Announcing’s Nestle 2016 results today (16 February) newly-installed CEO Mark Schneider revealed growth at the Swiss food giant came in below expectations. All eyes are now on Nestle’s direction under Schneider, who joined the business at the start of this year. Will there be a greater focus on margin enhancement? Has Schneider totally abandoned the ‘Nestle model’ targeting 5-6% organic growth each year? Could large-scale acquisitions or disposals be on the cards? Katy Askew investigates.
Subdued 2016 performance
Nestle’s 2016 organic sales and earnings missed analyst expectations.
The KitKat maker reported net earnings of CHF8.5bn (US$8.47bn), lower than 2015’s earnings of CHF9.01bn and well below analyst forecasts of CHF9.5bn. Nestle pointed to one-time expenses, including a deferred tax charge, to account for the drop.
The group also revealed its fifth straight year of slowing organic growth – which dropped to a rate of 3.2%.
Nestle CEO Mark Schneider, who took the helm at the beginning of January, said the company’s 2016 organic growth was “at the high end of the industry” but “at the lower end of our expectations”. The result, he suggested, was primarily due to a weak pricing environment as well as slowing volumes in “some key markets”.
Speaking during a press conference this morning, Schneider explained: “There were two trends under way at the second half of 2016. One is that our volume growth in some key markets decelerated. This is an across-the-board trend not something specific to Nestle; you are seeing it with all consumer goods companies. And then second, in terms of pricing, we did hope for the second half that pricing was going to improve and it did but it didn’t come in as fast or as strong as we would have hoped.”
The company was able to report higher operating profit margins, which rose to 15.3% from 15.1% in 2015. Schneider described that as a “very solid” performance.
Andrew Wood, an equity analyst covering Nestle at US investment bank Sanford Bernstein, said: “Overall, for FY2016 Nestle delivered 3.2% organic growth, 20bps margin growth, and 3% EPS growth…only broadly in-line with (recently lowered) management guidance. We had expected lacklustre Q4 sales and H2 margins/EPS, with cautious 2017 guidance, and that is what we got…except the results and guidance were even below our expectations.”
Organic growth target lowered
Looking to 2017, Nestle said it expects to deliver organic growth in the region of 2-4%. Schneider said he felt it was “prudent” to offer up conservative guidance where the “mid-point” is at the run-rate Nestle has seen over the last three quarters. “We are at a bit of an inflection point right now, we are seeing a lot of volatility in the market, we are hoping pricing may come up and help us but we don’t know when and how that will come,” he suggested.
In the longer term, Nestle said it is targeting organic growth in the mid-single digits by 2020. In many respects, that suggests Nestle is re-basing the so-called “Nestle model” that calls for organic growth of 5-6%.
At investment bank Jefferies, analyst Martin Deboo postulated: “Schneider, with the weight of expectation and a consensual long upon him, looks to be shifting the long-term algorithm away from top-line and towards margin. While organic growth is stated to be key to long-term value creation, Nestle is now aspiring to ‘mid-single digits’ rather than the old Nestle model of 5%-6%.”
However, Schneider was keen to stress Nestle is not backing away from its prioritisation of organic growth as a long-term value creator.
“Organic growth we consider key to value creation,” he insisted. “Mid-single digit mathematically softens us towards the low and the high end… in a more turbulent environment to narrow it to 5-6%, especially something you are targeting several years out, is probably not the right thing. But the underlying message… is the same: there is nothing better for an organisation in the long-term than healthy organic growth. It drives opportunity inside the company, it keeps the team motivated and on their toes, it drives overhead leverage, it drives capacity utilisation, it drives cost savings and experience curve effects in manufacturing. It does a whole lot of good things and we are committed to that… the direction remains the same.”
Balancing growth and margins
According to Schneider’s assessment, Nestle is positioned between two poles that have emerged in the food sector today. On the one side, there are what he describes as the “bottom-line guys”. These could be companies “under private-equity ownership… [or] under pressure from activist shareholders”, Schneider explained. “They basically focus on the bottom line at all cost. That may be great in the short term but there is a price most of these companies are paying when it comes to organic growth. And keep in mind you can make a saving only once… Then the question is: where is the organic growth in the future?”
