Dean Best sets out the things you need to know from Nestlé’s first-half financial results and the views of the food giant on areas including innovation and pricing.

Margin surprise within Nestlé H1

Nestlé reported a set of half-year results that drew a positive response from the market on Friday (26 July).

The KitKat and Maggi owner posted a 3.5% increase in reported sales to CHF45.5bn (US$45.83bn). Trading operating profit – an adjustment of operating profit that excludes income and expenses incurred at a group level, such as for M&A – stood at CHF7.06bn, compared to CHF6.39bn in the first half of 2018.

First-half net profit was lower, falling from CHF5.83bn in the first six months of last year to CHF4.97bn this. A year ago, Nestlé’s net profit benefited from the sale of its US confectionery assets to Ferrero.

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However, in the second quarter of 2019, the world’s largest food maker saw its quarterly organic sales rise by the fastest rate for three years, helping it meet analyst expectations for the first half of the year as a whole. Greater-than-expected increases in underlying first-half operating profit margins and earnings per share also contributed to Nestlé’s share price closing the day up on Friday.

“Many of our initiatives are getting traction, and it clearly shows in our top and bottom lines. Most of all, the balanced pursuit of organic growth on the one hand and operating efficiency on the other is clearly paying off,” CEO Mark Schneider said.

The numbers attracted praise from analysts covering Nestlé. At Sanford Bernstein, Andrew Wood said the figures represented “overall … a positive reporting” and described the growth in Nestlé’s underlying trading profit margins as “the biggest surprise, almost shock” of the results. “We already thought our expectation of plus 70 basis points was aggressive, but 100 basis-point growth was outstanding, albeit helped by M&A impacts of 20 basis points. Looking back in time, we see that H1 2010 saw similar growth, so it is not totally unprecedented, but this sort of margin growth is not what many expect to see from Nestlé.”

The 100 basis-point rise took Nestlé’s underlying trading profit margin to 17.1% in the second quarter. Back in the autumn of 2017, the Swiss food giant set a target for its underlying trading operating profit margin to be between 17.5% and 18.5% by 2020 (up from 16% in 2016), which, at the time, was not exactly what was expected or demanded by some in the investment community – but the progress made so far was noted on Friday.

Why Asia bucked the trend – and not in a good way

Geographically, Nestlé’s developed markets, on an organic basis, saw sales rise by 2.4%, the fastest rate the group had seen for seven years, CFO François-Xavier Roger said.

Schneider said Nestlé’s business in the US – the company’s largest market – had performed “particularly well”, with growth on an organic basis and also by the group’s “real internal growth” metric, which strips out pricing, rising. Pet care and beverages stood out but Nestlé even reported growth from its US frozen-food and ice-cream units, businesses being closely watched by some analysts.

In Nestlé’s combined Europe, Middle East and Africa (EMENA) division, sales (on that “real internal growth” basis) “accelerated notably”, Roger said, pointing to the company’s pet-care and infant-nutrition businesses. Confectionery “improved”, with “double-digit” growth from KitKat, while the smaller vegetarian business also saw double-digit sales, this time in western Europe.

It was Nestlé’s third main geographic division – Asia, Oceania and Africa – that didn’t see sales growth accelerate from the first quarter, with its performance weighed down by issues in Pakistan (dairy deflation) and China, a market MainFirst’s Alain Oberhuber says accounts for just short of 7% of the group’s sales.

Nestlé points to “softness” in China food sector

Reflecting on China, Nestlé finance chief Roger described a mixed performance and muted trading conditions. Nestlé’s organic sales in China “slowed to low single-digit growth”, he said.

“China saw softer growth in some categories, but reported good growth in culinary and ice cream. This is consistent with softer food and beverage category growth, which reached the lowest level in a decade according to Nielsen and Kantar,” Roger explained.

It was the performance in China that prompted questions from analysts on a call to discuss Nestlé’s results. Asked to provide more detail on why the market in China was soft, CEO Schneider said: “The consumer goods area has been very muted in the first half. I think that’s a picture that’s not just reflected here by our performance but also some other companies’,” he said. “We see that in particular in the mainstream areas.”

Schneider pointed to two of Nestlé’s businesses in China – Hsu Fu Chi and Yinlu. He said Hsu Fu Chi, the confectionery company Nestlé acquired in 2011, had, like other businesses, suffered from a “disappointing” Chinese New Year selling season.

“Clearly, the troubles here go back also to the Chinese New Year season / beginning of the year that, I think, broad-based in the industry has been a bit of a disappointment. This is, of course, where confectionery and some of the Hsu Fu Chi articles in particular are hit. We’re working very hard when it comes to offering new product varieties, and so overall, I think there’s a lot of work underway to improve the situation.”

Roger, meanwhile, admitted “there was a bit of a slowdown maybe in China” for Nestlé’s infant-formula business.

On China, overall, the Nestlé chief added: “We’re working very hard to improve and as always, long term, we’re quite bullish on this key market.”

Nestlé’s comments on trading conditions in China will no doubt interest many in the food sector. That said, Yinlu, the food and beverage business in which Nestlé first invested in 2011, has proven a headache for the company a number of times in recent years. “It looks likely that the Yinlu challenges are not solved yet,” MainFirst’s Oberhuber reflected on Friday.

