Summary

• Nestle is global food giant with market cap of CHF 313 B and wide range of products produced and marketed all over the world.
• The company has paid dividend for 61 years and has increased it for 26 consecutive years. Dividend is safe and the management is committed to increasing it every year.
• Strong appreciation of the Swiss franc impacted otherwise strong sales and earnings. Pet Care and plant – based food contributed most to organic growth.
• Share buybacks have led to the increase in debt. However debt is well covered by operating profit and operating cash flow.
• Resilient high – quality business is already trading at high P/E multiple leaving less scope for stock price appreciation and future investment returns.

Dividend    Revenue    Profitability    Financial Strength    Investment Case

Swiss food giant Nestle (NESN) produces prepared dishes, cooking aids and pharmaceuticals. With market capitalization over CHF 313 B it is one of the largest food company in the world operating in 186 countries.

Nestle has the following reporting geographical zones:

• AMS – North America, Latin America, Caribbean;
• EMENA – Europe, Middle East, North Africa;
• AOA – Asia, Oceania, sub – Saharan Africa.

The company has the following divisions by product category:

Powdered & Liquid Beverages, Water, Milk Products & Ice Cream, Nutrition & Health Science, Prepared Dishes & Cooking Aids, Confectionery, PetCare.

The company owns such brands as Nescafe, Kit Kat, Maggi, Nespresso, Perrier and others. Nestle invests in R&D around CHF 1.6 B per year and develops solutions to meet fast – changing consumer needs.

Over 2020 the company completed the acquisitions of Lily’s Kitchen, Freshly, Mindful Chef which, among other, expands meal delivery services. Acquisitions of Zenpep, Vital Proteins Aimmune Therapeutics were made to strengthen Health Science division. Nestle sold several underperforming businesses such as water brands in North America and confectionary businesses.

Dividend

Dividend	Dividend Yield	5Y Growth	PayOut Ratio	Ex-Dividend Date
CHF 2.75 per share	2.5%	4% per year	64%	2021 April 16

Despite the pandemic related disruptions Nestle increased dividend. Now it is about 2% higher than in 2019. That is less than 5 years average dividend growth of 4%. Dividend has been increased for 26 consecutive years. The company is committed to increase dividend every year. According to the company it has maintained or increased dividend over the last 61 years.

Dividend yield, 2.5%, is in line with peers: majority of large companies in this industry have dividend yields in the range from 1% to 3.3%. Dividend is well covered with payout ratio of 64% and free cash flow (FCF) coverage of 1.3x. Also dividend sustainability is improved by the company’s practice of share buybacks.  It has the three – year CHF 20 B share buyback program that began in January 2020.

In its outlook the company intends to increase sales growth and improve profit margins. That should allow Nestle to return to 4% average annual dividend growth in the coming years.

Revenue

Revenue	5Y Growth	Organic revenue growth over 2020	Mid-term Outlook
CHF 84.3 B	-1% p. a.	Total sales                                    +3.6% Powdered & Liquid Beverages +3.2% Water                                            -7% Milk Products & Ice Cream        +7.9% Nutrition & Health Science        +1.7% Prepared Dishes & Cook. Aids   +4.7% Confectionery                             -1.5% PetCare                                        +10.2%	Nestle expects sustained mid single – digit organic sales growth.

Organic growth was highest in the last 5 years at 3.6%. Sales grew strongest in Americas. Divestures decreased sales by 4.6% and forex changes reduced sales by 7.9% as the Swiss franc appreciated vs other currencies. Hence total sales decreased by 8.9% over the year.

Organic growth was highest in PetCare division, over 10%. Dairy was up about 8% mainly due to higher demand for home – baking products. Powdered & Liquid Beverages division was up about 3% due to stronger demand for Starbucks products, Nespresso & Nescafe. Nutrition & Health Science’s organic growth was 1.7% though its Health Science part grew at double – digit rate due to higher demand for healthy food. Water was down 7% as sales in out – of – home channels were low due to the pandemic related restrictions.