At the other end of the spectrum, Schneider identified the smaller, start-up companies that are typically local and mission-based in their outlook. Here, he said, the questions are: “How much staying power do you have? How sustainable is a trend like this? How scalable is it? Does it really make sense for a large company like us to bring those trends through the market?”
Nestle, Schneider suggested, is positioned between these two extremes. “Being in the middle is a good thing… we believe we can offer a long-term attractive combination of bottom-line development and top-line development that underlines our staying power. And by doing both we can really deliver value in the long term.”
Margin ambition confirmed
Schneider confirmed Nestle’s margin target, first unveiled in May, to deliver 200 basis points of structural cost savings by 2020. “When it comes to structural costs, capacity utilisation, those are areas that are very interesting to us,” he said. “Not all of that will flow to the bottom line some of that will be used to fuel organic growth.”
Nestle revealed it will step up its restructuring efforts in 2017 and said it will “increase restructuring costs considerably” in the year. Restructuring costs will rise to CFH500m in 2017, up from CHF150m in 2015 and CHF300m in 2016.
Schneider conceded the efficiency drive could have some impact on jobs. “The restructuring levels I am talking about are not unprecedented… at the present time, I do think it is the right time to take that [initiative] but we will not deviate from dealing very fairly with our employees that are affected. Mind you, not all of [the restructuring charges] have employment consequences; some of that also is fixed costs of a certain nature that is not payroll related. This is not in a veiled way to announce any large-scale lay-offs.”
“Prudent” approach to M&A
Schneider insisted Nestle would take a “prudent” approach to M&A given the current high valuations in the market.
“M&A can be, at the right moment, the right tool to build a strategic position but it should not be a goal in and of itself. So what you will see moving forward is a prudent approach, no surprises from left field… It has to make strategic sense there has to be a good concept for how to integrate, there has to be a good culture fit… we are not in the moment trying to impress the market or create headlines… we are not swinging for the fences.”
Schneider continued: “These are heady markets and the combination of low interest rates and a lot of interest in the consumer goods area has led to lofty valuations. Those things typically don’t last forever… It is all about picking the right time, picking the right target. It doesn’t mean we will do no M&A because at the mid-sized spectrum there are a lot of opportunities that are not subject to full global market exposure.”
While Nestle has said it is not interested in any transformational acquisitions, MainFirst analyst Alain Oberhuber noted the company did not rule out further disposals and portfolio trimming. “Nestle does not show any intention to acquire larger business at the moment. However, we think that this does not exclude any potential divestments,” he suggested.
In particular, Euromonitor analyst Lianne van den Bos suggested Nestle’s confectionery business – which would seem to be out of step with its health and wellness strategy – could be a potential candidate for disposal. “The current vast restructuring plan, strong reduction of working capital and the cessation of any large scale M&A for the foreseeable future, as stated by the new CEO, signals the company is getting lean and ready for a big transformation towards health science, its key growth pillar. Whilst unthinkable before, the shedding of Nestle’s confectionery arm may become a very real scenario in this transition. To date, it carries the second lowest trading operating profit compared to its other divisions, and clearly does not fit the wider portfolio,” van den Bos believes.
For his part, however, Schneider played down the focus being placed on health science, suggesting that the company’s portfolio should be viewed in the broader context of positive nutrition.
“Let me reaffirm my personal commitment to the nutrition health and wellness strategy for the company. Upon my appointment there was for my taste too much speculation over was there a strategy change, are we turning into a pharma company, a biotech company. None of that applies. We have a very solid nutrition, health and wellness strategy… we have been doing good progress executing on that strategy. What it means is we are continuously updating in our core business the nutritional profile of our offerings, so sugar reductions for example,” he said.
Schneider also insisted confectionery products do have a place within this strategy as an “indulgence” item. “On the one hand, we all have this interest in health and better nutrition. On the other when we eat… we also creatures that are open to indulgence. In moderation there is nothing wrong with that,” he said.