Pricing and premiumisation

One “negative” from Nestlé’s results MainFirst’s Oberhuber called out on Friday was on the pricing the company managed to achieve, with prices overall rising 0.9% in the second quarter versus 1.2% in the first three months of the year.

Prices rose 1.4% in the Americas (Nestlé saw, for example, prices rise in the US) and inched up 0.6% in the AOA division, held back by conditions in China.

However, prices again fell for Nestlé’s EMENA business due, again, to deflationary trends in western Europe.

Overall, the growth in pricing Nestlé managed to achieve was, of course, a factor in that margin growth that so surprised some analysts.

Nevertheless, the muted overall growth again proved a talking point on the call with analysts. Asked by Kepler Cheuvreux’s Jon Cox if pricing is “going backwards again”, Schneider said in the second quarter Nestlé was lapping “some of the significant pricing that was taken last year”, especially on its waters business.

He added: “On pricing, we stay as focused as ever because I think this is a key lever that we need to watch very carefully. We have a lot of initiatives underway when it comes to improving revenue management. But when it comes to the underlying substance, where it’s important for us for our high-quality good products that we get paid properly, this is something that we remain very, very much focused on.”

Amid the pressure on prices in Europe, Nestlé has sought to improve its efforts on “premiumisation” – that is, develop and launch products it hopes consumers will pay more for, as outlined in just-food’s recent interview with the head of the company’s EMENA division. And the call on Friday was littered with references by Nestlé to its efforts to launch and market “premium” products in categories like pet care, coffee, waters and infant nutrition.

Throwing down gauntlet on plant-based

Nestlé’s results calls often include the company’s management calling out a particular facet of its business in the executives’ prepared remarks. On Friday, Schneider gave some time to the company’s (relatively) fledgling plant-based businesses.

The company has made a series of moves over the last two or three years to bolster its positions in the growing plant-based market, both organically and via acquisitions. Organic moves have included launching products under its Garden Gourmet brand in Europe (not that all efforts have been successes), while, on the M&A front, Nestlé has bought companies like Terrafertil in South America and Sweet Earth in the US.

Speaking to analysts on Friday, Schneider said there had been “strong investor and media interest” in plant-based food during the second quarter – likely a reference to the IPO of US firm Beyond Meat.

And in comments that could cause furrowed brows at the Californian upstart, he added: “I understand that there’s a lot of media buzz in this space right now, and at times, it is hard to put all the details in the proper context. I just wanted you to know that we have the ambition and the perseverance to be a major player in this area.”

Schneider’s biggest challenge so far

It’s just over three years since Schneider was named Nestlé CEO, succeeding Paul Bulcke (currently the company’s chairman). In a question away from the nuts and bolts of the company’s numbers, Schneider was asked what had been “the biggest surprise” for him since he had taken the helm (a job that also saw him enter the food industry) – and “the biggest challenge”.

“I think the biggest surprise to everyone, whether you’re new to the industry or whether you’re an old hand, for the last three years is the amount of change that has occurred in this industry – and in particular the amount of innovation that has been brought to the market by small and mid-sized focused companies,” Schneider said.

“And the challenge was very clear. We had to rise to this level and basically meet that rate of innovation; hence, the changes we’ve done to our research and development organisation. Also when it comes to launching products faster and learning on the fly and working with versions 2.0, 3.0 to learn as we go as opposed to answering all the questions first and then launching maybe too late, that sort of approach. We are much nimbler now and doing well. And this is where the industry is going, continues to go, and hence, you’ll see more efforts in that regard.”

Like many of its Big Food peers, Nestlé has been working to try to be more agile and get products to market faster, as a senior executive at its US business told us last year and as the company’s global innovation director outlined at a recent event just-food chaired in London.

All the signs point to this “biggest challenge” – that of smaller companies being more able than in years gone by to meet the ever-evolving demands of consumers – continuing.

The rest of 2019

Nestlé tweaked the guidance it is giving to the market for how it sees its organic sales growth and its underlying trading operating margin unfolding in 2019.

What was “continued improvement in organic sales growth and underlying trading operating margin towards our 2020 targets” is now organic sales growth of “around 3.5%” and margins “at or above 17.5%”.

Jefferies analyst Martin Deboo, who described the first-half numbers as “a strong and reassuring result in the round” said the new guidance would have caught the market’s eye. “We expect the conversation this morning to focus on why firmed FY top line guidance of 3.5% is so apparently cautious relative to the H1 result and momentum,” he wrote on Friday. Consensus forecast numbers among analysts are for organic sales growth of 3.7% and margins of 17.6%.

On the call with analysts later on Friday, JPMorgan Chase & Co.’s Celine Pannuti asked if there are “any issues that would worry you as you go into H2 and which weighed on your decision to guide to 3.5% for the second half of the year?”

Schneider pointed to Roger’s commentary for the second six months of the year in which he said Nestlé was set to “face tougher comparables” in the second half and, more specifically, in Q4. The Nestlé finance chief also stressed how the company was lapping last year’s truckers strike in Brazil, while he said businesses the company had put up for review (and therefore could be sold this year) – the Skin Health arm and the Herta charcuterie unit – had contributed 20 basis points of growth. 

Schneider added: “It is important for me that you can always rely on the kind of expectations and outlooks that we’re giving, and hence, that meet or exceed culture is a very important one to me.”