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October 31, 2019

Nestle may soon show how rules of game have changed in China

Nestlé's business in China may be set for significant changes. If they materialise, what would it signify for the world's largest food maker's operations in the market?

By Dean Best

Nestlé is reportedly weighing up options for two of its under-performing Chinese businesses. Should deals for Yinlu and Hsu Fu Chi materialise, it would not mean Nestlé is pulling back from China but, Dean Best reports, pragmatically redrawing its business for a market where old expansion strategies no longer apply.

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Could Nestlé’s business in China, the company’s second-largest market by sales, be set for some significant changes?

Yesterday (30 October), Bloomberg reported Nestlé is weighing up options for two of its Chinese businesses – Yinlu and Hsu Fu Chi – which have both seen sales come under pressure.

It’s important to note Nestlé declined to comment, saying when contacted by just-food the company does not comment on market speculation. However, should deals of some sort materialise – be they a selling down of Nestlé’s stakes in both businesses or outright disposals – it would not come as a huge surprise.

And, importantly, the moves would demonstrate the world’s largest food maker has – correctly – recognised the rules of the game in China have changed.

What multinational FMCG companies need to do to succeed in China is different from two or three decades ago. In the wake of China starting to open up to foreign investment in the late 1970s and early 1980s, multinationals across a range of industries – including packaged food – stepped up their presence in the country over the next 30 years, with many seeking a blanket, one-size-fits-all approach, selling into mainstream categories and investing in local, mainstream businesses.

But China has changed. Modern Chinese consumers have very different demands and habits to their parents. They are increasingly looking for more premium products, for healthier foods and for lifestyle brands. The shift to online shopping in China – more advanced than in many other western markets – has also upended the way FMCG categories operate there.

Nestlé invested in peanut milk and porridge maker Yinlu and in confectioner Hsu Fu Chi in 2011, emphasising the “entrepreneurship, product expertise and consumer understanding” of the former and the “entrepreneurship” and “strong brands” of the latter. The Swiss giant first acquired a 60% stake in Yinlu in 2011, upped that to 80% in 2017 and then to 100% last year. Nestlé also bought a 60% stake in Hsu Fu Chi – a shareholding that has stayed at that level ever since.

Even in 2011, both deals were classic emerging-market plays; investing in local businesses with solid local distribution and an understanding of the local consumer.

However, both units have had specific challenges, predominantly from stiff local competition, and Nestlé has been struggling to breathe fresh life into the assets.

Yinlu, the maker of ready-to-drink peanut milk and of congee, a rice porridge, has proven a headache for Nestlé a number of times in recent years. When Nestlé CEO Mark Schneider reported Nestlé’s 2018 financial results in February, he grouped Yinlu among businesses on a slide titled ‘Fixing base business’. He said Yinlu had had “fairly negative growth rates in 2015 and 2016” but had seen Nestlé “stabilise the situation” in 2017 and had “more growth coming through” in 2018.

However, fast-forward to two weeks ago when Nestlé reported its group sales for the first nine months of 2019 and Schneider had a less positive message. “We’ve seen a disappointing year when it comes to congee and peanut milk and so we’re working very hard to address that situation,” Schneider admitted.

Not all elements of the Yinlu business are in the doldrums. Two-thirds of Yinlu’s CHF1bn (US$1.01bn) in sales come from local products. The rest comes from ready-to-drink coffee. In China, Nestlé runs its ready-to-drink coffee business –  Shakissimo – out of Yinlu and reports from that unit have been better.

“Yinlu, in particular the peanut milk, as well as the congee, is not performing well. It’s further contracting,” Alain Oberhuber, a consumer-goods analyst covering Nestlé for German bank MainFirst, says. “It has a low market share, low growth and also, regarding growth, margins and return on capital employed, it’s a soft brand. It’s good to get rid of that. Shakissimo, I guess they would like to keep that because that’s performing fine.”

Oberhuber says the issues facing Hsu Fu Chi, though like Yinlu centred around tough local competition, have been more recent. However, he argues there could be some weight to the rumours due to the overall position of confectionery in the global Nestlé portfolio, with not just the US business sold off but brands in markets including Australia and Europe offloaded recently.

“Hsu Fu Chi performed well when they acquired it but, since the beginning of this year, it looks like growth has softened, in particular in Q3. That’s what we assume,” Oberhuber says. “Therefore, [Schneider] is probably looking also into that business, in particular, because confectionery itself is not a core category any more for Nestlé.”

Schneider and Chris Johnson, the head of Nestlé’s operations in Asia, have both spoken in recent months about how Hsu Fu Chi suffered during the key Chinese New Year selling period this year and both have been keen to point out how the business was not the only one in the industry affected.

