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July 30, 2018

Nestle results provide food for thought – key takeaways

Nestlé revealed a generally positive set of first-half results on Thursday that were received favourably by the stock market, despite a tweak to the Swiss food giant's organic growth outlook. But what was most interesting is what can surely only be deemed as a veiled kickback by CEO Mark Schneider at activist investor Daniel Loeb. Simon Harvey looks at the key takeaways.

Nestlé revealed a generally positive set of first-half results on Thursday that were received favourably by the stock market, despite a tweak to the Swiss food giant’s organic growth outlook. But what was most interesting is what can surely only be deemed as a veiled kickback by CEO Mark Schneider at activist investor Daniel Loeb. Simon Harvey looks at the key takeaways.

Activist investors have ratcheted up the ante on some of the world’s largest food companies of late to streamline operations and boost value for shareholders, with Nestlé not escaping criticism.

Daniel Loeb, whose Third Point US investment fund reportedly owns Nestlé shares valued around US$3bn, has so far remained quiet on the KitKat maker’s latest set of results. But early in July he was more voiceful, repeating demands Nestlé ditch ill-fitting businesses such as ice cream, frozen foods and confectionery in what he said was a “call for urgency, rather than incrementalism”

For some industry watchers, however, and of course Nestlé’s own directors, Loeb’s cry to arms could be viewed as unwarranted given the efforts undertaken by chief executive Mark Schneider to slant the business towards “high-growth” categories and divest operations delivering less-positive returns.

Since taking the helm at the world’s largest food company in early 2017, Schneider has sold off the underperforming US confectionery business – to Italy’s Ferrero in January – while undertaking strategic acquisitions that better fit with its refined focus on nutrition, health and wellness brands, including Garden of Life owner Atrium Innovations and US plant-based food firm Sweet Earth.

And he has responded to investor pressure to set specific financial targets, with progress already being made somewhat in achieving them, along with streamlining geographical operations and embarking on a cost-efficiency drive, particularly in Nestlé’s EMENA division.

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Schneider’s veiled response

Fast-forward to this week, when discussing Nestlé’s half-year financial results with analysts, Schneider spoke at length to underline “how best to advance our plans to increase value for our shareholders and other stakeholders”, purportedly seen as a veiled response to Loeb.

“Our progress is the result of a plan developed with the complete alignment of our board, its leadership and our management team,” Schneider said on a conference call on Thursday (26 July), speaking in the context of Nestlé’s “nutrition, health and wellness” strategy.

“Let me underscore in this context, my strong working relationship with our chairman Paul Brabeck-Letmathe. We are in full agreement regarding the scope and the accelerated pace of the actions we are putting into place and we are unanimous in our commitment to analyse all aspects of our strategy, as well as ensuring that our structure aligns with the strategy, in all cases objectively, and in a fact-based manner.”

“As CEO, I have the full authority to undertake this analysis and implement the right actions to meet our objectives.”

Schneider then proceeded to batten down the hatches. “As CEO, I have the full authority to undertake this analysis and implement the right actions to meet our objectives. We will continue to seek out expert views including from our board of directors. 

“We will continue to look objectively and thoughtfully at how best to advance our plans to increase value for our shareholders and other stakeholders. We have continuously sought feedback from all of our shareholders, and we appreciate your constructive input, your support and your investment.”

The CEO’s comments were interpreted by a number of food industry analysts as a kickback to Loeb, who has also called for Nestlé to divide its business into three divisions – beverages, nutrition and grocery – and add an outsider to the board of directors with expertise in the food and beverage business.

Martin Deboo, a consumer goods analyst at Jefferies International, honed in on another Schneider comment: “The logic and direction of the strategy will evolve at an appropriate speed and will only become visible over time.”

Deboo saw that as “coded messages to Third Point, in our view, that Nestlé will not mortgage long-term top line for the sought-after nearer-term margin fireworks”.  

Organic growth outlook “narrowed”

Nestlé’s shares were up 2% on the Swiss stock exchange around two hours after the conference call concluded on Thursday, despite the revision to the organic growth target, as the owner of brands such as Maggie noodles and Häagen-Dazs ice cream indicated an “improvement” for its forthcoming second-half results over those just reported.

Chief financial officer Francois-Xavier Roger said the “headwinds” Nestlé faced in the first-half from commodities (estimated around 20 basis points, translating to CHF90m) should turn to “tailwinds” through the course of the final six months of the year, bringing an overall positive impact.

That said, Nestlé “narrowed” its outlook for its 2018 organic sales growth to the mid-point of the 2-4% range previously spelled out for 2018, saying organic growth should now come in “around” the 3% mark.

The organic growth number was 2.8% for the first half, in line with Nestlé’s expectations, with a “positive” impact from the offload of the US confectionery business. The real internal growth metric (which strips out pricing effects) was 2.5%.