To support sales growth the company constantly explores consumer trends and develops new and existing products. Decentralized business model allows fast response to shift in consumer needs and tastes.  The company invests in high growth categories and platforms, in trusted brands and regions with high growth potential. Last year E-commerce grew over 48% and was almost 13% of total sales. The company will enhance digital capabilities further by developing ecosystems across each of product categories.

Recently the company reported the first quarter sales. Strong momentum in retail sales, market share gains across most geographies, recovery of out – of – home channels resulted in strong organic growth of 7.7%. Emerging markets growth was 11.4% and developed markets 5%. The quarter was the best over at least the last two years.

So mid – single – digit organic sales growth targeted by the company in its outlook should be achievable.

 Profitability

Profit	5Y Growth	Net Profit Margin	ROE	Mid – term Outlook
EPS CHF 4.3; Net Profit CHF 12.2 B	8.2% p. a.	12.52%	23%	Moderate underlying operating profit margin improvements.

Reported EPS was unchanged and net profit decreased by 3% to CHF 12.2 B. Due to share buybacks the number of shares was down from 2.88 B to 2.82 B and that contributed to EPS increase. Underlying EPS increased by 3.5% in constant currency and decreased by 4.5% on a reported basis. So Swiss frac appreciation has a major impact on the company results. The company works on improving operational efficiency at all levels of business. Underlying operating margin increased by 20 pbs to 17.7%, supported by cost reductions and portfolio management. The company’s 5 years EPS growth is impressive 8% per year and in the last three years even higher. Expected sales growth, efficiency measures Nestle implements and the focus on higher profitability products and segments should let EPS to grow faster than sales in the future.

 Financial Strength

Company Capital Structure (in CHF B)

Year	2019	2020
Equity	52.035	45.695
Cash	7.469	5.235
Debt	37.164	39.347
Net Debt	27.1	31.3
Debt/Equity	71%	87%

Net debt was higher at the end of the year mainly due to share buybacks of CHF 6.8 B completed in 2020 in line with three years share buyback program. Debt -to-Equity ratio of 87% is quite high. However the company’s debt is well covered as interest coverage by operating profit is 15x and operating cash flow is 36% of the debt. So Nestle can handle debt with ease.

 Investment Case

The estimate of future stock price and investment returns based on P/E ratio

Assumptions of dividend and EPS growth over the next 5 years
Dividend could grow at 4% per year to CHF 3.35 per share. So the total dividend income over the next 5 years would amount to CHF 15.49. We could assume EPS growth of 6% p.a. Then EPS in 5 years will be CHF 5.75 per share.
Projected stock price
Average P/E over the last 5 years (20.84) multiplied by EPS in 5 years = 20.84 x CHF 5.75 = CHF 119.92
Future Returns Based on the Assumptions
Stock price upside potential                                    10%    from the current price CHF 109.12 Overall return on investment*                                  24% Compound Annual Return on Investment               4.4%

*- Includes the expected dividend income over the next 5 years and dividends are not reinvested.

The company showed significant resilience in the face of the pandemic. It has portfolio diversified across geographies, products and channels and the management is focused on building profitable high – growth businesses.  However this sustainable good quality business is already highly valued by investors as the company is traded at higher P/E multiple than historical average. Hence there is less scope for stock price appreciation and overall investment return. So this is low risk and moderate growth company suitable to be part of a balanced portfolio. 

Disclosure:

I have no position in the stocks mentioned in this article and do not intend to initiate any positions within the next 72 hours.

Notes

Data source – the company’s financial reports, presentations and its website. Source of pictures – the company website unless otherwise stated. Colored circles next to headings mean an author’s evaluation of the relevant performance criteria of the company: green means positive, yellow neutral and red negative evaluation. There are many ways to estimate the future stock price. We use only one of them, the one based on P/E ratio. All estimates made in the article are for the informational purposes only. No taxation, brokerage fees and other expenses related to investing are considered in the estimates. The estimates are the result of the rule of thumb assumptions and the real outcome might differ materially from those estimates. As the future unfolds, macro events, not mentioned in the article, could impact the company fundamentals. Use the information in the article only as a starting point for your own due diligence.