A fortnight ago when Nestlé reported its sales for the first nine months of this year, CFO François-Xavier Roger cautioned it was too early to give a verdict on how Hsu Fu Chi would have performed in 2019 as a whole. “It’s too early to draw conclusions for the year because it’s a very seasonal activity that we have. We need to wait for Chinese New Year to have more visibility there,” Roger said, before adding: “Hsu Fu Chi is largely in the mainstream offering, which is traditionally a category that is suffering a little bit more.”

Analysts at Zurich-based investment bank Vontobel say when Nestlé invested in Hsu Fu Chi in 2011 the Chinese firm’s sales were CHF670m. Due to the way exchange-rates have moved since – and with the underlying growth the unit has seen – the bank estimates its sales are now at around CHF700m.

Weighing up the two businesses, Jon Cox, an analyst covering Nestlé for French brokerage Kepler Chevreux, suggests the manufacturer is reappraising how it does business in China.

“This is probably an indication that they’re moving more to focus on returns and really focus in terms of market segmentation, rather than the blanket ‘we want to be all over the aisle’ approach historically,” Cox says.

“If it’s true, I don’t think it’s a bad thing. If you look at both brands, they’re a bit dusty and probably don’t appeal to millennial consumers in China who want healthy, new, lifestyle brands, rather than stuff that potentially their grandparents were consuming. From that perspective, it probably makes sense but the most important thing is it shows Nestlé is really being much more granular when looking at individual markets rather than ‘Okay, we want to be in China, we’re just going to be in everywhere.’ You don’t need to do that any more because different parts of the market growing at different speeds.’

Other parts of Nestlé’s business in China are doing well. During a conference call with analysts to discuss the company’s nine-month sales, Roger called out the performances of pet care and ice cream. They are issues with parts of Nestlé’s infant-formula business but it is having success with brands positioned as premium, such as Illuma.

“China was flat due to softness in some categories where we are seeing different dynamics between price points,” Roger said. “Super-premium offerings such as Illuma [infant formula] and Purina [pet food] grew well, while mainstream products like Yinlu peanut milk, congee and S-26 [infant formula] were challenged. This polarisation of consumption patterns between premium and mainstream is consistent with Nielsen and Kantar findings.” 

Since Schneider took the helm at Nestlé two-and-a-half years ago, he has demonstrated a readiness to cut loose business units he deemed were not performing to his satisfaction or were not central to the company’s strategy. Deals have been done for assets including Nestlé’s US confectionery arm, frozen-food brands in Italy and its skin-health business, with others – like much of the Herta meats unit – under review. 

“Post the nine-month sales, we wrote: ‘The strong performance in the two most profitable divisions, pet care and coffee, must not overshadow the ongoing issues in mainstream waters and some businesses in China. More disposals ahead?’ Vontobel analyst Jean-Philippe Bertschy says. “Nestlé continues to invest in the brands as the costs-savings programme is gaining traction ahead of the plan. Management, however, is not neglecting the portfolio with an ongoing streamlining of under-performers. We like the speed of the execution of the plan.”

More specifically to China, if Nestlé does sell either Yinlu or Hsu Fu Chi (or both), it would demonstrate the world’s largest food maker has acknowledged the rules of the game in China have changed, leaving the group to focus on areas like coffee and infant formula, categories that offer opportunities to leverage the premium and health trends shaping the FMCG market in the country.

Related Companies

Free Whitepaper
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What is the impact of China’s Zero-COVID lockdowns on economic activity, consumer goods and the foodservice industry?

While wanting to protect the country from being overwhelmed by Omicron, China’s adherence to a Zero-COVID policy is resulting in a significant economic downturn. COVID outbreaks in Shanghai, Beijing and many other Chinese cities will impact 2022’s economic growth as consumers and businesses experience rolling lockdowns, leading to a slowdown in domestic and international supply chains. China’s Zero-COVID policy is having a demonstrable impact on consumer-facing industries. Access GlobalData’s new whitepaper, China in 2022: the impact of China’s Zero-COVID lockdowns on economic activity, consumer goods and the foodservice industry, to examine the current situation in Shanghai and other cities in China, to better understand the worst-affected industry sectors, foodservice in particular, and to explore potential growth opportunities as China recovers. The white paper covers:
  • Which multinational companies have been affected?
  • What is the effect of lockdowns on foodservice?
  • What is the effect of lockdowns on Chinese ports?
  • Spotlight on Shanghai: what is the situation there?
  • How have Chinese consumers reacted?
  • How might the Chinese government react?
  • What are the potential growth opportunities?
by GlobalData
Enter your details here to receive your free Whitepaper.

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