|Marktkapitalisierung||310.5 billion USD|
|Dividend Stability||0.98 (max. 1.0)|
|Cash-Flow Stability||0.90 (max. 1.0)|
The Nestle stock enjoys great popularity. Shareholders appreciate the high-quality company, which increases profitability and margins over decades and of course pays dividends. Admittedly, the stock is currently not cheap. But as you will see in a moment, the stock is not expensive, either.
Nestle is a Swiss multinational food and beverage company which owns a wide variety of well-known brands such as Nescafé, Nestea and Kit Kat. Most of these brands are in the foods and beverages category, but the company also owns cosmetics brands like Garnier and Maybelline through its ownership in L’Oréal.
Nestle reported full year 2019 results back in the middle of February. Results came in largely as guided, with organic sales growth of 3.5% vs. 3.5% expected. The underlying operating margin came in at 17.6% which is a 0.6 percentage-point increase over the prior year and 0.1 percentage-points higher than the 17.5% the company guided for.
Next to sales and operating margin, all the other important financial metrics improved as well and quite substantially at that. Net income increased 24.4% to CHF 12.6bn which drove a 28% increase from CHF 3.36 to CHF 4.30 in earnings per share. Underlying EPS increased 9.8% from CHF 4.02 to CHF 4.41. Proceeds from the sales of Nestle Skin Health contributed to net income, but the growth in underlying EPS was mainly a result of improved operating performance, with 1.9% contributed by share buybacks. Free cash flow increased 10.9% to CHF 11.9bn, also driven by improved operating performance. Nestle stated that they expect FCF to remain at around 12% of sales. As a result of better profitability, capital efficiency also improved slightly with ROIC increasing 20bps to 12.3%.
Source: Company presentation
Nestle continually adjusts its product portfolio to stay on top of consumer trends and capture growth opportunities and does not hesitate to divest underperforming businesses. Selling underperforming assets might sound trivial, but companies often hold on to those assets for far too long thinking they can turn things around. Obviously, jumping ship too early is just as bad. Nestle has shown that they are good at judging the viability of a business and this ability has materialized in organic sales growth. Another quality that sets Nestle apart from other companies is the fact that it derives most of its organic growth from volume as opposed to price. Of the 3.5% organic revenue growth in 2019, only 0.6% were contributed by price effects.
The company has also proven its ability to improve profitability despite its size. The operating margin (red line in the graph below) which is not as susceptible to one-time effects as the net margin, has trended upward during the past two decades. Nestle achieves this through cost discipline and divesting underperforming assets to avoid them being a drag on performance. Divestitures are also a reason for revenue declines in individual years since the revenue that the business generated is lost after divesting it. This is one reason for the variation in the revenue curve.
We also see a definitive upward trend in operating cash flow generation. This is unsurprising given that increased profitability in the form of a higher operating margin coupled with increased revenues translate into higher cash flows. Admittedly, increasing revenues only played a part in some periods as you can see in the revenue chart. In some periods we see an increase in revenues while it declined in other periods (Most likely due to divestitures as mentioned previously). Another reason for the increase in per-share results is the fact that Nestle buys back its own stock. Between 2017 and 2019, the company bought back CHF 20bn worth of stock and plans to spend the same between 2020 and 2022. This decreases the number of outstanding shares, which in turn means that the cash flow is divided among less shares and is therefore higher. Higher cash flows also enable the company to pay out higher dividends to shareholders.
Nestle has proven its commitment to shareholder returns by its strong track record of increasing dividends. The company increased its dividend for 23 consecutive years and the proposed CHF 2.70 for FY19 marks the 24th increase in a row.
Also, by maintaining a conservative payout ratio, the company ensures that they can keep the dividend constant in difficult years. The consistency of demand for its products also enables Nestle to do well in times when other companies struggle. In 2008 and 2009, when other companies reduced or suspended their dividends, Nestle raised its distributions quite substantially. The proposal for FY19 is a 10% increase over the previous year.