Alain Oberhuber, a consumer goods analyst at Zurich-based MainFirst Schweiz, said the organic growth rate would have been higher had it not been for the truckers’ strike in Brazil.

The dispute over inflated diesel prices in Brazil erupted in May and caused widespread disruption across whole industries as deliveries were suspended and animals slaughtered, with global food manufacturers feeling much of the brunt.

With respect to Nestlé, Oberhuber said: “We assume that the guidance of an FY-18 organic growth rate of around +3% is conservative as: one, the organic growth rate for H1 would have been 3%, stripping out the Brazilian truckers’ strike, which cost around 25 basis points on a group wide-basis. Here, we assume that around 10-15 bps could be recovered in H2; two, the organic growth in H2 could accelerate as pricing will be higher.” 

Ticking the boxes

After taking the helm in 2017, Schneider outlined some key areas which would help Nestlé achieve its 5-6% organic growth target by 2020: investing “selectively” in fast-growing categories and regions; address the under-performers in its portfolio; innovation; efficiencies; ongoing active portfolio management; and embracing digital opportunities.

But he got off to a poor start, with Sanford Bernstein analyst Andrew Wood describing last year’s 2.4% print as the “lowest this century”.

However, the CEO appears to be making progress in ticking off the boxes, most notably with the disposal of the US confectionery business and the acquisitions already mentioned. 

There have been a host of announcements recently, with a flurry in May, suggesting plans had already been in motion are coming to fruition, which perhaps bodes well for future earnings.

Nestlé said it introduced organic products to the Spanish market for the first time, building on a similar launch in Brazil, revealed a reorganisation of its operations in sub-Saharan Africa, and opened a powdered-milk facility in Cameroon. More business disposals have featured too, such as the sale of some of its confectionery brands in New Zealand and the divestiture of the Serbian chocolate brand Cipiripi.

And while another notable deal falls outside the food space, it could prove to be a significant one, with a marketing agreement with global coffee chain Starbucks, again inked in May.

But it will take time for all these developments to bear fruit and filter through to earnings, with Nestlé noting “acquisitions and divestments netted to zero” in the first half.

“Solid progress”

As with any large corporation, adapting and responding to an evolving business landscape is a key component to drive a successful enterprise forward for the longer-term benefit to shareholders.

And Nestlé appears to be making inroads in an effort to boost efficiencies but, in the short term, such initiatives come at a cost. 

In that respect, the food and drinks giant recently consolidated its research and development footprint in Europe from three sites into one, and is making efforts to optimise operations in marketing, supply chain, management and capacity utilisation. None of these measures will lead to any job losses or plant closures, Nestlé has stressed.

But the company incurred restructuring costs of CHF700m in the first half, albeit within its expectations. In 2017, restructuring and related costs rose by CHF900m to CHF1.5bn, resulting in a 60 basis-point decrease in a key metric – the trading operating profit margin – to 14.7%. That margin was hit again from restructuring costs in the latest numbers, falling 50 basis points to 14.6%.

On a more positive note, however, there was an improvement in the closely-watched underlying trading operating profit margin introduced by Schneider in response to pressure from activist investor Loeb. It climbed 20 basis points to 16.1%, supported by what Nestlé described as “operational efficiencies and ongoing restructuring initiatives, offset by higher commodity and packaging costs”.

And Schneider opined, “our margin development is fully consistent with our 2020 target”, which currently rests at 17.5% to 18.5%. “We have committed to specific higher margin targets and are already delivering margin improvements without sacrificing growth.”

MainFirst’s Oberhuber said: “We think that Nestlé could increase margins by +80bps in H2 due to: one, in H2 efficiency programmes will kick-in; two, price increases taken in Q2 will have a positive effect on margins; three, Nestlé faced around -20bps headwinds from higher input costs in H1. This will reverse to a +20bps positive effect in H2.”
 
From Schneider’s standpoint, he concluded “solid progress” has been made in terms of organic sales growth.

In his earnings release statement, the CEO said: “We are creating value by pursuing growth and profitability in a balanced manner. Our first-half results confirmed that our strategic initiatives and rigorous execution are clearly paying off. As we look towards the second half of 2018, we expect further improvement in our organic revenue growth. Margin improvement is expected to accelerate with further benefits from our efficiency programmes and more favourable commodity pricing.” 

Nevertheless, despite all his positivity, Schneider conceded Nestlé was falling short on one of the key components toward achieving the 2020 organic growth target – e-commerce. Still, advances are being made, he said, adding he was “very encouraged by the progress”.

At the end of the day, with a significant portion of Schneider’s conference earnings comments seemingly aimed at appeasing Loeb, it remains to be seen how the activist investor swallows the latest results. But no doubt he will not remain quiet for long.

To that end, the Nestlé CEO perhaps sought to head-off or even placate any further reaction.

“We are pleased but not satisfied; we are far from done. There’s a lot more to come. Our commitment to investing for the future and leading change at Nestle is unwavering.”

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