Nestle US confectionery assets include Butterfinger brand

Nestle US confectionery assets include Butterfinger brand

Confectionery, particularly chocolate, is one of Nestle's flagship businesses and has often been the subject of speculation among industry watchers and the investment community. At the turn of this decade, talk centred on whether Nestle would look to build its position in confectionery through the acquisition of a company like Switzerland's Lindt & Sprungli but, in recent quarters, the chatter has switched to whether the KitKat maker would look to quit the sector. Nestle's announcement yesterday (15 June) of plans to review the future of its US confectionery business has sparked a debate among analysts covering the world's largest food group. Dean Best reports.

About a decade ago, talk about whether Nestle would buy Lindt & Sprungli would regularly hit the headlines, with some industry watchers arguing the upmarket Swiss chocolate maker would be a tasty target for the KitKat maker should it wish to build a strong position in the growing premium end of the market.

In the spring of 2013, then Nestle chairman Peter Brabeck-Letmathe reportedly poured cold water in the chatter, telling reporters in Switzerland the world's largest food maker had no interest in buying chocolate companies. Nestle has spent much of the last 20 years expanding its position in the healthier parts of the sector. In 1997, Nestle set up a nutrition strategic business division, which was to evolve into Nestle Nutrition in 2006. In 2011, the company created a division focusing on specific dietary needs, Nestle Health Science. Nevertheless, Nestle's management insisted its portfolio of confectionery products, which also include Crunch, Cailler and Rowntree's Fruit Pastilles, was not at odds with this push into health and nutrition.

The just-food interview from July 2013: Nestle CEO Paul Bulcke expounds benefits of "good food, good life"

However, a change of CEO always sparks speculation of new priorities and it has been no different since Mark Schneider joined Nestle from Germany-based healthcare company Fresenius at the start of the year. Add to that the pressure on packaged food majors from some in the investment community to offload slow-to-no growth assets, plus the trend of declining sales and margins from Nestle's confectionery business and talk among industry watchers has grown about whether the new Nestle CEO could look to offload what, to some, is a totemic part of the Swiss food giant.

"Whilst unthinkable before, the shedding of Nestle's confectionery arm may become a very real scenario in this transition," Euromonitor analyst Lianne van den Bos wrote in February. "To date, it carries the second lowest trading operating profit compared to its other divisions, and clearly does not fit the wider portfolio."

Nestle does not appear prepared to go quite that far but yesterday (15 June) signalled it could be set to offload part of its confectionery operations. The company plans to "explore strategic options" for its confectionery business in the US, including the possible sale of a division that includes brands like Butterfinger and Raisinets. Nestle said the review, which it expects to be completed by the end of the year, only covers its confectionery assets in the US. It insisted it "remains fully committed to growing its leading international confectionery activities around the world, particularly its global brand KitKat". Nestle made the announcement yesterday afternoon after the markets closed in Europe. Today, investors seem to have reacted positively, with shares in Nestle up 2.47% at CHF83 at 13:48 CET.

According to data from Euromonitor, Nestle is the fourth-largest confectionery business in the US, with a market share of 5.2%, behind Mondelez International in third with 6.3% and then a jump to Hershey in second (23%) and Mars first (25.2%). Nestle said yesterday its US confectionery sales were around CHF900m in 2016, representing around 10% of its total confectionery sales last year.

In 2016, Nestle's total, global confectionery sales were up 1.8% at CHF8.68bn, although the trading operating profit margin from the division was down 30 basis points at 13.7%. By comparison, in 2012, Nestle's total confectionery sales were CHF10.44bn, while the division enjoyed trading operating margins of 17.1%. MainFirst analyst Alain Oberhuber cites Nestle's "weak" US confectionery business as one of the factors in those declines. And, reflecting on the performance of Nestle's overall confectionery business in 2016, the company itself singled out the US as "disappointing, impacted by the competitive environment and low growth in the mainstream chocolate market".

Responding to Nestle's announcement yesterday, Oberhuber said: "It's a first step away towards health and wellness, and towards higher return on capital employed," Oberhuber said. "It became clear Nestle is too small in the US confectionery market with a weak number four market position and a market share of just 9%. Nestle has never been able to obtain KitKat's licensing rights from Hershey [and] it missed out on the trend to premium in particular in the US premium chocolate segment."

Nestle's announcement, if one assumes it will eventually lead to a sale of the business, received a more cautious response elsewhere in the investment community. "We can understand some of the potential rationale for the strategic review but, on balance, we would disagree with the move if it leads - as it probably will - to the eventual sale of the business," Sanford Bernstein's senior research analyst on the European food sector, Andrew Wood, said this morning.

Wood argued an exit from the US confectionery market could hamper Nestle's remaining businesses in the sector. He suggested Nestle could miss on any future strategic moves in the sector overall and, more specifically on the US, would not be able to capitalise on the trend of "premiumisation" in the country's confectionery market.

"We are frequently reminded of the view of Brabeck-Letmathe, which we would paraphrase as in order to be a strong global leader you have to be strong in the world's biggest and strongest market. Of course, there could be a reasonable debate as to whether Nestle is strong in the US market but total withdrawal could significantly hinder Nestle's global position," Wood said.

"If confectionery remains a fundamental part of Nestle's long-term strategy, will the disposal of its US business hinder prospects for long-term strategic progression? For example, what if Hershey puts itself up for sale? What if somebody else buys Hershey and the rights to KitKat revert to Nestle? What if Lindt or Ferrero become available? In these cases - and possibly others - the sale of Nestle's US business could weaken its ability to compete for or manage these assets. Of course, it may be many years - or even decades - before any of these opportunities arise but Nestle has always prided itself in taking the long-term view and short-term expediency at the cost of long-term opportunity does not seem like the Nestle way."

Elsewhere, there has been the suggestion Schneider and Nestle should go further and exit the confectionery sector completely. "The assets would be more attractive if Nestle decided to sell its entire worldwide confectionery business," Pablo Zuanic, an analyst at US investment and trading firm Susquehanna International Group, said. "If Nestle is going in a different strategic direction globally (its new CEO came from Fresenius), we would suggest they sell their entire global confectionery business. That way they would also maximize the value of those assets."

Such a move would be a bold one to make, not least by a CEO only a matter of months into the job. Moreover, a brand like KitKat remains a significant part of the Nestle portfolio, with solid positions in markets like the UK and Japan. While there is some weight to Zuanic's assertion selling all of Nestle's confectionery assets could present greater value than just the US arm, the company's Stateside confectionery business does appear to be in a weaker position than in other markets worldwide, with sales under pressure and generating lower margins amid some stiff competition and a proliferation of snacking options, especially healthier items.

Whatever the pros and cons what looks set to be an exit from US confectionery, it is unlikely this review will be the last strategic move undertaken by the new Nestle CEO.

"We view the business as subscale and suspect other parts of confectionery, a market undergoing structural challenges, could go as part of a portfolio overhaul," Kepler Cheuvreux analyst Jon Cox wrote. "We expect disposals - and acquisitions - under new CEO Mark Schneider, who is looking to reaccelerate growth. We argue that the disposal of confectionery, frozen/chilled and cereals could raise CHF40bn, add 50 basis points to group margin and growth, and fuel M&A in nutrition."

And, looking further ahead, Cox suggested: "More recently, we believe a takeover/merger with Danone could make sense as a way to build a European champion large enough to withstand a potential takeover by 3G/Kraft and the aggressive cost-cutting business model dominating in North America."

Interesting times at Nestle with a new man at the helm.