Commodity prices should benefit agricultural investment, CEO Bulcke suggests

Commodity prices should benefit agricultural investment, CEO Bulcke suggests

Shares in Nestle dipped following the company's annual investor meeting in Vevey this week, reflecting investor concerns over spiking commodity prices. However, while the Swiss food giant did provide some candid commentary on the outlook for its input costs, it was also upbeat on its ability to continue to improve margins and drive revenues. Katy Humphries reports.

Speaking during Nestle's annual investor meeting this week (7-8 June), management painted a gloomy outlook for rising commodity prices.

Factors such as increasing demand, political instability, rising oil prices, poor weather conditions, bio fuels, chronic underinvestment in agricultural development and speculative buying on the commodities markets have all driven up prices for some of Nestle's largest ingredients - including coffee, cocoa and sugar.

Striking a tone that was to be echoed throughout the two-day event, Nestle head of procurement Kevin Petrie said that the company was being hit by "unprecedented rises in the in the price of commodities: we see tremendous volatility and headwinds".

He added that this situation was expected to continue for years to come.

According to Petrie, the world is currently in the grip of its fifth historical commodity boom cycle. The current boom began in 2004 and could continue until 2024, he said

As one of the world's largest food raw material buyers, Nestle spends around CHF60bn (US$71.5bn) a year on central procurement, of which CHF22bn is spent on ingredients and CHF8bn is spent on packaging, Petrie revealed. With such an immense commodities-related spend, it is all too clear that the swings of the commodities markets could have a grave impact on Nestle's bottom line.

Nestle said that it expects input costs this year to come in at the the high end of the company's forecast range of CHF2.5-3bn. However, Petrie also insisted that the group is working to minimise the impact that high prices and volatility have on Nestle's profitability by streamlining procurement and manufacturing.

The company has established a number of global commodities research teams in an attempt to predict pricing trends and provide early warnings for any spikes. At low points, Nestle attempts to lock-up supplies using futures contracts and hedging, reducing its exposure to price swings, Petrie added.

According to MF Global analyst Andy Smith, such initiatives mean that Nestle is well-positioned to tackle rising commodities prices when compared to its peers in Europe's food industry.

"Our analysis of the movement of the current basket of input costs suggests that Nestle is in a much better position to manage the pressures on input costs much more effectively that either Danone or Unilever," he wrote in an investor note.

Chief executive Paul Bulcke said that "raw materials prices are here to stay" and they are not something "you can sit it out". However, he does expect to see an uplift in agricultural investment and R&D, which in the long run should result in higher production. This, Bulcke insisted, was an absolute necessity to support the food requirements of the world's growing population.

"Headwinds in raw material costs ... are preconditions to have food security in the future," he said. "Agriculture is something that had been badly treated. Raw materials went down during the last 30 to 40 years."

As part of its commitment to tackle this issue, Nestle revealed that it is devoting greater resources in supporting sustainable farming and higher levels of agricultural productivity.

"The group can proudly lay claim to some impressive strides it has managed in sustainability, procurement and manufacturing, with the clear message that there is more to come," Credit Suisse analysts wrote in a note to investors yesterday. "The message was also that all this was further fuel to drive growth. Every Nestle presentation has at its heart the growth mantra, it is in the company's DNA."

Management said that it expected to drive growth in emerging markets and, while the group did not rule out bolt-on acquisitions, Bulcke insisted that Nestle's priority was investing behind its own brands.

The company said that it aims to generate 45% of revenue in its Asia, Africa, Oceania and the Middle East region by 2020. According to regional head Frits van Dijk, the group must book sales growth of "at least" 8-10% a year to hit this target.

Other growth areas identified by the company include Nestle's health science business - a unit formed this year with the goal of developing products to prevent chronic disease - and its infant formula business.

The company revealed that it plans to roll-out its BabyNes infant formula capsule system globally in 2012 in a bid to echo the success it has seen with its single-serve Nespresso machines. BabyNes went on sale in Switzerland last month.

"This has been a major innovation. We have bigger ambitions than Switzerland," said Martin Grieder, director of the BabyNes unit. "We don't want to go into details, but by 2012 we will be rolling it out to other markets."

Nestle reiterated its full-year outlook for sales growth of 5-6% and improved operating margins on a constant currency basis. The company said that it expected gains to be weighted to the second half as tough comparisons and the strength of the Swiss franc - which reached an all time high against the euro this week - are likely to take their toll on the first-half.

Despite the company's confidence in its ability to deliver results - this year and for years to come - shares in the group dipped from an open of CHF53.90 on Tuesday to close at CHF53.30 yesterday.

Credit Suisse cut its earnings estimates from CHF60 per share to CHF55 per share due to the strength of the Swiss franc, while CS Research lowered is price target on the stock and Barclays downgraded its rating from "overweight" to "equal weight".