do not construe them as financial advice or investment advice. You should do your own research and due diligence before making any financial and investment decisions.
Nestlé S.A. - expanding its operating efficiencies
Love the breakdown. Great analysis.
I will include your article in my Monday post "Emerging Market Links + The Week Ahead (September 18, 2023)" as Nestle is huge in emerging markets... Note that Nestle also has some local units listed in certain emerging market countries...