Nestle remains excellently capitalized with a debt to equity ratio of 0.7x and a leverage ratio of 2.42x. The debt to equity ratio only considers the financial debt of the company and compares is to the equity. In this case, Nestle has less financial debt than equity on its balance sheet which is a good thing. The leverage ratio also considers other liabilities and compares the total assets of the company to the equity position. Here, Nestle has total assets worth 2.42 times its equity which also fine.
The current debt to assets is 54.5%. This means that about half of the company is financed by debt. Note that treasury stocks are added back to the assets in this calculation to adjust for the effect of buybacks.
Conservative debt usage and strong profitability materialize in a 13x interest coverage for the year 2019. The company also finished FY19 with a considerably higher cash cushion compared to the previous year. As of December 31, 2019, Nestle had CHF 7,469 in cash and cash equivalents and an additional CHF 2,794 in short-term investments for a combined total of CHF 10,263. This is roughly 1.4x what they paid out in dividends during 2019. You can also see this yourself in the graph below, if you divide the cash & equivalents (yellow bar) by the dividend amount. This 10,263/7,230 ≈ 1.4x.
[stock_market_widget type=”chart” template=”basic” color=”blue” assets=”NESN.SW” range=”10y” interval=”1d” axes=”true” cursor=”true” api=”yf” style=”height: 350px;”]
The stock of Nestle is certainly not cheap given its P/E ratio of 24. This is quite high for a company which grows at around 3% a year. The justification for the elevated price is that Nestle’s business model is extremely robust, and its earnings and cash generation are therefore stable in every economic environment. To find out whether the current price of CHF 105 is reasonable, I valued the company using a discounted cash flow valuation. I assumed that the company would continue to grow at its targets of low- to mid-single-digits and that the operating margin would gradually improve to 20% within 5 years. For these assumptions, I get a fair value estimate of CHF 104 per share which translates into $108 per share. This is right at the current trading price, indicating that shares are fairly valued right now.
Historic multiples indicate a slight overvaluation on the other hand. The dividend-fair value for the stock is CHF 89 at this point in time.
But if we adjust the valuation period to the last few years, we get a fair value estimate of up to CHF 101.
In recent years, the market has realized that Nestle is worth a higher price. Especially in the low interest rate environment and the current coronavirus outbreak, a stable and safe business should be worth a lot more than it used to be in previous years.
When the company released the results for the year 2019 on February 13, 2020, it stated that the financial impact of the Covid-19 outbreak could not be quantified at the time. Originally, Nestle guided for revenue growth and operating margin expansion in 2020. In the quarterly release on April 24, 2020, the company reiterated that the Coivd-19 impact remains an uncertainty. Nestle did however provide the insight that its business segments are affected to differing extents. Prepared meals and pet care products showed an increase in demand while confectionary sales declined. Most importantly, the company reaffirmed that they still expect revenues to grow and margins to expand in 2020.
Nestle is an excellent business with a healthy capital structure, strong profitability that has been consistently improving for several decades and a management that is committed to increasing shareholder returns. The Covid-19 impact on the company should be very limited given its product portfolio of essential products for which demand should stay consistent, regardless of the current situation. Unfortunately, this stability and safety has kept the share price at high levels. Despite the fact that historic multiples indicate an overvaluation, I think shares are fairly valued today when accounting for future improvement potential. I also think the fact that Nestle is one of the few companies who will not be materially impaired by the Covid-19 pandemic is something that investors should appreciate. For this reason, I think shares of Nestle are reasonably attractive for their safety right now.
I have no position in any of the securities mentioned in this article and no intend to initiate a position in the next 72 hours.
This is neither an offer nor a recommendation to buy or sell securities. The points presented in this article are estimates and opinions of the author and may or may not correctly indicate the future.
I am not a financial advisor and this report is not to be considered financial advice. Please always conduct your own research and consult a financial advisor before making any investment decisions.
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